INTRODUCTION TO

INVESTMENT
INVESTMENT ANALYSIS (MEN-INA-411)
OUTLINE
INTRODUCTION

• The money a person earns is partly spent and the rest saved for meeting future expenses.
• Instead of keeping the savings idle s/he may like to use savings in order to get return on it
in the future. This is called Investment.
• The term investment refers to exchange of money wealth into some tangible wealth.
• The money wealth here refers to the money (savings) which an investor has and the term
tangible wealth refers to the assets the investor acquires by sacrificing the money wealth.
• By investing, an investor commits the present funds to one or more assets to be held for
some time in expectation of some future return in terms of interest or dividend and capital
gain.
DEFINITION OF INVESTMENT

• Investment may be defined as an activity that commits funds in any

financial/marketable or physical form in the present with an
expectation of receiving additional return in the future.
• For example, a Bank deposit is a financial asset, the purchase of gold is
a physical asset and the purchase of bonds and shares is marketable
asset.
• Investment is the commitment of current funds in anticipation of
receiving larger inflow of funds in future, the difference being the
income.
• An investor hopes to be compensated for (i) forgoing present
consumption, (ii) for the effects of inflation, and (iii) for taking a risk.
FEATURES OF AN INVESTMENT

• There are three basic features common to all types of investment:

1) There is a commitment of present funds
2) There is an expectation of some return or benefits from such
commitment , and
3) There is always some risk involved in respect of return and the
principal amount invested.
OBJECTIVES OF INVESTMENT

• Investment is widespread practice and many have made their fortunes in the
process.
• All the personal investment is designed in order to achieve certain objectives.
• These objectives may be tangible such as buying a car, house, etc., and
intangible objectives such as social status, security, etc.
• Similarly, these objectives may be classified as financial or personal objectives.
• Financial objectives are safety, profitability and liquidity. Personal or individual
objectives may be related to personal characteristics of individual such as family
commitments, status, etc.
OBJECTIVES OF INVESTMENT

• The objectives can be classified on the basis of the investors approach as follows:
a) Short-term high priority objectives:
some investors have high priority towards achieving certain objectives in short
time. For example, a young couple will give high priority to buy a house.
b) Long-term high priority objectives:
some investors look forward and invest on the basis of objectives of long-term
needs. They want to achieve financial independence in long period. For
example, investing for post retirement period or education of child,
etc.
OBJECTIVES OF INVESTMENT

• The objectives can be classified on the basis of the investors approach

as follows:
c) Low priority objectives:
These objectives have low priorities in investing. These
objectives are not painful. After investing in high priorities assets,
investors can invest in these low priority assets. For example,
provision for tour, domestic appliances, etc.
d) Money making objectives:
Investors put their surplus money in this kind of investment.
Their objective is to maximize wealth. Usually, the investors
invest in shares of companies which provides capital
appreciation apart from regular income from dividends.
OBJECTIVES OF INVESTMENT

1) RETURN
• Investors expect a good rate of return from their investments.
• Return from investment may be in terms of revenue return or
income (interest or dividend) and/or in terms of capital return
(capital gain i.e. difference between the selling price and the
purchasing price).
• The net return is the sum of revenue return and capital return.
• For example, an investor purchases a share (Face Value FV K10) for
K130. After one year, he receives a dividend of K3 (i.e. 30% on FV
of K10) from the company and sells it for K138. His total return is
K11, i.e., K3 + K8. The normal rate of return is K11 divided by K130
i.e., 8.46%.
OBJECTIVES OF INVESTMENT

1) RETURN
• In the same case, if he is able to sell the share only for K128, then
his net return is K1 (i.e., K3 – K2) only. The annual rate of return in
this case is 0.77% (i.e., 1/130)
a) Expected Return:
• The expected return refers to the anticipated return for some future
period.
• The expected return is estimated on the basis of actual returns in the
past periods.
b) Realised Returns:
• The realized return is the net actual return earned by the investor over
the holding period.
OBJECTIVES OF INVESTMENT

2) RISK
• Variation in return i.e., the chance that the actual return from an
investment would differ from its expected return.
• Measuring risk is important because minimizing risk and
maximizing return are interrelated objectives.
• There are two types of risk i.e. Systematic Risk and Unsystematic
Risk.
OBJECTIVES OF INVESTMENT

3) LIQUIDITY
• Liquidity, with reference to investments, means that the investment
is saleable or convertible into cash without loss of money and
without loss of time.
• Different types of investments offer different type of liquidity; Most
of financial assets provide a high degree of liquidity. Shares and
mutual fund units can be easily sold at the prevailing prices.
• An investor has to build a portfolio containing a good proportion of
investments which have relatively high degree of liquidity.
OBJECTIVES OF INVESTMENT

3) LIQUIDITY
• Cash and money market instruments are more liquid than the
capital market instruments which in turn are more liquid than the
real estate investments.
• For example, money deposited in savings account and fixed deposit
account in a bank is more liquid than the investment made in
shares or debentures of a company.
OBJECTIVES OF INVESTMENT

4) SAFETY
• An investor should take care that the amount of investment is safe.
• The safety of an investment depends upon several factors such as
the economic conditions, organization where investment is made,
earnings stability of that organization, etc. Guarantee or collateral
available against the investment should also be taken care of.
OBJECTIVES OF INVESTMENT

4) SAFETY
• For example,
•  Bonds issued by RBM are completely safe investments as
compared with the bonds of a private sector company.
•  Like wise it is more safer to invest in debenture than of preference
shares of a company
•  Accordingly, it is more safer to invest in preference shares than of
equity shares of a company, the reason being that in case of
company liquidation, order of payment is debenture holders,
preference share holds and then equity share holders.
OBJECTIVES OF INVESTMENT

5) TAX BENEFITS
• Investments differ with respect to tax treatment of initial
investment, return from investment and redemption proceeds.
• For example, investment in Public Provident Fund (PPF) has tax
benefits in respect of all the three characteristics.
• Equity Shares entails exemption from taxability of dividend income
but the transactions of sale and purchase are subject to Securities
Transaction Tax or Tax on Capital gains.
• Sometimes, the tax treatment depends upon the type of the investor.
OBJECTIVES OF INVESTMENT

5) TAX BENEFITS
• The performance of any investment decision should be measured by its
after tax rate of return.
• For example, between 8.5% PPF and 8.5% Debentures, PPF should be
preferred as it is exempt from tax while debenture is subject to tax in the
hands of the investors.
OBJECTIVES OF INVESTMENT

6) REGULARITY OF INCOME
• The prime objective of making every investment is to earn a stable return.
• If returns are not stable, then the investment is termed as risky.
• For example, return (i.e. interest) from Savings account, Fixed deposit
account, Bonds & Debentures are stable but the expected dividends from
equity share are not stable.
• The rate of dividend on equity shares may fluctuate depending upon the
earnings of the company.
CHARACTERISTICS OF INVESTMENT

a) Return
b) Risk
c) Safety
d) Liquidity
e) Time horizon
(refer objectives of investment topic notes)
INVESTMENT & SPECULATION

• In speculation, there is an investment of funds with an expectation of

some return in the form of capital profit resulting from the price change
and sale of investment.
• Speculation is relatively a short term investment. The degree of
uncertainty of future return is definitely higher in case of speculation
than in investment.
• In case of investment, the investor has an intention of keeping the
investment for some period whereas in speculation, the investor looks
for an opportunity of making a profit and “exit- out” by selling the
investment.
INVESTMENT & SPECULATION

Differences in investment and speculation

INVESTMENT ALTERNATIVES

• One may invest in:

• Physical assets like real estate, gold/jewellery, commodities etc. and/or
• Financial assets such as fixed deposits with banks, small saving
instruments, insurance/provident/pension fund etc. or
• Marketable assets - securities market related instruments like shares,
bonds, debentures, derivatives, mutual fund etc.
CLASSIFICATIONS OF INVESTMENT ACTIVITIES

1) Direct Investing
• Direct investing involves the buying and selling of securities by investors
themselves.
• The securities may be capital market securities such as shares, debentures
or derivative products, or money market instruments such as Treasury Bills,
Commercial Bills, Commercial Papers, Certificates of Deposits, or real
assets such as land and building, house, etc or non-financial assets such as
gold, silver, art, antiques, etc.
CLASSIFICATIONS OF INVESTMENT ACTIVITIES

2) Indirect Investing
• Investors may not directly invest and manage the portfolio, rather they
buy the units of funds that hold various types of securities on behalf of
the investors
• Examples may include, Mutual funds, Public Provident fund (PPF),
National Savings Scheme (NSS), National Savings Certificate (NSC), and
investment in Insurance Company schemes.
INVESTMENT PROCESS

Investment Process Model for an Ongoing Equity Investment Process

INVESTMENT PROCESS

PORTFOLIO
PORTFOLIO
INVESTMENT POLICY ANALYSIS VALUATION CONSTRUCTIO
EVALUATION
N

Investment process of securities

INVESTMENT PROCESS

1) Investment Policy
• The government or the investor before proceeding into investment,
formulates the policy for the systematic functioning.
• The essential ingredients of the policy are the investible funds, objectives
and the knowledge about the investment alternatives and market.
a) Investible funds:
• The entire investment procedure revolves around the availability of
investible funds.
• The fund may be generated through savings or borrowings.
INVESTMENT PROCESS

• If the funds are borrowed, the investor has to be extra careful in the
selection of investment alternatives.
• The return should be higher than the interest he pays.
• Mutual funds invest their owner’s money in securities.
b) Objectives:
• The objectives are framed on the premises of the required rate of
return, need for regularity of income, risk perception and the need
for liquidity.
• The risk taker’s objective is to earn high rate of return in the form of
capital appreciation, whereas the primary objective of the risk
averse (person not interested in taking risk) is the safety of the
principal.
INVESTMENT PROCESS

c) Knowledge:
• The knowledge about the investment alternatives and markets
plays a key role in the policy formulation.
• The investment alternatives range from security to real estate.
• The risk and return associated with investment alternative differ
from each other.
• Investment in equity is high yielding but has more risk than in fixed
income securities.
INVESTMENT PROCESS

2) Security Analysis
• After formulating the investment policy, the securities to be bought
have to be scrutinized through the market, industry and company
analysis.
a) Market Analysis
• The general economic scenario is reflected in the stock market.
• The growth in gross domestic product and inflation are reflected
in the stock prices.
INVESTMENT PROCESS

2) Security Analysis
• The recession in the economy results in a bear market.
• The stock prices may be fluctuating in the short run but in the
long run they move in trends i.e. either upwards or downwards.
b) Industry Analysis
• The industries that contribute to the output of the major
segments of the economy vary in their growth rates and their
overall contribution to economic activity.
INVESTMENT PROCESS

2) Security Analysis
• Some industries grow faster than the GDP and are expected to
continue in their growth. For example, IT industry has higher
growth rate than the GDP in 1998.
• The economic significance and the growth potential of the
industry have to be analysed.
INVESTMENT PROCESS

2) Security Analysis
c) Company Analysis
• The Company’s earnings, profitability, operating efficiency, capital structure
and management have to be analysed.
• These factors have direct bearing on the stock prices and the return of the
investors.
• Appreciation of the stock value is a function of the performance of the
company.
• Company with high product market share is able to create wealth to the
investors in the form of the capital appreciation.
INVESTMENT PROCESS

3) Valuation
• The valuation helps the investor to determine the return and risk
expected from an investment in the common stock.
• Intrinsic Value: Intrinsic value is the present value of securities of
all future cash inflows by using simple discounting models.
• Future Value: Future value of the securities could be estimated by
using a simple statistical technique like trend analysis. The analysis
of the historical behaviour of the price enables the investor to
predict the future value.
INVESTMENT PROCESS

3) Valuation
Construction of Portfolio:
• A portfolio is a combination of securities. The portfolio is
constructed in such a manner to meet the investor’s goals and
objectives.
INVESTMENT PROCESS

3) Valuation
Diversification:
• The main objective of diversification is the reduction of risk in the
loss of capital and income.
• A diversified portfolio is comparatively less risky than holding a
single portfolio.
• Various types of diversification are:
1) Debt – equity diversification
2) Industry diversification
3) Company diversification
INVESTMENT PROCESS

3) Valuation
Selection:
• Based on the diversification level, industry and company analyses
the securities have to be selected.
• Funds are allocated for the selected securities.
INVESTMENT PROCESS

3) Valuation
Evaluation:
• The portfolio has to be managed efficiently.
• The efficient management calls for evaluation of the portfolio.
INVESTMENT PROCESS

3) Valuation
Appraisal:
• The return and risk performance of the security vary from time to
time.
• The variability in returns of the securities is measured and
compared.
• The developments in the economy, industry and relevant
companies from which the stocks are bought have to be appraised.
• The appraisal warns the loss and steps can be taken to avoid such
losses.
INVESTMENT PROCESS

3) Valuation
Revision:
Revision depends on the results of the appraisal.
The low yielding securities with high risk are replaced with high
yielding securities with low risk factor.
To keep the return at a particular level necessitates the investor to
revise the components of the portfolio periodically.
BUY-SELL DECISION RULES FOR INVESTORS

• BUY RULE: If the market price of a security is less than its value, it is
an undervalued security and it should be bought and held. Then, when
price increases then it may be sold to make profit.
• SELL RULE: If the market price of a security is more than its value, it is
an over priced and it should be sold .Then, when price falls at later
stage, it may be sold to make profit.
• NO BUY-SELL: If the price is equal to its value then equilibrium exists.
The security is correctly priced and an investor may not make any
profit from buying or selling.