securities anallysis

8/17/2019 Securities Anallysis

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A project report

on

A study on securities analysis

at

Networth Stock Broking Pvt Ltd.

Submitted in partial fulfillment of the

Requirements for the award of the Degree

of

MASTER OF !S"#ESS ADM"#"STRAT"O#

Submitted $

Arun

13BK1E00

!nder the %uidance of

EPA!"#EN" $% B&S'NESS A #'N'S"!A"'$N

S" PE"E!S EN('NEE!'N( )$LLE(E

&Affiliated to 'awaharlal #ehru Technological !ni(ersit$ )$derabad*

)$derabad

+,-. / +,-0


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1)A2TER "

"#TROD!1T"O#


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'N"!$ &)"'$N

The ris34return relationship is a fundamental concept in not onl$ financial anal$sis5 but in e(er$

aspect of life6 "f decisions are to lead to benefit ma7imi8ation5 it is necessar$ that

indi(iduals4institutions consider the combined influence on e7pected &future* return or benefit as

well as on ris34cost6 The requirement that e7pected return4benefit be commensurate with ris34cost

is 3nown as the 9ris34return trade:off9 in finance6

This session discusses the trade:off and5 using con(entional statistical tools5 pro(ides a method

for quantif$ing ris36 Two categories of ris3 borne b$ the firm;s stoc3holders5 business ris3 and

financial ris35 are discussed and demonstrated5 as is the concept of le(erage6 The session also

e7amines ris3 reduction (ia portfolio di(ersification and what requirements need to be met for firms to e7perience the benefits of di(ersification6 The 1apital Asset 2ricing Model &1A2M* is

used to demonstrate the ris34return trade:off b$ relating the required return on the firm;s

in(estments to its beta &or mar3et* ris36

Syste*atic !isk

S$stematic Ris35 as the name suggests is the ris3 inherent in the economic s$stem6 Macro factors

such as domestic as well as international policies5 emplo$ment rate5 the rate and momentum of

inflation and general le(el of consumer confidence etc6 are what constitute s$stematic ris36

%enerall$5 in(estors cannot hedge or di(ersif$ against this ris3 as it affects all 3inds of asset

classes and affects the entire econom$ as such6

&nsyste*atic !isk

This is the ris3 inherent in a particular asset class6 The best wa$ to combat this ris3 is b$

di(ersification6 )owe(er5 one must remember that the di(ersification must be in the class of asset

and not the asset itself6 An e7ample of the abo(e is e(enl$ distributing $our portfolio in ban3

deposits5 Reser(e an3 of "ndia &R "* bonds5 real estate and equities6 That wa$ if a certain

uns$stematic ris3 affects let;s sa$ the real estate mar3et &sa$ the prices crashes*5 then the

presence of other classes of assets in $our portfolio sa(es $ou from a total washout6 )owe(er5

note that di(ersif$ing within the same asset class &bu$ing different equit$ shares* is not strictl$

combating uns$stematic ris36


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THEORETICAL BASE TO THE STUDY

'N"!$ &)"'$N

The ris34return relationship is a fundamental concept in not onl$ financial anal$sis5 but in e(er$

aspect of life6 "f decisions are to lead to benefit ma7imi8ation5 it is necessar$ that

indi(iduals4institutions consider the combined influence on e7pected &future* return or benefit as

well as on ris34cost6 The requirement that e7pected return4benefit be commensurate with ris34cost

is 3nown as the 9ris34return trade:off9 in finance6

This session discusses the trade:off and5 using con(entional statistical tools5 pro(ides a method

for quantif$ing ris36 Two categories of ris3 borne b$ the firm;s stoc3holders5 business ris3 andfinancial ris35 are discussed and demonstrated5 as is the concept of le(erage6 The session also

e7amines ris3 reduction (ia portfolio di(ersification and what requirements need to be met for

firms to e7perience the benefits of di(ersification6 The 1apital Asset 2ricing Model &1A2M* is

used to demonstrate the ris34return trade:off b$ relating the required return on the firm;s

in(estments to its beta &or mar3et* ris36

"mportant


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classes and affects the entire econom$ as such6

&nsyste*atic !isk

This is the ris3 inherent in a particular asset class6 The best wa$ to combat this ris3 is b$

di(ersification6 )owe(er5 one must remember that the di(ersification must be in the class of asset

and not the asset itself6 An e7ample of the abo(e is e(enl$ distributing $our portfolio in ban3

deposits5 Reser(e an3 of "ndia &R "* bonds5 real estate and equities6 That wa$ if a certain

uns$stematic ris3 affects let;s sa$ the real estate mar3et &sa$ the prices crashes*5 then the

presence of other classes of assets in $our portfolio sa(es $ou from a total washout6 )owe(er5

note that di(ersif$ing within the same asset class &bu$ing different equit$ shares* is not strictl$

combating uns$stematic ris36

&nderstanding &nsyste*atic !isk

The one thing that almost all in(estors would agree upon is the fact that equit$ is definitel$ more

ris3$ than debt6 "rrational e7uberance with a rising mar3et has left man$ an in(estor losing their

shirts and in some cases e(en more sensiti(e garments6

)owe(er5 does this mean that in(esting in debt instruments is entirel$ ris3:free@ !nfortunatel$5

the answer is in the negati(e though the (olatilit$ is much less6 So first5 let us e7amine what 3ind

of ris3s do debt instruments pose

'nterest !ate !isk

"nterest rates and prices of fi7ed income instruments share an in(erse relationship6 "n other

words5 when the o(erall interest rates in the econom$ rise5 the prices of fi7ed income earning

instruments fall and (ice (ersa6 "nterest rates in the econom$ ma$ fluctuate due to se(eral factors

such as a change in the R ";s monetar$ polic$5 1ash Reser(e Ratio &1RR* requirements5 fore7

reser(es5 the le(el of the fiscal deficit and the consequent inflation outloo3 etc6 E7traneous

factors such as energ$ price fluctuations5 commodit$ demand and suppl$ and e(en capital flows

ma$ result in rates fluctuating6

Then there are the e(ent:based factors that affect interest rates6 For e7ample5 the --4 episode inthe !nited States of America and -.4-+ in "ndia6 "f there is a war5 interest rates will rise6

)owe(er5 t$picall$ such e(ents are temporar$ in nature and in fact a good fund manager can

actuall$ ta3e ad(antage of such hiccups6

To illustrate how fluctuations in interest rates affect the returns5 let us ta3e the e7ample of mutual

funds &MFs*6 Adjusting the portfolio to the mar3et rate of returns is called ;mar3ing to mar3et;6


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>e assume that the current #et Asset =alue A=* of the MF is Rs6 -, and its corpus is Rs6 -,,,

crores6 This means that if the fund sells all the assets of the scheme and distributes the mone$ on

equitable basis to all the unit holders5 the$ will recei(e Rs6 -, per unit6 #ow suppose5 the interest

rate falls from -,B to B6 "mmediatel$5 thereafter $ou wish to in(est Rs6 - la3h in the scheme6

Realise that the entire corpus of the fund stands in(ested at an a(erage return of -,B6 "f the fund

sells the units to $ou at it;s current #A= of Rs6 -,5 $ou will be allotted -,5,,, units6 This will

benefit $ou immensel$6 Cou will be a partner in sharing the benefit of the higher returns of -,B5

though the fund will be forced to in(est $our Rs6 - la3h at the lower rate of B6

This is injustice to the e7isting in(estors6 Therefore5 something has got to be done to protect their

interest6 )ere comes the ;mar3 to mar3et; concept6 The fund raises its #A=

to Rs6 --6--6 Cou will be allotted onl$ 5,,, units and not -,5,,,6 The returns on 5,,, units at

-,B would be identical with the returns on -,5,,, units at B6 "n other words5 the #A= riseswhen the interest falls6

)redit !isk

This is the ris3 of default6 >hat if the compan$ whose fi7ed deposit $ou in(ested in goes

ban3rupt@ There ha(e alread$ been se(eral such cases6 Deposits with plantation companies and

time:share resorts are more cases in point6 True5 $ou ha(e legal remed$666but e(er$one 3nows

how much time our courts ta3e6

The onl$ factor5 which dilutes this ris3 somewhat5 is the credit rating6 Fi7ed income earninginstruments get rated for (ar$ing degrees of safet$6 "n(esting in a highl$ rated instrument is safe

but not sufficient6 Firstl$5 the instrument ma$ be down graded $ou ha(e to be on the loo3out for

the same6 Then there ha(e been cases where the issuer has got rated b$ different agencies but

chooses to indicate onl$ the higher ones6

Eli*ination o+ !isks

There is some good news though6 1redit ris3 can be simpl$ eliminated b$ in(esting in so(ereign

securities ::securities issued b$ the go(ernment6 There is simpl$ no ris3 of default6 Or so we

hope5 for retail in(estors5 MFs offer gilt schemes5 where almost the entire corpus is in(ested in

so(ereign securities thereb$ achie(ing the same result6

"nterest rate ris3 discussed earlier is alwa$s pre(alent6 )owe(er5 it comes into pla$ onl$ when a

transaction is underta3en during the pendanc$ of the fi7ed income instrument6 Ergo5 it follows

that if the in(estment is held till maturit$5 there would be no interest rate ris36"n(estments such as


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2ublic 2ro(dent Fund &22F*5 Relief onds etc6 are normall$ held till maturit$6 These are

e7amples where both the ris3s inherent in debt instruments are at a bare minimum

(overn*ent Action !isk This is a unique 3ind of ris35 which has reared its ugl$ head in recent times6 "n the pre(ious

paragraph5 it is mentioned that the interest rate ris3 is eliminated b$ simpl$ holding the

instrument till maturit$6

)owe(er5 such principles of in(estment had not contended with unilateral go(ernmental action6

For e7ample5 the rates of 22F o(er the past three $ears ha(e been consistentl$ reduced b$ the

authorities from -+B p6a6 to B p6a6 To add insult to injur$ these rates are applicable on the

entire corpus and not on additional in(estment6 Relief onds ha(e come down to B6 Rates on

other small sa(ing instruments ha(e also been slashed across the board6 !nfortunatel$5 there is

no escape from this ris3 ::: that of our go(ernment

#easuring !isk

So far5 we ha(e acquainted oursel(es with the 3inds of ris3s inherent in in(estment instruments6

)owe(er5 merel$ 3nowing this much ma$ not be enough to ta3e an informed decision6 The

article began with the premise that return is

BENE%'"S "$ S,A!E,$L E!S

>h$ should $ou purchase shares of a compan$@ >hat are benefits that accrue to $ou as a

shareholder@ Apart from the right to (ote and decide the future course of action that a compan$

ta3es5 the real benefit that $ou5 as a shareholder ha(e is in form of participation that $ou get in

profit made b$ the compan$6 At the same time5 $our liabilit$ is limited onl$ to the face (alue of

the shares held b$ $ou6 The benefits distributed b$ the compan$ to its shareholders can be -*

Monetar$ enefits and +* #on Monetar$ enefits6

1. #onetary Bene+its -


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A6 ividend- An equit$ shareholder has a right on the profits generated b$ the

compan$6 2rofits are distributed in part or in full in the form of di(idends6

Di(idend is an earning on the in(estment made in shares5 just

li3e interest in case of bonds or debentures6 A compan$ can issue di(idend in two

forms a* "nterim Di(idend and b* Final Di(idend6 >hile final di(idend is

distributed onl$ after closing of financial $ear companies at times declare an

interim di(idend during a financial $ear6 )ence if G


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shareholder of G


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industries where growth has retarded incur losses or declining gains6 "ndustr$ specific

go(ernment regulations too impact returns from in(estments made therein6

c6 #anage*ent !isk The management is the face of an enterprise6 "t is the team which

gi(es direction to the future course of action that a compan$ will ta3e6 Iualit$ of

management is hence paramount6 Management changes often ha(e a serious impact on

polic$ matters of companies5 thereb$ impacting the share price6 A management which is

unable to meet the challenges posed b$ competition is li3el$ to suffer in performance6

d6 Business !isk usiness ris3 is a function of the operating conditions faced b$ a

compan$ and the (ariabilit$ that these conditions inject into operating income and hence

e7pected di(idends6 usiness ris3 can be classified into two broad categories e7ternal

and internal6 "nternal business ris3 is largel$ associated with the efficienc$ with which a

compan$ conducts its operations within the broader en(ironment imposed upon it6

E7ternal ris3 is the result of operating conditions imposed upon the compan$ b$

circumstances be$ond its control6

e6 %inancial !isk Financial ris3 is associated with the wa$ in which a compan$ finances

its acti(ities6 A compan$5 borrowing mone$ for business5 creates fi7ed pa$ment

obligations in form of interest that must be sustained6 e$ond a specified limit5 the

residual income left for shareholders gets reduced5 thereb$ affecting the returns on shares6

More importantl$5 it increases default ris35 i6e5 a hea(il$ le(eraged compan$5 is at agreater ris3 of not being able to meet its liabilities and hence going ban3rupt6

f6 E2change !ate !isk 1ompanies toda$ earn si8eable re(enues from outside their

parent countr$6 )ence5 an$ appreciation in the currenc$5 as was recentl$ witnessed with

technolog$ companies5 ad(ersel$ affects earnings5 which results in falling or stagnant

share prices6

g6 'n+lation !isk Rising prices or inflation reduces purchasing power for the common

man resulting in a slowdown in the demand in the econom$6 This has implications for allthe sectors in the econom$6 )ence5 in an inflationar$ en(ironment5 share prices of most

companies face a downturn as the e7pected fall in demand reduces their future e7pected

income6


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h6 'nterest !ate !isk "nterest rate ris3 refers to the uncertaint$ of future mar3et (alues

and si8e of future income5 caused b$ fluctuations in the general le(el of interest rates6

Rising interest rates increase cost of borrowing5 which results in an increase in the prices

of products and a corresponding slowdown in demand6 )ence5 an interest rate hi3e affects

share prices of companies cutting across the board6

,ow to overco*e risks-

Most ris3s associated with in(estments in shares can be reduced b$ using the tool of

di(ersification6 2urchasing shares of different companies and creating a di(ersified portfolio has

pro(en to be one of the most reliable tools of ris3 reduction6

"he rocess o+ iversi+ication -

>hen $ou hold shares in a single compan$5 $ou run the ris3 of a large magnitude6 As $our

portfolio e7pands to include shares of more companies5 the compan$ specific ris3 reduces6 The

benefits of creating a well di(ersified portfolio can be gauged from the fact that as $ou add more

shares to $our portfolio5 the weightage of each compan$Js share gets reduced6 )ence an$ ad(erse

e(ent related to an$ one compan$ would not e7pose $ou to immense ris36 The same logic can be

e7tended to a sector or an industr$6 "n fact5 di(ersif$ing across sectors and industries reaps the

real benefits of di(ersification6 Sector specific ris3s get minimi8ed when shares of other sectorsare added to the portfolio6 This is because a recession or a downtrend is not seen in all sectors

together at the same time6

,owever all risks cannot e reduced -

Though it is possible to reduce ris35 the process of equit$ in(esting itself comes with certain

inherent ris3s5 which cannot be reduced b$ strategies such as di(ersification6 These ris3s are

called s$stematic ris3 as the$ arise from the s$stem5 such as interest rate

ris3 and inflation ris36 As these ris3s cannot be di(ersified5 theoreticall$5 in(estors are rewardfor ta3ing s$stematic ris3 for equit$ in(estment 6

(etting started-

)a(ing anal$8ed all aspects of ris3 and return associated with equit$ in(estment5 $ou are now

read$ to ta3e the plunge6


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"he case +or long/ter* invest*ent in e uities

The mo(ement during these fifteen $ears shows that it is rewarding to sta$ in(ested in equities

for the long term6 The following factors justif$ this

-6 "ndustries and businesses5 to which companies belong5 mature o(er a period of time6 Asindustries grow5 so do the profits of companies belonging to them6 The best e7ample of

this can be found in the "ndian telecommunications industr$6 )ence5 in(estors start

reaping the benefit of their in(estment o(er a period of time6

+6 >hile mar3ets undergo c$clical phases5 which follow a series of pea3s and troughs5 o(er

a period of time these factors get negated and returns from stoc3s present a (alid picture6

So5 although $ou ma$ incur some losses in the short term5 if $ou are loo3ing to in(est in

equities $ou must alwa$s thin3 long:term6

.6 Equities are the onl$ in(estment asset5 which are e7empt from long:term capital gains

ta75 which means that $ou own all the returns generated6 All other in(estments5 e7cluding

22F and life insurance5 are ta7ed for the gains made6 This reduces the o(erall return in

in(estment assets li3e #S15 ban3 deposits etc6

H6 An in(estor can ill:afford to ignore that "ndia is a fast growing econom$ and it is widel$

percei(ed that this robust growth would continue for man$ more $ears to come6 The

biggest beneficiar$ of this growth stor$ would be the industries and ser(ice sector6 "t is

almost certain that the "nde7 of "ndustrial 2roduction &""2* would grow at a rate of o(er -, per cent in the ne7t few $ears6 This would enhance profit growth of companies and it

would get reflected in the upward mo(ement of their share price6

"he !isk !eturn "rade/o++ in %inancial Analysis

"t is widel$ accepted that the major determinant of the required return on the asset &or the rate to

be applied to a stream of receipts to capitali8e its (alue* is its degree of ris36 Ris3 refers to the

probabilit$ that the return and therefore the (alue of an asset or securit$ ma$ ha(e alternati(e

outcomes6 Ris3 is the uncertaint$ &toda$* surrounding the e(entual outcome of an e(ent which

will occur in the future6


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E7ample when tossing a coin5 some one is not sure e7actl$ what will be the outcome6 The

outcome ma$ be to ha(e a Tail or the )ead5 so there is a concept of ris36 "n a football match5

three outcomes can be e7perienced win5 lose or draw6 "n business5 the same can happen

regarding the e7pected return on the in(estments in (arious sectors6

"n Financial Anal$sis5 the ris34return trade:off states that financial decisions that subject

stoc3holders to more ris3 must offer a higher e7pected return6 ris3 a (ersion is the tendenc$ to tr$

to a(oid ris3$ situations unless adequate compensation is offered6

E7ample The ris3 a(erse indi(idual faced with two e(ents each ha(ing the same e7pected

outcome will choose t he outcome with the lower le(el of ris36

)ategories o+ !isk and Leverage %aced y the %ir* and y

Stockholders

• This t$pe of ris3 is magnified b$ the degree to which the firm relies on fi7ed operating

e7penses in producing sales6

• "n man$ cases there is not much the firm can do about this t$pe of ris3 some industries

ha(e more (olatile sales and higher fi7ed operating e7pense than others6

Operating le(erage results when the firm has fi7ed operating e7penses in its cost structure6

• These e7penses do not disappear when sales drop5 nor do the$ increase when sales

increase6

• Operating le(erage tends to magnif$ an$ change in sales on Earnings efore "nterest and

Ta7es &E "T*6

• Stoc3holders are the ultimate bearers of the ris3 that results from le(erage and the$ are

the residual recipients of higher E "T should sales increase6

B- %inancial risk

This t$pe of ris3 arises primaril$ because of the fi7ed interest pa$ments firms must ma3e to their

long:term creditors &debt capital*6


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• This t$pe of ris3 is reflected in (olatile #et "ncome and Earnings 2er Share6

%inancial leverage

Results when the firm finances some portion of its assets with borrowed funds

• Financial le(erage means that changes in E "T will magnif$ changes in net income and

Earnings 2er Share• As a firm increases its degree of financial le(erage5 its e7pected return &net income and

Earnings 2er Share* increases as does its ris3• The financial manager has some discretion in determining the e7tent of financial

le(erage6

!'SK '4E!'S'%')A"'$N

Di(ersification occurs when different assets ma3e up a portfolio6

The benefit of di(ersification is ris3 reduction the e7tent of this benefit depends upon how the

returns of (arious assets beha(e o(er time6

The mar3et rewards di(ersification6 >e can lower ris3 without sacrificing e7pected return5 and4or

we can increase e7pected return without ha(ing to assume more ris36

Di(ersif$ing among different 3inds of assets is called asset allocation6 E6g6 A telephone operator

with man$ ph$sical assets such as houses can di(ersif$ b$ acquiring financial assets which in

turn earns return to the compan$6 1ompared to di(ersification within the different asset classes5

the benefits recei(ed are far greater through effecti(e asset allocation e6g6 di(ersif$ing among

different t$pes of financial assets6

E7ample of di(ersification in Telecom industr$ is when a licensed mobile operator who pro(ides

fi7ed line telephones ser(ices also operates the communit$ based telecenters5 teleshops5 card

phones5 etc6

Other wa$s to reduce ris3 include the use of the following strategies


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• Mass ad(ertising to reduce erratic sales and hence to increased profit

• Entering into long:term sales or purchase contracts

• Recapitali8ing toward more equit$ and less debt so as to reduce the burden of fi7ed

financial e7penses

• The use of temporar$ labor instead of permanent emplo$ees

!'SK 'N A P$!"%$L'$

A portfolio is a collection of ris3$ assets6 "f we (iew indi(idual assets as one big asset we ha(e a

portfolio6 ecause of ris3 reduction5 the nature of ris3 is fundamentall$ different when an asset is

(iewed as part of a portfolio instead of being (iewed in isolation6

This equation gi(es the theoreticall$ correct required rate of return on a project based upon its

s$stematic &or beta* ris36

The formula is applicable onl$ in situations where all di(ersifiable ris3 has been eliminated6

The ris3:free rate &RFR* is a base rate reflecting the fact that the project should at a minimum

offer a return equal to what could be earned in the Treasur$ bill mar3et6 E(en ris3 less

in(estments has a positi(e required rate of return6

The mar3et ris3 premium5 &3m : RFR*5 indicates the premium in(estors require o(er the ris3:free

rate to in(est in the general mar3et inde76

The required return on a project is positi(el$ related to the project;s beta6

A (er$ ris3$ project &sa$ a new e7pansion (enture* will ha(e a high beta coefficient5 whereas low

ris3 projects &such as a replacement machine* will ha(e a lower beta6

Knowing a project;s beta &and thus its minimum required return* is important for good financial

management5 because it indicates whether or not the e7pected rate of return is abo(e5 equal to5 or

below the required rate of return and whether or not stoc3holders are being properl$

compensated for the non:di(ersifiable ris3 the$ bear due to the project6


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!esearch ga"n(estment decisions are influenced b$ (arious moti(es6 Some people in(est in a business to

acquire control and enjo$ the prestige associated with it6 Some people in(est in e7pensi(e $achts

and famous (illas to displa$ their wealth6 Most in(estors howe(er are largel$ guided b$ the

pecuniar$ moti(e of earning a return on their in(estment6

Return is the primar$ moti(ating force that dri(es in(estment6 "t represents the reward for

underta3ing in(estment6 Since the game of in(esting is about returns &after allowing for ris3*5

measurement of reali8ed &historical* returns is necessar$ to access how well the in(estment

manager has done6 "n addition5 historical returns are often used as an important input in

estimating future &prospecti(e* returns6


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$B5E)"'4ES-6 To calculate the ris3 and return of a particular stoc3 to estimate weather the compan$ is

reliable for the in(estor to in(est in the shares of the compan$6

+6 To anal$8e the (arious ris3s and returns patterns in shares6.6 To 3now the ris3 in(ol(ed with in(ests in equities6

H6 To anal$8e which is the best performance

06 To stud$ the in(estors reference in in(esting in Stoc3s6


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,y othesis

,y othesis 1

The null h$pothesis of the stud$ assumes5

), There is no significant impact of securit$ anal$sis while in(estor in(esting in a securit$5)- There is a significant impact of securit$ anal$sis while in(estor in(esting in a securit$56

,y othesis 6

), The in(estment performance of securities are not done b$ the hedging5

)- The in(estment performance of securities are done b$ the hedging

,y othesis 3

), The ris3 and return of the securities are not considered while in(estors ma3ing decisions on

their in(estment securit$5

)- The ris3 and return of the securities are considered while in(estors ma3ing decisions on their

in(estment

,y othesis 7

), The ris3 and return of the securities will not ha(e major impact on the securities

)- The ris3 and return of the securities will ha(e major impact on the securities6

,y othesis 8

), The sample securities ma$ not influence the whole industr$5

)- The sample securities will influence the whole industr$


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Sco e o+ the study

The scope of the stud$ is confined to onl$ fi(e securities that are harath 2etroleum ltd5 2


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!EASEA!), #E",$ $L$(9

!esearch esign

The present stud$ is based on Secondar$ data6 The (arious source of secondar$ data include

• "nternet

• Share prices of different SE Sense7 companies6

• "nformation pro(ide b$ networth stoc3 bro3ing

• Maga8ines

securities anallysis

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