INVESTING IN STOCKS

Investing in Stocks (Part 1)

• Equity as an Investment: Equity securities represent ownership claims on a company's net assets, providing investors with residual claim and voting rights.
• Diversification of Risk: Diversification can be achieved through cross-sectional (across business sectors and industries) and time series (across various time periods) approaches to reduce risk in equity investments.
• Risks of Equity Investments: Key risks include:
  • Market Risk: Fluctuations in equity share prices due to market dynamics, measured by beta.
  • Sector-Specific Risk: Risks affecting a particular sector or industry, also known as idiosyncratic risks.
  • Company-Specific Risk: Risks affecting a single company's performance.
  • Transactional Risk: Risks due to the other party not fulfilling contract terms.
  • Liquidity Risk: Risk of not being able to find a buyer or seller for equity holdings, measured by impact cost.
  • Currency Risk: Risk arising from volatile exchange rates, affecting international investors.
• Overview of Equity Market: The equity market provides various choices to investors in terms of risk-return-liquidity profile, with opportunities in listed and unlisted equity spaces.
• Equity Research and Stock Selection: Involves thorough analysis and research of companies and their environment to identify stocks that suit investors' requirements, using frameworks such as fundamental analysis, top-down approach, bottom-up approach, quantitative screens, and technical indicators.
• Buy-Side Research vs. Sell-Side Research: Buy-side analysts work for fund managers, generating investment recommendations for internal consumption, while sell-side analysts work for firms providing investment banking and broking services, publishing research reports with specific recommendations.

Investing in Stocks (Part 2)

• Fundamental Analysis: The process of determining the intrinsic value of a stock based on underlying economic factors such as future earnings, cash flows, interest rates, and risk variables.
• Intrinsic Value: The true value of a stock, which may differ from its market price, but is expected to converge with the market price over time.
• Top-Down Approach: A method of fundamental analysis that starts with macroeconomic analysis, then moves to industry analysis, and finally to company analysis.
• Bottom-Up Approach: A method of fundamental analysis that starts with company analysis and then moves to industry and macroeconomic analysis.

Key Concepts in Fundamental Analysis

• EIC Framework: A commonly used approach to understanding fundamental factors impacting a company's earnings, scanning both micro and macro data and information.
• Economy Analysis: The analysis of macroeconomic factors such as GDP, inflation rates, interest rates, and unemployment to understand their impact on industries and companies.
• Industry Analysis: The analysis of an industry's relationship with the business cycle, including its stage in the life cycle and its sensitivity to interest rates and inflation.
• Company Analysis: The analysis of a company's strengths, weaknesses, opportunities, and threats to determine its intrinsic value and potential for growth.

Industry Life Cycle

• Introduction: The initial stage of an industry's life cycle, characterized by modest sales and small or negative profits.
• Growth: The stage of rapid growth, where the market develops and profits are high.
• Maturity: The longest phase, where growth matches the economy's growth rate and competition is high.
• Decline: The final stage, where sales decline due to shifting demand and profits are under pressure.

Company Analysis Components

• Financial Statement Analysis: The analysis of a company's profit and loss account, balance sheet, and cash flow statement to calculate ratios and understand its performance.
• SWOT Analysis: The examination of a company's strengths, weaknesses, opportunities, and threats to understand its internal and external environment.
• Competitive Strategies: The analysis of a company's defensive or offensive strategies to understand its competitive position.

Estimation of Intrinsic Value

• Price vs. Value: The difference between the market price of a stock and its intrinsic value, which is based on evaluation and analysis.
• Valuation Approaches: Various methods used to estimate the intrinsic value of a stock, including uncertainties associated with inputs and outputs.
• Art and Science of Valuation: The combination of analytical skills and judgment required to estimate the intrinsic value of a stock.

INVESTING IN STOCKS (Part 3)

• Valuation: The process of determining the intrinsic value of a stock by combining knowledge, experience, and professional judgment. The purpose of valuation is to relate the market price of the stock to its intrinsic value and judge whether it is fairly priced, over-priced, or under-priced.
• Approaches to Valuation: There are three most popular approaches to valuation:
  • Discounted Cash Flow (DCF) Approach: This approach is conceptually the most appropriate for valuations when the stream of future cash flows, timings of these cash flows, and expected rate of return of the investors (called discount rate) are known.
  • Asset-Based Valuation: This methodology is used in asset-heavy businesses, such as financial institutions, real estate, and gold, gems, and jewelry. The value of the firm is equal to the adjusted current market values of net tangible, intangible, financial, and net current assets.
  • Relative Valuation: This approach involves comparing the valuation of a company to that of similar companies or the market as a whole.

Discounted Cash Flow Model

• Definition: The DCF approach calculates the present value of future cash flows using a discount rate.
• Key Components: Stream of future cash flows, timings of these cash flows, and expected rate of return of the investors (discount rate).

Relative Valuation

• Definition: Relative valuation involves comparing the valuation of a company to that of similar companies or the market as a whole.
• Multiples: Standardized values that are used to compare companies, such as:
  • Price-to-Earnings (P/E) Ratio: The most common stock valuation measure used by analysts.
  • Price-to-Book Value (P/BV) Ratio: Compares a stock's price per share to its book value of equity per share.
  • Price-to-Sales (P/S) Ratio: Calculated by taking a company's market capitalization and dividing it by the company's total sales or revenue.
  • Price-to-Earnings Growth (PEG) Ratio: Takes into account the price, earnings, and earnings growth rates of a company.

Other Valuation Metrics

• Economic Value Added (EVA): Measures the true economic profit produced by a company.
• Market Value Added (MVA): The difference between the current market value of a firm and the original capital contributed by investors.
• Key Considerations: When using these metrics, it is essential to consider the limitations and potential biases of each approach.

INVESTING IN STOCKS (Part 4)

• Enterprise Value (EV): EV is a measure of a company's total value, including both its equity and debt. It is calculated as: Market capitalization of equity + Market Value of Debt - Excess cash and cash equivalents.
• EBIT/EV and EV/EBITDA Ratio: These ratios are used to compare companies. EBIT (Earnings Before Interest and Taxes) is a measure of a company's profitability, while EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a measure of a company's cash flow.
• EV/S Ratio: The Enterprise Value-to-Sales (EV/S) ratio compares a company's EV to its annual sales. This ratio is useful for valuing companies with high capital intensity.
• Dividend Yield: The dividend yield is the ratio of the annual dividend payment to the stock's current price. It represents the return an investor can expect from the dividend alone.
• Earnings Yield: The earnings yield is the ratio of the company's earnings per share to its current stock price. It represents the return an investor can expect from the company's earnings.
• Industry/sector specific valuation metrics: Different industries and sectors have unique valuation metrics. For example, the P/E Ratio is commonly used for non-cyclical sectors like FMCG and Pharma, while the Replacement Cost Method is used for capital-intensive industries like cement and steel.

Combining Relative Valuation And Discounted Cash Flow Models

• Discounted Cash Flow (DCF) Models: DCF models estimate a company's intrinsic value by discounting its future cash flows.
• Relative Valuation Metrics: Relative valuation metrics, such as the P/E Ratio, compare a company's value to that of similar companies.
• Connection between DCF and Relative Valuation: DCF models and relative valuation metrics are connected, as multiples (such as the P/E Ratio) can be seen as a simplified version of DCF.

Technical Analysis

• Technical Analysis: Technical analysis involves studying historical market data, such as price and volume, to forecast future price movements.
• Assumptions of Technical Analysis: Technical analysis assumes that market prices reflect all available information, and that prices move in trends.
• Technical vs. Fundamental Analysis: Technical analysis focuses on price movements, while fundamental analysis focuses on a company's intrinsic value.
• Advantages of Technical Analysis: Technical analysis can be useful for short-term trading, and can provide insights into market trends and sentiment.
• Technical Rules and Indicators: Common technical indicators include Trend-Line Analysis, Moving Averages, and Bollinger-Band Analysis.

Qualitative Evaluation of Stocks

• Corporate Governance: Corporate governance practices are essential for evaluating a company's quality and potential for long-term success.
• Qualitative Aspects: Qualitative aspects, such as a company's management team, industry trends, and competitive position, are important for evaluating a company's potential.