SECURITY ANALYSIS

AND PORTFOLIO
MANAGEMENT
FUNDAMENTAL ANALYSIS
1.MACRO ECONOMIC AND INDUSTRY ANALYSIS
2. FINANCIAL STATEMENT ANALYSIS
FUNDAMENTAL ANALYSIS
INDUSTRY FACTORS:
supply chain
constraints,
technological
advancements,
industry growth
MACRO FACTORS: rates, and regulation FIRM POSITION
Inflation, interest WITHIN INDUSTRY:
rates, global trade market share, brand
policies, and strength, operational
geopolitical stability. efficiency, and
innovation
FIRM’S
EARNINGS
PROSPECTS
DEPEND ON:
THE GLOBAL ECONOMY
International Economy Affects Firm Prospects:
• Performance of economies in different countries and regions  affect
firm success.
• Contracting economies  difficult for business to operate

Political Risk
• Political instability  disrupt markets and affect firms’ earnings
potential, eg, Greek and Spanish economies, U.S. fiscal cliff.

Exchange Rate Risk

• Fluctuations in currency exchange rates
• impact the prices of imports and exports
• international business operations more unpredictable.
• eg, Indian Pharma and IT companies get adversely impacted by a
stronger rupee as they are export oriented.
STOCK MARKET RETURNS AND ECONOMIC
PERFORMANCE
 THE DOMESTIC MACROECONOMY
• Stock prices rise with earnings
• P/E ratios are normal range:
12-25
• Forecasting the performance
of the broad market begins
with an assessment of the
economy as a whole
• Key variables:
• Gross domestic product
• Unemployment rates
• Inflation
• Interest rates
• Budget deficit
• Sentiment
KEY MACRO ECONOMIC VARIABLES:
MACRO OPERATIONAL IMPACT STOCK PRICE IMPACT
ECONOMIC
VARIABLE
Gross Domestic • GDP  total value of goods and services As GDP increases, stock
Product produced within a country. prices generally rise due to
• Growing GDP  strong economy. improved earnings prospects
• Robust GDP growth  companies perform for companies.
better, which boosts investor confidence.
Unemployment • High unemployment rates  economic • Falling unemployment rate
Rates weakness, reducing consumer spending and  Rising stock prices as
corporate profits. businesses anticipate
• Low unemployment rates  higher stronger demand
disposable incomes, increased consumption, • Rising unemployment rate
and better business performance.  bearish stock market.
Inflation • Inflation  rising prices in the economy • High inflation  hurts stock
• Moderate inflation  sign of a healthy prices as it reduces
economy. (2% in USA and 4% in India) consumer spending and
• High inflation  erode consumer purchasing corporate profits.
power, increase costs for businesses.
• Very high inflation ( exceeds 6% in India) 
RBI raise interest rates to control it.
KEY MACRO ECONOMIC VARIABLES:
MACRO OPERATIONAL IMPACT STOCK PRICE IMPACT
ECONOMIC
VARIABLE
Interest Rates • Rising interest rates borrowing • Rising interest rates  ↑ cost of
becomes more expensive  slow capital and ↓ corporate profits 
economic growth. negative impact on stock prices
• Falling interest rates  encourage • Falling interest rates  cheaper
borrowing and investment  borrowing and ↑ business
stimulates economy. investment  boost stock prices.
Budget Deficit • A budget deficit  government • Rising budget deficit  concerns
spends more than it collects. about the sustainability of
• High deficits  ↑ government government debt  -ve impact on
borrowing  crowd out private stock prices.
investment and ↑ interest rates. • Short term  government spending
• Sustained deficits  weak can boost economic activity and
economic growth. support stock prices.
Sentiment • Sentiment  overall attitude of • +ve sentiment  ↑ demand from
investors toward the market. confident investors  ↑ stock prices.
• Influenced by economic reports, • -ve sentiment  sell-offs and ↓ stock
political events, and market prices, even if economic
trends etc. fundamentals remain strong.
DEMAND SHOCKS
DEMAND SHOCKS An event that affects demand for goods and services
in the economy

Demand side
policy: Fiscal Policy and Monetary Policy
• Fiscal Policy:
• Most direct way to stimulate or slow the economy
• Formulation of fiscal policy is often a slow, cumbersome political
process
• Monetary Policy:
• Money supply manipulation  to influence economic activity
• Increasing the money supply lowers interest rates  stimulates the
economy
• Less immediate effect than fiscal policy
• Tools of monetary policy: Open market operations, Discount rate,
Reserve requirements
SUPPLY SHOCKS
SUPPLY SHOCKS An event that influences production capacity or
production costs

Supply side
policies

• Creates an environment in which workers and owners of capital have

the maximum incentive and means to produce and develop goods
• Supply-siders focus on how tax policy can improve incentives to work
and invest
ECONOMIC INDICATORS
LEADING INDICATORS
HOW THEY RELATE EXAMPLES IMPACT
• Move ahead of the • Stock Market Performance: Investors and
broader economy and Rising stock prices  investor policymakers use
can give early insights confidence in future economic leading indicators
into stock price growth  increased investment. to make
trends. • Manufacturing Orders: If predictions and
• Leading indicators are manufacturers receive more orders take early actions,
closely watched by  increased production and eg, adjusting
investors because potential business growth  +ve portfolios, setting
they signal potential for manufacturing companies. monetary policy.
changes in the stock • Consumer Sentiment: If
market. consumer confidence is high 
higher spending,  +ve for
consumer-oriented companies.
Leading indicators are used to anticipate future stock price movements.
Investors look for signals to buy or sell stocks before a trend starts.
ECONOMIC INDICATORS
COINCIDENT INDICATORS
HOW THEY RELATE EXAMPLES USE
• Reflect current • Gross Domestic Product • Confirms current
economic conditions (GDP): Strong GDP growth stock market
and often move robust economic performance trends.
simultaneously with and higher corporate earnings • eg, if stock prices
stock prices. • Employment Levels: High are rising, higher
• Help investors employment levels  strong GDP or
understand whether the economic activity  higher employment
current economic corporate profits and increased levels can
environment is strong or investor demand for stocks. confirm that the
weak, providing a real- • Personal Income: Rise in economy is
time snapshot of the household incomes  supporting the
economy. consumer spending increases upward trend in
 +ve for companies stock prices.
Coincident indicators help investors understand the current economic
environment, offering confirmation of existing stock market trends.
ECONOMIC INDICATORS
LAGGING INDICATORS
HOW THEY EXAMPLES USE
RELATE
• Reflect economic • Unemployment Rate: Falling Confirm long-term
conditions after a unemployment rate  economic trends and to
shift has already recovery is underway after stock assess whether
occurred. prices have already started rising. changes in the
• Help investors • Inflation: Rising inflation confirms economy (such as
evaluate the that higher input costs or wages are a recovery) have
sustainability of putting pressure on companies’ taken hold.
stock price profitability .
movements. • Corporate Profits:
• Strong profits  validate earlier
Lagging indicators providerises
retrospective validation of past stock price
in stock prices
movements, helping investors
• Weakassess whether
profits earlier
 signal stock price changes were
overvalued
appropriate based on economic conditions.
stocks.
 • Economic performance can vary widely across
industries.
INDUSTRY • A firm in a troubled industry does not perform
ANALYSIS well
Industry Cyclicality
Industry cyclicality refers to the tendency of certain industries to go through periods of growth,
contraction, and recovery, often in response to broader economic conditions.

Cyclical Industries in India

• Highly sensitive to changes in consumer income and demand.
• In boom times: demand for cars and two-wheelers rises
Automobile •
Industry During recession: lower discretionary spending  sharp declines in sales.
• Other factors: credit availability, government policies on emissions, and fuel
prices.
• Affected by interest rates, government infrastructure spending, and housing
Real Estate demand.
and • Good Economic growth  ↑ demand for housing and commercial buildings 
Constructio boosts the construction sector.
n • In downturns  higher interest rates and lower demand for property  slow
down growth
• Cyclical, depending on both domestic and global demand for raw materials.
• Industrial activity is high  demand for metals like steel and aluminum
Metals and increases.
Mining • Conversely, during economic slowdowns, demand drops.
• Global commodity prices influence the industry's performance.
Non-cyclical or Defensive Industries in India
These industries are relatively stable and less affected by economic fluctuations. They
produce essential goods and services that people continue to need, regardless of economic
conditions.

• Includes products like food, beverages, personal

FMCG (Fast- care items, and household goods.
Moving • Demand for these products remains stable even
Consumer
Goods) during economic downturns because they are
necessities.

Pharmaceutical • Healthcare needs do not vary significantly with the

s and economy, making this sector relatively recession-
Healthcare proof.
THE BUSINESS CYCLE
Economic growth, increasing employment, rising
Expansion: consumer spending, and business investment.

The point at which economic activity reaches its

Peak: highest level before contraction begins.

Declining economic activity, reduced consumer

Contraction: spending, and falling demand for goods and
services.

The lowest point of the economic cycle, marking the

Trough: beginning of a recovery phase.
 Sensitivity of sales

• Necessities vs. discretionary goods

• Items that are not sensitive to income levels
FIRM’S (such as tobacco and movies) vs. items that
are, (such as machine tools, steel, autos)

SENSITIVI Operating leverage

TY TO • Firms with low operating leverage (less fixed

BUSINESS
assets) are less sensitive to business
conditions
• Firms with high operating leverage (more

CYCLE fixed assets) are more sensitive to the

businessleverage
Financial cycle

• Interest is a fixed cost that increases the

sensitivity of profits to the business cycle
THE BUSINESS CYCLE AND INDUSTRY CYCLICALITY

Cyclical Industries Non-Cyclical Industries

Highly sensitive to economic Stable and less affected by

changes economic cycles

Perform well during economic

Maintain steady performance even
expansions, poorly during
during recessions
recessions
Provide discretionary goods and Provide essential goods and
services services

Examples: Automobile, Real Examples: FMCG, Healthcare,

Estate, Banking, Metals Utilities, Telecom
SECTOR ROTATION

• Portfolio is shifted into industries

or sectors that should outperform,
according to the stage of the
business cycle
• Peaks — natural resource
extraction firms
• Contraction — defensive
industries such as
pharmaceuticals and food
• Trough — capital goods
industries
• Expansion — cyclical industries
such as consumer durables
INDUSTRY LIFE CYCLE STAGES
What drives stock prices?
• Stock prices are driven by
growth potential rather than
Start-up: current earnings, with higher
risks and volatility.
• Prices start to reflect more
stable earnings growth and
Consolidation: efficient operations, with less
volatility than in the start-up
stage.
• Stock prices become more
predictable, often valued based
Maturity: on dividends and steady profits,
with moderate risk.
• Stock prices may fall due to
shrinking revenue and profits,
Relative Decline: but some value may remain for
income-oriented investors
through dividends
INDUSTRY STRUCTURE AND STOCK
PRICES
• High barriers to entry  protection to established firms from
Threat of New new competitors  stable stock prices.
Entrants • Low barriers  new competitors threaten profitability  stock
prices are volatile .

• Strong supplier power  Inc in input costs, leading 

profitability declines, lower stock prices.
Bargaining power • If companies maintain strong negotiating power over
of Suppliers suppliers  they can better control costs, which can help
support higher stock prices.

• High buyer power  lower profitability and declining stock

Bargaining power prices.
of Buyers • Industries where companies have pricing power  stable or
rising stock prices as they retain control over margins.
INDUSTRY STRUCTURE AND STOCK
PRICES
Threat of • Industries facing high threats from substitutes  volatile
Substitute stock prices as companies strive to retain market share.
Products or • Investors may perceive industries with fewer substitutes as
Services more stable, which can lead to higher stock prices.

• High rivalry can pressure stock prices if companies are

forced to lower margins.
Industry Rivalry • Industries with less rivalry often see more stable or growing
stock prices, as companies can maintain pricing power.
IDENTIFYING FUNDAMENTALLY
STRONG COMPANIES
FEATURE RATIO MIN VALUE MAX VALUE

ROA 5% NA

PROFITABILITY ROE 15% NA

ROCE 12% NA

EFFICIENCY ASSET TURNOVER 1 NA

LIQUIDITY CURRENT RATIO 1.5 3

DEBT TO EQUITY NA 0.5

SOLVENCY
INTEREST COVERAGE RATIO 3 NA
IDENTIFYING RIGHT TIME TO INVEST
PE RATIO
LOW PE MODERATE PE HIGH PE
<15 15-25 >25
• Undervalued relative to Fairly valued • Investors are willing to
its earnings, making it pay more for future
a potential value growth and earnings,
investment. often found in growth
• Fundamentals are stocks.
strong: • Stock is overvalued,
Right time to invest. and investors need to
• Fundamentals are be cautious, as such
weak: stocks could face
Low P/E can also signal corrections if growth
risks or market expectations are not
skepticism about future met
growth.
IDENTIFYING RIGHT TIME TO INVEST
MTB RATIO
LOW MTB MODERATE MTB HIGH MTB
<1 1-3 >3
• Company's stock is • Considered • Investors expect significant
trading for less than its reasonable, growth and are willing to
book value. • Common for pay a premium above the
• Fundamentals are strong: companies with stable company’s book value.
Stock is undervalued and earnings and a • Typical for growth
presents a buying balance between companies, where
opportunity. growth prospects and intangible assets (brand
• Fundamentals are weak: asset valuation. value, intellectual property,
Investors expectations of etc.) are not fully reflected
underperformance in the in the book value, justifying
future. a premium.
• However, a very high M/B
could indicate an
overvaluation if the
expected growth does not
TIMING THE BUY
• Tech and Growth Stocks: These sectors typically
have higher P/E and M/B ratios because investors
expect strong future growth.
Sector Adjustments: • Utilities and Financials: These sectors tend to
have lower P/E and M/B ratios, reflecting more
stable and predictable earnings and lower growth
expectations.

• P/E Ratio: Helps assess how much investors are

willing to pay for earnings. Lower P/E suggests
potential undervaluation; higher P/E reflects
growth expectations.
Key Takeaway: • M/B (P/B) Ratio: Indicates how much investors
are paying relative to the company's tangible
assets. Lower M/B suggests undervaluation; higher
M/B reflects premium for growth prospects.
STOCK SELECTION USING
SCREENER
• OPEN SCREENER AND SELECT STOCKS