1.1 What is Analysis?

The examination and evaluation of the relevant information to select the best course of action from among various alternatives. The methods used to analyze securities and make investment decisions fall into two very broad categories: fundamental analysis and technical analysis. Fundamental analysis involves analyzing the characteristics of a company in order to estimate its value. Technical analysis takes a completely different approach; it doesn't care one bit about the "value" of a company or a commodity. Technicians (sometimes called chartists) are only interested in the price movement in the market.

1.2 Types of Analysis:

There are numerous ways of taking investment decisions in the market like Technical Analysis. Fundamental Analysis.

1.2.1 What is technical analysis? Technical analysis is a method of evaluating securities by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity

1.2.2 What is fundamental analysis? Fundamental analysis is method of analyzing the stock value that uses the financial and economic analysis to envisage the movement of the stock prices. The fundamental data could include the financial and non-financial information such as growth, demand of product, comparisons of industry, economic changes, and changes in government policies. The fundamental analysis is the alternative method of technical analysis.

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Security analysis is the first step undertaken in the process in the process of investment decisions. The task involves determining prospective benefits from investment security, the conditions subject to which they may be received, and the likelihood of such condition. In a sense, the task involves forecasting future conditions, the prospective benefits from holding a security given these conditions, and arriving at what ought to be the price for the security, given these benefits and adjusting for the inherent time and risk. Security valuation is the end objective of the security analysis in this sense. Fundamental analysis is an approach to determine this what ought to be price. Its objective is to identify the underpriced and overpriced security in the market place so that the investment decision buying and selling can be made. (A security is said to be underpriced if its current price is below the what to be price otherwise known as intrinsic or true value. Conversely, it is an overpriced security if its current market price is above its intrinsic value.) The fundamental analysis believe that due to temporary market disequilibrium, the market price may be at variance with its intrinsic value, but in the long run the market price would get back to its intrinsic value. So, an investor usually has an opportunity to profit from a wide discrepancy between the current market price and the intrinsic value. By buying an underpriced security, and selling an overpriced security, an investor would be able to make profit. It may be noted the end objective of fundamental analysis is not to make a speculative profit which call for frequent entering in and exiting from the market switching from one security of portfolio to another. Rather it is to avoid the risk of loss from buying an overpriced stock and selling an underpriced stock. The fundamentalists view investment as long-term decision, in fact, for such a long period that the holding of a security of portfolio can be considered permanent.

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The fundamentalist may buy a security if the current market price matches its intrinsic value, that is, when it is a fair price. By buying a fair priced security, a person earns the normal rate of return on his investment. Buying an underpriced stock enable one to earn some abnormal return (relative to risk) on his investment. This is known as beating the market. The fundamentalists are a cadre of participants in the market who believe that the stock market can be beaten.

Concept of Intrinsic Value

A general definition of intrinsic value is given by Graham and Dodd. They define the intrinsic value of a security as that value which is justified by the facts, e.g. assets, earnings, dividend, definite prospects, including the factor of management (of the company). The intrinsic value of the stock is estimated by discounting by the companys prospective earning stream or the shareholders prospective dividend stream: As the prospective earning of the prospective dividends to its shareholders depend very much on the economic and industrial environment, relative importance of the company within its industry, companys financial strength, its policies, quality of assets and management, the analyst seek to establish quantitative relationship between economic, industrial, and company indicators with a view to forecast earnings and dividend. For this purpose, an economic analysis, industrial analysis, and company analysis are undertaken. The quality of assets (technology) and the quality of management are, of course, the factors about which a qualitative assessment is made. It should be noted that in practice, a fundamental analyst calculates a range of intrinsic value rather than value. A stock is said to be mispriced (overpriced or underpriced) if its current price falls outside this range.

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1.3 Relevance of Fundamental Analysis.

Lets take some reasons why the fundamental analysis is used for stock selecting in the market.

1.3.1 Efficient Market Hypothesis (EMH)

Market efficiency signifies how quickly and accurately does relevant information has its effect on the asset prices. Depending upon the degree of efficiency of a market or a sector thereof, the return earned by an investor will vary from normal (return to risk level). According to EMH, successive absolute price changes are independent. The hypothesis is based on the assumption that market comprises of rational investor. The term rational means the investor will select assets based on their risk and return profile. Market efficiency as a phenomenon certainly plays a major role in bringing equilibrium in any market. With a variety of participants at work and their action are influenced by their respective opinion about prices or returns, the market should all the times be in a state of dynamic equilibrium. There are three forms of EMH, depending on the available information: 1. Weak form of EMH It is also known as random walk model, it says that current prices fully reflect all historical information, hence, any attempt to predict prices based on historical price or information is totally futile as future price changes are independent of past prices changes. The weak form of the EMH implies that investor should not able to outperform the market using something that everybody else knows. It is not surprising that the weak form of market hypothesis hold good in any market, since even the critics of EMH will admit that prices adjust to information albeit with lag.

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Tests of weak form Auto correlation test. Runs test.

2. Semi strong form of EMH The semi strong form of the EMH states that current price reflects all publicly available information such as earnings, stock and cash dividend, splits, merger, and takeover, interest rate changes, etc. It also says that prices adjust to such information quickly and accurately so abnormal/ superior profit on a consistent basis cannot be earned.

Tests of semi strong form of EMH Residual Analysis. Event studies.

3. Strong form of EMHAccording to the strong form of market hypothesis, prices of security fully reflect all available information both (i) public and (ii) private. That is, if this form is true, prices reflect the information that is available to only selected groups like management, financers and stock exchange officials. There are two versions of strong form the near strong form and the super strong form. As per super strong form, conclusion and opinions drawn by analyst based on publically available information are also reflects in the prices. The super strong form is more extreme and states that confidential information available only to selected groups of people mentioned is also of no use in information as well. As can be expected, super strong form has been rejected by many while near super strong has found some support.

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Test of Strong form of EMH Trading by Exchange officials. Trading by Mutual Fund Managers.

1.4 How does fundamental analysis works?

In the EMH, investors have a long-term perspective and return on investment is determined by a rational calculation based on changes in the long-run income flows. However, in the markets, investors may have shorter horizons and returns also represent changes in short-run price fluctuations. Recent years have witnessed a new wave of researchers who have provided thought provoking, theoretical arguments and provided supporting empirical evidence to show that security prices could deviate from their equilibrium values due to psychological factors, fads, and noise trading. Thats where investors through fundamental analysis and a sound investment objective can achieve excess returns and beat the market. Fundamental analysis is carried out with the aim of predicting the future performance of a company. It is based on the theory that the market price of a security tends to move towards its real value or intrinsic value. Thus, the intrinsic value of a security being higher than the securitys market value represents a time to buy. If the value of the security is lower than its market price, investors should sell it.

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1.5 Steps in fundamental analysis.

Fundamental analysis consists of a systematic series of steps to examine the investment environment of a company and then identify opportunities. Some of these are: Macroeconomic analysis - which involves analyzing capital flows, interest rate cycles, currencies, commodities, indices etc. Industry analysis - which involves the analysis of industry and the companies that are a part of the sector. Situational analysis of a company. Financial analysis of the company. Valuation.

1.6 Tools of fundamental analysis.

a. Earning per share EPS b. Price to Earnings Ratio P/E c. Price to Sales P/S d. Price to Book P/B e. Dividend Payout Ratio f. Dividend Yield g. Book Value h. Return on Equity i. Ratio Analysis.

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LITERACHER RIVEW

Fundamental analysis is very exciting and interested subject and lot of literature has been written on this subject. Basically, the fluctuations in the market tend to put investor to choose this in which hi tries to minimize his risk or to get the same return with the less risk and some investors wants to invest for a long time and get the profit. The investors analyses the market in two different ways 1. Fundamental analysis 2. Technical analysis. Get advantage volatility of prices and get the return in short term then investment made on the basis of technical analysis which is based on the only past performances of the company and chart pattern and who able taking the risk they are risk lovers. But the fundamental analysis use that investors who get the advantage of long term benefit and the person who not able to take risk and this analysis gives the abnormal profit. Our research is extension on that subject and tries to prove that the fundamental analysis gives an abnormal and lower risk return as compare to technical analysis. For making the fundamental analysis use a various tools for the analysis like ratios and analysis of financial report and based on the graph and the analyzing trend analysis made and based on that analysis made. In real the fundamental works very much for getting abnormal return with minimal risk.

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