1. Equity Investments HimanshuShah 9970836701 shahhr21@gmail.com

3. Overview of Markets

4. Security market indices

5. Efficient Capital Markets

6. Market Efficiency and Anomalies

7. Security Valuation

8. Industry, Company and Stock Analysis

11. Sale of new issues of securities

12. Initial Public offerings (IPOs)/Seasoned Issues

14. Where securities trade after their initial offerings

15. Provide liquidity to the investors

18. Trade in exchange listed securities on an OTC basis(save commission)

19. 4th market:

21. Stock is only traded at specific times

24. Trade occur at any time till the market is open

25. The price is set either by auction process (Order Driven) or by dealer bid-ask quotes(Quote Driven)

29. Floor Brokers – Work as a broker for other commission broker

31. Best possible price when the order reaches the trading floor

32. Executes the transaction at current price

33. Limit order:

34. Execute order at price limit or better

35. Buy: price < = limit and Sell: price > = limit

36. May have time limits- Day, Week, GTC (Good till Cancelled)

37. Stop order:

38. Becomes a market order when the stop price is reached

39. Used to limit the losses. Specially used with Short Sales Oreder

40. Short sales:

41. Sale of borrowed shares; requires margin to insure adverse movement in prices;

42. Borrower needs to pay the dividends to the owner during the short period;

44. It is the minimum amount investor should provide as equity at inception

45. Current requirement – 50%Types Of Margin

47. It is the minimum equity amount investor is required to maintain for his open trade.

48. Current requirement – 25%

49. Margin balance falls below margin requirement, investor receives margin call, either he has to liquidate the position or bring the margin amount to minimum requirement. Trigger Price for margin call = Initial Price 1 – Initial Margin 1 – maintenance Margin Formula

51. Functions include:Enable indexed portfolio creation Works as a Benchmark for investment managers Proxy for market portfolio to measure beta and systematic risk Facilitate comparisons across international markets Aiding market technicians for investment decisions

53. How it is weighted?

55. Market Value Weighted Index

56. Un weighted Index

58. Market Return can be matched by purchasing equal no of shares of each stock

59. Biased by higher priced securities

60. Special adjustment of denominator in case of stock splits to hold average constant

61. Since most portfolios do not have equal number of shares this is not a good benchmark of portfolio evaluation

63. Index(1) = index(0) x [market cap(1)/ market cap(0)] and market cap = sum of (Price x No. of shares)

64. Stocks with highest market cap can bias index

65. Calculated on free floating shares.

66. Market Return can be matched by proportionate market value investments

67. Good benchmark since institutional investors invest more into higher market cap stocks

69. Here, all attention is given to returns of each stock

70. Index may be calculated on arithmetic or geometric basis.

73. Difficult in creation of bond index rather than stock index-

74. Much broader bond universe than stocks

76. Bond Indexes fall into three categories:

77. Investment Grade Bond Indexes

78. High yield Bond Indexes

80. Benefits of Diversification If Securities from different countries and different asset classes are combined together, risk reduces to great extent because correlation between securities from two different countries is definitely much lower than 1

82. Many times, arbitrage process, to bring the security to efficient prices through fundamental analysis , is not riskless. Traders do not know that when the gains would be realized. Example : Internet stock bubble

84. Existence of risk as it is difficult to find two securities having same risk with mispricing

85. With limitation of funds, arbitragers can eliminate only significant mispricing

88. Reasons of existence of Anomaly Trading Restrictions Restrictions on some trading strategy make it impossible to exploit any anomaly. Example: restriction on Short selling at the opening of IPO Irrational behavior Limits on arbitragers – Previously discussed (Limited capital, strategy risk, restriction by lenders of the funds etc)

90. Arbitragers have already exploited the opportunity and hence it is not profitable

93. Multiples of firm can be compared with its peers of the industry.

96. Dividend Discount Model These issues are addressed through simplification of the model

99. Infinite Period Constant Dividend discount model: valid for preferred stock Price (preferred stock) = Div(1)/k(p)

101. Company pays dividends and Dividends grow at constant rate (g)

102. Required rate of return is constant

103. Required rate of return is greater than growth in dividends

104. Valid for mature firms which regularly pay hefty dividends

105. As per dividend discount model, Current price = Div1/(1+k) + Div1*(1+g)/(1+k)^2 + …… The equation reduces to – Current Price = Div(1)/[k– g]

106. Growth Rate of the Company Earnings would rise on funds invested back in the business. ROE would be generated on those retained funds. Growth rate is firms’ earnings plough back times its ROE g = Retention Ratio * ROE

107. Constant Growth (Gordon) Model IMPACT ON STOCK PRICE

110. As assumption of Infinite DDM does not hold true here, so Gordon formula cannot be used.

113. Factors affecting Required rate of Return

117. Income Distribution

118. Ethnic composition

119. Trends in geographical composition etc.

120. Lifestyles do affect industries significantly.

121. Consumption patterns are affected by trends and perceptions and discretionary income.2. Lifestyles

123. Technology also affects the consumption pattern and pricing of products

124. Example : Computer replaced type-writers

125. Changes in political climate and government policies can affect industries significantly.

126. Example: Imposition of Import duties help domestic industries and players 4. Policies and Regulation

128. After picking best industries, analyst has to find the best stock. For that, he needs to analyze the fundamentals of the company, its future prospects, its intrinsic value and current price of the stock.

130. Good company with strong fundamentals, high growth prospects may not turn into good investment option as everything is already priced in its current price.

131. So, analyst should always look for good stock which will generate high returns rather than good company.

136. Speculative companies are the companies, equipped with risky assets, having potential to earn enormous returns.

137. Earnings, revenues of these companies are dependent on some uncertain factors. Example : Oil exploration, diamond mining etc

139. Growth stock enjoys high multiples such as PE ratio and trade at high prices compared to its peers

140. Value Stock refers to the company, having strong fundamentals, still enjoys low multiples such as PE ratio, PBV multiple etc.

142. Earnings Multiplier Model and DDM As per Gordon’s Indefinite DDM, Current Price = Div(1)/[r– g] P0 = Div(1)/[r– g] Multiply both sides by forward earnings, P0/E1 = Div(1) * E1 /[r– g] PE Ratio = Div(1) * E1 /[r– g]

143. Relationship

147. Multiples of firm can be compared with its peers of the industry.

149. On the basis of the calculation of the earnings (Denominator ) P/E Ratio can be categorized as –Leading P/E Ratio: Next years expected earnings are taken. Trailing P/E Ratio: Earnings of the most recent 12 months are taken

150. Leading P/E Ratio= Market Price per Share Forecasted EPS for next 12 months Trailing P/E Ratio= Market Price per Share EPS over previous 12 months Advantages P/E Ratio is popular in the investment community. Empirical research shows that P/E differences are significantly related to long term stock returns.

151. Disadvantages Negative earnings can produce useless P/E Ratios. Volatility in the earnings and abnormal income can make interpretation of P/E Ratio difficult. Differences in the Accounting policy can hinder comparison.

152. Price to Book Value Ratio P/B Ratio indicate the cost of investment in relation to the book value of net assets available per share as per the balance sheet. P/B Ratio= Market price per share Book value per share Book Value= Common Share holders equity = Total Assets- Total Liabilities - Preference shares

153. Advantages The book value is generally positive and so can be used even when negative earnings render P/V Ratio useless. Book value is more stable that EPS P/BV Ratio can be used to value companies that are expected to go out of business Empirical evidences show that P/BV Ratio helps to explain differences in long term average returns

154. Disadvantages P/BV does not recognize non physical assets like human capital Difference in Accounting policies for valuation of assets can make comparison difficult Inflation and Technological change can cause the book and the market value of the assets to change radically.

155. Price to Sales Ratio The P/S Ratio indicates the Cost of the investment of investor in relation to the sales per share P/S Ratio= Market value per share Sales per share

156. Advantages As sales are always positive P/S Ratio can be used even in the case of distressed firms Sales are difficult to manipulate unlike earnings are book value P/S ratios are relatives less volatile

157. Disadvantages High growth in sales does not necessarily indicate growth in operation profits Difference in revenue recognition practices can distort the forecasts As only sales are considered, differences in the cost structure across companies are not considered.

158. Price to Cash Flow Ratio The Price to Cash Flow Ratio indicates the cost of investment per unit of cash flow generated. For the purpose of the P/CF Ratio any of the following may be considered as the cash flow- Cash Flow= Net income+ Depreciation+ Ammortisations Adjusted CFO= CFO +Net cash interest outflow net of tax Free Cash Flow available to Equity Share Holders EBITDA

159. P/CF Ratio= Market Price per Share Cash Flow per share Advantages Cash flows are difficult to manipulate Price to cash flow is more stable than price to earning Reliance on Cash Flow rather than earnings addresses the problem of the difference in the quality of the reported earnings

160. Disadvantages The definition of the term Cash Flow are not clear eg: EBITDA, FCFE Some items affecting actual cash flow from operation are ignored when EPS plus non cash transaction approach is used example: change in working capital FCFE can be volatile

161. Questions

162. Thank You