“Analyzing & Evaluating investment opportunities & related factors for a new investor”
An investment is the current commitment of dollars for a period of time in order to derive future payments that will compensate the investor for :
The time the funds are committed
The expected rate of inflation
The uncertainty of the future payments
The investor can be an individual, a government, a pension fund or a corporation. Investors trade with the intention to earn some future rate of return out of his investment which will provide a future stream of payments that will be greater than the current outlay.
There are two major factors that drive the motive of investors. These are:
Required rate of return
Risk associated with the investment
Any investor must analyze properly these two factors before investing in any sector.
There are financial markets where all the investments take place. These markets offer different investment instruments for the investors.
There are several types of markets for investment:
· Primary market
· Secondary Market
· Third Market
· Fourth Market
· Over the counter market
These markets are familiar for any kinds of investment related trading. These are the core places for any investment to take place.
Types Of Investment Instruments
There are basically two types of investment instruments. These are:
Money market instruments
Capital market instruments
Among all these instruments followings are most popular
Shares represents small portion of ownership of an entity. Stocks or shares are the core instruments offered by a company to raise capital. Each share has a par value & a face value which is comparable with it’s market value. The difference in value indicates the position of a share in the stock market.
Investors invest in shares in order to get some future benefit which is termed as dividend.
Besides bonus shares are also lucrative offers of a share issue.
Bonds are long term debt instruments representing a contractual obligation on the part of the issuer to pay interest and repay principal.
On the other side, debentures are unsecured bonds backed by the general credit of a company.
The popular name for open end investment companies which continually stand ready to sell new shares to public and to redeem their own outstanding shares on demand at a price equal to an appropriate share of the value of their portfolio which is computed daily at the close of the market.
These are usually investment companies i.e. financial intermediaries that sell shares to the public and invests the proceeds in a diversified portfolio of securities.
Each share sold represents a proportionate interest in the portfolio of securities managed by the investment company on behalf of the company’s shareholders.
Choosing Investment Instrument
For investing among shares, bonds and mutual funds, I would suggest for mutual funds for investing for the first time.
The favorable reasons behind choosing the option are stated below:
Portfolio of shares
As mutual funds consists of portfolio of shares, there is diversion of risk observed.
The risks are analyzed properly in order to make a diversified portfolio. It tries to minimize the unsystematic risks for the investors.
There is flexibility to sell & redeem the shares at investors option.
Net Asset Value
The share price of mutual funds are based on net asset value per share.
The share prices are quoted on a bid-offer basis which is a good practice.
The investors can sell their share any time with a small fee to the company. This is known as back-end load funds
For the privilege of the investors, there are two types of securities: Class A & Class B. Class A is for short time holding of investments & Class B is for long term investments.
Thus, a mutual fund can be a good choice for investors who are investing for the first time.
The selection of a company for making investment decision is a prime factor for the investors.
Followings are some basic factors that works behind company selection:
The CAMEL rating of a company is a good indicator to rate a company. The CAMEL Stands for:
C= Capital Adequacy
A= Asset Quality
M= Management efficiency
E= Earning Profit
L= Liquidity position
The ratings vary with a range from 1 to 5 with a mark up through strong to dissatisfactory.
|1 to 1.4||Strong|
|1.5 to 2.4||Satisfactory|
|2.5 to 3.4||Moderate|
|3.5 to 4.4||Low|
|4.5 to 5||Dissatisfactory|
Financial Statement Analysis
The analysis of financial statement is very important issue for the investors. Followings are some important points to be taken care of :
Analysis of Time Series Data
Analysis of Cross Sectional Data
Analysis of Different Ratios
Analysis of Profit & Net Income Trend
Feasibility of investment areas
Analysis of Debt portion
Analysis of Asset-Liability Management & Balance
Net rate of return
Incase of investing in an IPO issue, investors must properly go through the prospectus issued by the company. The major issues include:
Company fact description
Risks & return analysis
For investing in existing company, following issues must be taken care of:
Minimum paid up capital Tk 10 million
The company must be a registered public limited company
Shares to be subscribed by a minimum of 250 no.s of shareholders
Some other related factors are:
Use of Proceeds
Single vs. multi product
Stock Price Index:
To measure the market position of shares, there are several indices in operation. These indices rate the companies according to their performance. These are stock market indicators.
Some popular indices are:
Dow Jones Industrial Average
Standard & Poor’s 500 composite index
DSE & CSE index
Category wise Company Selection:
There are four types of company category which determines the position of a company based upon it’s performance. It also indicates financially sound & strong company.
The categories are:
A category companies
B category companies
Z category companies
G category companies
A category companies:
Companies which are regular in holding the current annual general meetings & have declared dividend at the rate of ten percent or more in the last financial year.
B category companies
Companies which are regular in holding the annual general meeting but have failed to declare dividend at least at the rate of ten percent in the last English calendar year
Z category companies
Companies which failed to hold the current annual general meetings or have failed to declare any dividend or which are not in operation for more than six months or whose accumulated loss after adjustments of revenue reserve, if any, is negative and exceeded its paid up capital
G category companies
Newly listed shares of those companies, which do not fall under any of the categories, shall be placed under G category companies for which the settlement procedure followed for B category companies shall be applicable.
Investors who wish to take risk can invest in B,C or G category shares.
Investors who wish to get stable return can invest in A category companies’ shares.
Required Rate of Return:
The minimum expected return on asset that an investor requires before investing
The chance that the actual return on an investment will be different from the expected return
Any investor must trade-off between the risk & return in order to ensure his future return with a positive cash flow stream.
Determinants of required rate of return
Followings are some determinants of required rate of return:
The real risk free rate
Conditions in the capital market
Investors attitude ( risk averse or risk taker )
Risk Components: Measures & Sources
The basic return for undertaking risk is denoted as “ Risk premium”. Risk premium considers the following things. These are termed as sources of risk:
Exchange Rate Risk
The major measures of risk are:
Variance of rates of return
Standard Deviation of Rates of return
Coefficient of Variation of rates of return
Covariance of returns with the market portfolio
Any investor must take care of these issues when he tends to invest. The investment company or the brokers can help him to assess the position
Relationship Between Risk and Return
The expected relationship between risk and return is a positive relationship. The more the risk the more the return. The relationship shows that investors increase their required rates of return as perceived risk ( uncertainty ) increases. The line that reflects the combination of risk & return available on alternative investments is referred to as the security market line (SML).
The SML reflects the risk-return combinations available for all risky assets in the capital market at a given time. Investors should select investments that are consistent with their risk preferences, some would consider only low-risk investments whereas others welcome high-risk investments.
Fundamental Risk Analysis:
There are two major risks associated with every investment. They are:
The market risk associated with investment which cannot be avoided or ignored.
The risks associated with investments which can be minimized with a portfolio investment option but cannot be eliminated.
Any investor must measure these two risks & also evaluate the risk-return analysis to get the maximum future outflow.
Investor’s Focus Points
Any investor should concern about the following matters:
When to buy
When to sell
What Amount &
How to trade
When to Buy & Sell:
When the market predicts that the prices of shares will go up then it is right time to buy shares so that these can be sold at high prices afterwards.
When the market predicts that the prices of shares will go down then it is right time to sell shares so that afterwards these share price may call for loss.
The investors must identify the total number of shares that he wants to buy or sell. It may be a bulk of shares or may be a small lot depending on investors investment opportunity & also if the brokers advice them to do so.
Investors may invest in following types of categories:
How to Trade
Investors must draw a proper track about how he will make his investments. There are few possible ways regarding this matter:
Margin trading is a way to make investment in stocks or securities through the financial help of the broker. Here only a portion of the investment proceed comes from investors’ own money.
The remaining portion is borrowed from a broker. Followings are some features of margin trading:
Bet on a rise in the price of the security
Higher leverage, magnifying upside & down side risks
Stocks purchased on margin must be maintained with the broker as collateral for the loan
The percentage of stock value that must be maintained with the broker
Minimum amount of equity maintained in the account.
Call from a broker to put up more equity funds when exceeds minimum balance. Margin arrangements differ for different securities.
The broker controls how much equity must be maintained by margin traders. The equation is:
Equity = ( Total value of investment – Amount borrowed ) /Total Value of Investment
Here, High volatility stocks may not be marginable.
Short Sale is a way to make investment in stocks or securities through the borrowing of securities with the help of the broker when a decline in price is estimated. Here only a portion of the securities are supplied by the seller.
The remaining portion of securities are borrowed from a broker.
Followings are some features of short sale:
Bet on a decline in the price of the security
Higher leverage, magnifying upside & down side risks
The proceeds from the short sale must be maintained with the broker as collateral for the loan
Borrow stocks from a broker
Sell it, deposit the proceeds and margin money in an account
Close out the position by buying the securities & returning it to the lender
Short seller must pay any dividend paid during the short sale to the lender of the stock
Investors can make their own investment with full of their money. But there are several risks associated with this kind of investment. Investors must take proper & expertise advice incase of such investments.
A market in which the prices of securities fully reflect all known information quickly and on average accurately. The concept postulates that investors will assimilate all relevant information into prices in making their buy & sell decisions.
When Market is Efficient?
An efficient market exists when the following events occur:
A large number of rational, profit maximizing investors exist who actively participate in the market by analyzing, valuing and trading stocks. These investors are price takers; that is one participant alone cannot affect the price of a security.
Information is costless and widely available to market participants at approximately the same time
Information is generated in a random fashion such that announcements are basically independent of one another
Investors react quickly & fully to the new information, causing stock prices to adjust accordingly.
Forms Of Market Efficiency
Market efficiency can be of different types. Depending on Efficient Market Hypothesis (EMH) and market data analysis market efficiency can be of following forms:
There are evidences related to market sectors which helps to indicate the form of market efficiency.
Market analysis consists of following three major analysis. These are:
The idea that a security has an intrinsic value at any time, which is a function of underlying economic variables.
Fundamental Analysis at the company level involves analyzing basic financial variables in order to estimate the company’s intrinsic value. These variables include:
The tax rate
Sources of financing
Additional Analysis could involve the firm’s the firm’s competitive position and so on. The end result of fundamental analysis at the company level is the data needed to estimate the price of a stock using one of the valuation models.
In fundamental analysis “intrinsic value” is an important consideration. Intrinsic value or estimated value of a stock is its justified price, or the price supported by a company’s fundamental financial variables.
Alternatively, for a short run estimate of intrinsic value the earnings multiplier model could be used . Intrinsic value is the product of the estimated earnings per share(EPS) for the next year and the estimated multiplier or P/E ratio. The equation for finding out the intrinsic value:
Intrinsic Value = Po = Estimated EPS * Justified P/E Ratio
= E1 * Po / E1
If the intrinsic value is larger than the current market price, then the stock is undervalued. Thus investors should buy at this time. If the intrinsic value is less than the current market price, then the stock is overvalued. Thus investors should sell at this time.
The methodology of forecasting fluctuations in the prices of securities whether individual securities or the market as a whole. Technical analysis can be defined as the use of specific market generated data for the analysis of both the aggregate stock market and individual stocks. It is sometimes called market or internal analysis because it utilizes the record of the market itself to attempt to assess the demand for and supply of shares of a stock or the entire market. Thus, technical analysis believe that for market forecasts the market itself is its own best source of data.
Technical analysis assumes that prices are determined by the interaction of demand and supply and reflect the net optimism of market participants. The followings are some key points of technical analysis:
Technical analysis is based on published market data and focuses on internal factors by analyzing movements in the market or a stock. In contrast, fundamental analysis focuses on economic and political factors which are external to the market itself.
The focus of technical analysis is timing. Stock prices tend to move in trends as the stock price adjusts to a new equilibrium level. These trends can be analyzed and changes in trends detected by studying the action of price movements and trading volume across time. The emphasis is on likely price changes.
Technicians tend to concentrate more on the short run. The techniques of technical analysis are designed to detect likely price movements over a relatively short time. Fundamental analysts on the other hand have a substantial interest in the intermediate and longer run.
Technical Analysis—DOW Theory:
This aims at evaluating the primary, secondary & daily movements. It identifies two markets: 1. Bull market 2. Bear Market for investment purpose.
Strategies for Technical Analysis:
For a fair technical analysis followings things must be taken care of:
Out of sample Validity
With the help of above and by applying “Filter rule” strategy, a proper technical analysis can be done.
Investors must make intelligent judgments about the current state of the financial markets & possible changes. A logical starting point in assessing the stock market is to understand the economic factors that affect stock prices. Understanding the current & future state of the economy is the first step in understanding what is happening & what is likely to happen to the market. Because of the market’s impact on investor’s success, investors should seriously consider the market’s likely direction over some future period.
Business Cycle & Stock Market:
Movements in aggregate economic activity such as expansion and contraction can be termed as Business cycle. The relationship between the economy and the stock market is interesting—stock price lead the economy. Historically it is the most sensitive indicator of the business cycle. Therefore, investor must deal with a complex relationship. They are closely related but stock prices tend to consistently turn before the economy.
Composite Indexes of General Economic Activity:
A series of leading, coincident and lagging indicators of economic activity that help to assess the status of the business cycle.
Using Market Measures:
Market measures tell investors how all stocks in general are doing at any time or give them a “feel” for the market. Many investors are encouraged to invest if stocks are moving upward whereas downward trends may encourage some to liquidate their holdings and invest in money market assets or funds.
Some popular market measures are:
Valuing The Market:
While valuing the market following estimates are needed:
The Stream of Benefit
The Required Rate of Return
Overall Market Analysis:
Based on the above analysis, the major points to be highlighted are as below:
If the investor can recognize the bottoming out of the economy before it occurs, a market rise can be predicted , at least based on past experience , before the bottom is hit
As the economy recovers, stock prices may be level off or even decline. Therefore, a second significant movement in the market may be predictable again based on past experience.
Based on the last ten economic slumps, the market P/E usually rises just before the end of the slump. It then remains roughly unchanged over the next year.
The importance of analyzing business cycle turning points as an aid to market timing cannot be overemphasized. Investors would have always increased their returns by switching into cash before the business cycle peaks and into stocks before the cycle reaches its trough. It is particularly important to switch into stocks before business cycle troughs.
Choosing A Broker for Investment:
Choosing a broker before making investment decision is very important. The following matters are important to note regarding this issue:
Intelligence & Efficiency
Experience in Market
Someone who understands investor’s investment philosophy
Reputation in the Market
Costs & Commissions effective
Opening An Account:
Open account with enlisted broker
Apply in proper application form with two copies passport sized photograph
There must be an introducer who also should be a member of that broker
Incase of no introducer, with some other supporting documents one can proceed
There is no maximum or minimum amount to be deposited
Each investor is given a “client code” for trading
Market Condition Analysis Before Investment:
Following market factors need to be considered before making any investment decision; These are:
The monetary value of money should be considered
Analyzing trend & Govt. initiatives
Scenario of Capital Market
Whether the economy is in bullish or bearish form
The political condition & stability is important
The effects of frequent natural calamity is another factor for consideration
The analysis of upward & downward market trend
The Govt. policy may favorably or unfavorably effect the investment decision
The behavior of investors incase of investment decision. the investors may be:
Future Growth Analysis:
Analyzing of future growth is an important factor. The basic focus points are:
The position of liquidity position of any company is important
The EPS & related dividend factors
The inside trading is another important consideration
Analysis of country risk, exchange risk & financial risk are also need to be taken care of.
Recommendations for the Future Investors:
Followings are some recommendations for the future investors:
Choosing a right Broker
A very important issue for new investors to begin with.
Fundamental Analysis at the company level involves analyzing basic financial variables in order to estimate the company’s intrinsic value. This must be analyzed by a new investor.
Technical analysis assumes that prices are determined by the interaction of demand and supply and reflect the net optimism of market participants. This should also be analyzed by the investors.
Investors must make intelligent judgments about the current state of the financial markets & possible changes.
Market Efficiency Measurement
The concept postulates that investors will assimilate all relevant information into prices in making their buy & sell decisions.
Risk Factor Analysis
Different risk related factors must be considered by the new investors
The minimum expected return on asset that an investor requires before investing. This must be also evaluated by the investors.
Trading Instrument selection depending on risk-return analysis is a considerable factor.
The EPS & related dividend factors should be considered
The position of liquidity position of any company is important for new investors.
Future growth of company
Analyzing of future growth is an important factor for new investors..
Proper time for investment—buy & sell
Investors should try to make proper investment decision with the help of broker about when to buy & sell the securities.
Stock Market Index analysis
To measure the market position of shares, there are several indices in operation. These indices rate the companies according to their performance. This rating is important for the new investors.
Category wise company selection
There are four types of company category which determines the position of a company based upon it’s performance. It also indicates financially sound & strong company. Investors can consider these categories incase of company selection
Business Cycle analysis
Movements in aggregate economic activity such as expansion and contraction can be termed as Business cycle. New investors can focus on this issue for his purpose.
Financial Statement analysis
Analyzing Different issues of financial statement is very important for new investors
Whether to go for margin trading or short sale is another important factor
Therefore from the above points we come to know that a investor must properly scrutinize all his options especially the 2 most important factors that is required rate of return and risk associated with the investment.