Armed with the economic and industry forecasts, the analyst looks at the company-specific information. Company information is generated internally and externally. The principal source of internal information about a company is its financial statements. Quarterly and annual reports including the income statement, the balance sheet, and cash flows must be screened to assure that the statements are correct, complete, consistent, and comparable. Many popular and widely circulated sources of information about the companies emanate from outside or external sources. These sources provide supplements to company-generated information by overcoming some of its biases, such as public pronouncements by its officers. External information sources also provide certain kinds of information not found in the materials made available by companies themselves. There are traditional and modern techniques of company analysis.
Among the traditional techniques are forecasting expected dividends and earnings using price-earnings ratios which help us to determine whether a stock is fairly valued at a point in time. Such approaches allow us to evaluate an equity share for a short term horizon. Moreover, an approach combining the dividend discount model (with variable growth rates) and the concept of systematic risk can also be helpful in evaluating a stock for a longer-term holding period. Among the modern methods are regression analysis, and the related tools of trend and correlation analysis, decision tree analysis, and simulation. Modern methods have strengths of the traditional methods while attempting to overcoming their shortcomings.
Fundamental Analysis Tools: Although the raw data of the Financial Statement has some useful information, much more can be understood about the value of a stock by applying a variety of tools to the financial data.
1. Earnings per Share – EPS
2. Price to Earnings Ratio – P/E
3. Projected Earnings Growth – PEG
4. Price to Sales – P/S
5. Price to Book – P/B
6. Dividend Yield
7. Dividend Payout Ratio
8. Book value per share
9. Return on Equity
In the fundamental analysis, share prices are predicted on the basis of a three-stage analysis. After the analysis has been completed, the deciding factors that emerge are the financial performance indicators like earnings and dividends of the company. The fundamentalist makes a judgment of the equity share value with a risk-return framework based upon the earning power and the economic environment. However, in actual practice, it often happens that a share having sound fundamentals refuses to rise in value and vice versa. We would now examine an alternative approach to predict share price behavior. This approach is called Technical Analysis. It is used in conjunction with fundamental analysis and not as its substitute.
Technical analysis is an analysis for forecasting the direction of prices through the study of past market data, primarily price and volume. This Technique assumes market prices of securities are determined by the demand-supply equilibrium. The shifts in this equilibrium give rise to certain patterns of price and volume of trading which have a tendency to repeat themselves over a period of time. An analyst who is familiar with these patterns can predict the future behavior of stock prices by noticing the formation of these patterns. These predictions are indicative and do not provide irrefutable declarations about future trends. In this type of analysis, no weightage is given to intangible items like investors’ attitude, market sentiment, optimism, pessimism, etc.
Technical analysis is based on the following assumptions:
– The interplay of demand and supply determines the market value of shares.
– Supply and demand are governed by various factors – both rational and irrational.
– Stock values tend to move in trends that persist for a reasonable time.
– These trends change as a result of the change in demand-supply equilibrium.
– Shifts in demand and supply can be detected in charts of market action.
– Chart patterns tend to repeat themselves and this repetition can be used to forecast future price movements.
– Markets behave in a random style.
– Markets discount every future event that has a bearing on share values.