The term Initial public offering (IPO) slipped into everyday speech during the IT bull market of the late 1990s & also in the period of Ketan Parakh when we had the best run in the IPO market. Back then, it seemed you couldn’t go a day without hearing about a dozen new companies who were cashing in on their latest IPO. And after that bubble investors found them self in a trap and also they lost their hard earn money during that time.

So, what is an IPO? How did everybody get so rich so fast? And, most importantly, is it possible for simple mortals like us to get in on an IPO? All these questions and more will be answered in this write up.

An initial public offering, or IPO, is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has issued equity to the public, it’s known as an IPO.

Companies are mainly belonging to: private and public.

A privately held company has fewer shareholders and its owners don’t have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your command. Most small businesses are privately held. But large companies can be private too. What is the need for IPO?

It usually isn’t possible to buy shares in a private company. You can approach the owners about investing, but they’re not forced to sell you anything. Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. In India, public companies report to the Securities and Exchange Board of India (SEBI. From an investor’s point of view, the most exciting thing about a public company is that the stock is traded in the open market, like any other commodity. If you have the cash, you can invest.

• Because of the increased analysis, public companies can usually get better rates when they issue debt.
• As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
• When your stock traded in the open market you can offer your equity to your Employee to get best talent for your company.

Now if you want to apply for IPO here you have some points to watch out for.

No History

It’s hard enough to analyze the stock of an established company. An IPO company is even trickier to analyze since there won’t be a lot of historical information. Your main source of data is the red herring, so make sure you examine this document carefully. Look for the usual information, but also pay special attention to the management team and how they plan to use the funds generated from the IPO.

Successful IPOs are typically supported by bigger brokerages that have the ability to promote a new issue well. Be more wary of smaller investment banks because they may be willing to underwrite any company.

The Lock-Up Period

If you look at the charts following many IPOs, you’ll notice that after a few months the stock takes a steep downturn. This is often because of the lock-up period. Flipping 

When a company goes public, the underwriters make company officials and employees sign a lock-up agreement. Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period of time. The period can range anywhere from three to 24 months.  but the lock-up specified by the underwriters can last much longer. The problem is, when lockups expire all the insiders are permitted to sell their stock. The result is a rush of people trying to sell their stock to realize their profit. This excess supply can put severe downward pressure on the stock price.

Flipping is reselling a hot IPO stock in the first few days to earn a quick profit. This isn’t easy to do, and you’ll be strongly discouraged by your brokerage. The reason behind this is that companies want long-term investors who hold their stock, not traders. There are no laws that prevent flipping, but your broker may blacklist you from future offerings - or just smile less when you shake hands.

Of course, institutional investors flip stocks all the time and make big money. The double standard exists and there is nothing we can do about it because they have the buying power. Because of flipping, it’s a good rule not to buy shares of an IPO if you don’t get in on the initial offering. Many IPOs that have big gains on the first day will come back to earth as the institutions take their profits.

Avoid the Hype

It’s important to understand that underwriters are salesmen. The whole underwriting process is intentionally hyped up to get as much attention as possible. Since IPOs only happen once for each company, they are often presented as “once in a lifetime” opportunities. Of course, some IPOs soar high and keep soaring. But many end up selling below their offering prices within the year. Don’t buy a stock only because it’s an IPO - do it because it’s a good investment. Best examples of hype are NHPC & Adani Power when people are simply rushed to apply for the IPO & just see the results.

Tracking the Stock

Tracking stocks means when a large company de merges one of its divisions into a separate entity. The rationale behind the creation of tracking stocks is that individual divisions of a company will be worth more separately than as part of the company as a whole.

From the company’s perspective, there are many advantages to issuing a tracking stock. The company gets to retain control over the subsidiary but all revenues and expenses of the division are separated from the parent company’s financial statements and attributed to the tracking stock. This is often done to separate a high-growth division with large losses from the financial statements of the parent company. Most importantly, if the tracking stock rockets up, the parent company can make acquisitions with the subsidiary’s stock instead of cash.

While a tracking stock may be spun off in an IPO, it’s not the same as the IPO of a private company going public. This is because tracking stocks usually have no voting rights, and often there is no separate board of directors looking after the rights of the tracking stock. It’s like you’re a second-class shareholder! This doesn’t mean that a tracking stock can’t be a good investment. Just keep in mind that a tracking stock isn’t a normal IPO.

Conclusion:

So before investing in the IPO one should be very clear whether he would go for short term or long term investment. Than he should know in which company he is going to invest. Normally companies with good fundamentals won’t give better returns at the time of listing but over the period of time they would give good return so watch out for these types of companies also.

Fundamental of Stock Market: Tutorial-7

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Technical Analysis: Types of charts

There are four main types of charts that are used by investors and traders in order to determine the Trend of the Stocks.. The chart types are: the line chart, the bar chart, the candlestick chart and the point and figure chart. In these section we would introduced how these charts are formed.

1. Line Chart

The most basic of the four charts is the line chart because it represents only the closing prices over a set period of time. The line is formed by connecting the closing prices over the time frame. Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices. However, the closing price is often considered to be the most important price in stock data compared to the high and low for the day and this is why it is the only value used in line charts.

2. Bar Charts

The bar chart expands on the line chart by adding several more key pieces of information to each data point. The chart is made up of a series of vertical lines that represent each data point. This vertical line represents the high and low for the trading period, along with the closing price. The close and open are represented on the vertical line by a horizontal dash. The opening price on a bar chart is illustrated by the dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on the right. Generally, if the left dash (open) is lower than the right dash (close) then the bar will be shaded black, representing an up period for the stock, which means it has gained value. A bar that is colored red signals that the stock has gone down in value over that period. When this is the case, the dash on the right (close) is lower than the dash on the left (open).

3. Candlestick Charts

The candlestick chart is similar to a bar chart, but it differs in the way that it is visually constructed. Similar to the bar chart, the candlestick also has a thin vertical line showing the period’s trading range. The difference comes in the formation of a wide bar on the vertical line, which illustrates the difference between the open and close. And, like bar charts, candlesticks also rely heavily on the use of colors to explain what has happened during the trading period. A major problem with the candlestick color configuration, however, is that different sites use different standards; therefore, it is important to understand the candlestick configuration used at the chart site you are working with. There are two color constructs for days up and one for days that the price falls. When the price of the stock is up and closes above the opening trade, the candlestick will usually be white or clear. If the stock has traded down for the period, then the candlestick will usually be red or black, depending on the site. If the stock’s price has closed above the previous day’s close but below the day’s open, the candlestick will be black or filled with the color that is used to indicate an up day.

4. Point and Figure Charts

The point and figure chart is not well known or used by the average investor but it has had a long history of use dating back to the first technical traders. This type of chart reflects price movements and is not as concerned about time and volume in the formulation of the points. The point and figure chart removes the noise, or insignificant price movements, in the stock, which can distort traders’ views of the price trends. These types of charts also try to neutralize the skewing effect that time has on chart analysis.

When first looking at a point and figure chart, you will notice a series of Xs and Os. The Xs represent upward price trends and the Os represent downward price trends. There are also numbers and letters in the chart; these represent months, and give investors an idea of the date. Each box on the chart represents the price scale, which adjusts depending on the price of the stock: the higher the stock’s price the more each box represents. On most charts where the price is between $20 and $100, a box represents $1, or 1 point for the stock. The other critical point of a point and figure chart is the reversal criteria. This is usually set at three but it can also be set according to the chartist’s discretion. The reversal criteria set how much the price has to move away from the high or low in the price trend to create a new trend or, in other words, how much the price has to move in order for a column of Xs to become a column of Os, or vice versa. When the price trend has moved from one trend to another, it shifts to the right, signaling a trend change.

Conclusion

Charts are one of the most fundamental aspects of technical analysis. It is important that you clearly understand what is being shown on a chart and the information that it provides. Now that we have an idea of how charts are constructed, we can move on to the different types of chart patterns. Most of the traders are using Candlestick Patterns to predict the market movements but it’s all about depend on your comfortable level.

Fundamentals of Stock Market: Tutorial-6

Technical Analysis: What Is A Chart?

In this section we would provide information regarding charts i.e. basic definition of charts and its properties.

In technical analysis, charts are similar to the charts that you see in any business setting. A chart is simply a graphical representation of a series of prices over a set time frame. For example, a chart may show a stock’s price movement over a one-year period, where each point on the graph represents the closing price for each day the stock is traded:

Above Figure provides an example of a basic chart. It is a representation of the price movements of a stock over a 1.5 year period. The bottom of the graph, running horizontally (x-axis), is the date or time scale. On the right hand side, the prices of some script are running vertically (y-axis). By looking at the graph we see that in Point 1, the price of this stock was around 245, whereas in June 2005 (Point 2), the stock’s price is around 265. This tells us that the stock has risen between October 2004 and June 2005.

Chart Properties:

There are several things that you should be aware of when looking at a chart, as these factors can affect the information that is provided. They include the time scale, the price scale and the price point properties used.

The Time Scale

The time scale refers to the range of dates at the bottom of the chart, which can vary from decades to seconds. The most frequently used time scales are intraday, daily, weekly, monthly, quarterly and annually. The shorter the time frame, the more detailed the chart. Each data point can represent the closing price of the period or show the open, the high, the low and the close depending on the chart used.

Intraday charts plot price movement within the period of one day. This means that the time scale could be as short as five minutes or could cover the whole trading day from the opening bell to the closing bell.

Daily charts are comprised of a series of price movements in which each price point on the chart is a full day’s trading condensed into one point. Again, each point on the graph can be simply the closing price or can entail the open, high, low and close for the stock over the day. These data points are spread out over weekly, monthly and even yearly time scales to monitor both short-term and intermediate trends in price movement.

Weekly, monthly, quarterly and yearly charts are used to analyze longer term trends in the movement of a stock’s price. Each data point in these graphs will be a condensed version of what happened over the specified period. So for a weekly chart, each data point will be a representation of the price movement of the week. For example, if you are looking at a chart of weekly data spread over a five-year period and each data point is the closing price for the week, the price that is plotted will be the closing price on the last trading day of the week, which is usually a Friday.

The Price Scale and Price Point Properties:

The price scale is on the right-hand side of the chart. It shows a stock’s current price and compares it to past data points. This may seem like a simple concept in that the price scale goes from lower prices to higher prices as you move along the scale from the bottom to the top. The problem, however, is in the structure of the scale itself. A scale can either be constructed in a linear (arithmetic) or logarithmic way, and both of these options are available on most charting services.

If a price scale is constructed using a linear scale, the space between each price point (10, 20, 30, 40) is separated by an equal amount. A price move from 10 to 20 on a linear scale is the same distance on the chart as a move from 40 to 50. In other words, the price scale measures moves in absolute terms and does not show the effects of percent change.

If a price scale is in logarithmic terms, then the distance between points will be equal in terms of percent change. A price change from 10 to 20 is a 100% increase in the price while a move from 40 to 50 is only a 25% change, even though they are represented by the same distance on a linear scale. On a logarithmic scale, the distance of the 100% price change from 10 to 20 will not be the same as the 25% change from 40 to 50. In this case, the move from 10 to 20 is represented by a larger space one the chart, while the move from 40 to 50, is represented by a smaller space because, percentage-wise, it indicates a smaller move. In Figure 2, the logarithmic price scale on the right leaves the same amount of space between 10 and 20 as it does between 20 and 40 because these both represent 100% increases.

In the next section we would describe different types of the Charts and what would be the best methods to read the charts.

Fundamentals of Stock Market: Tutorial-5

Difference between technical & Fundamental analysis

Technical analysis and fundamental analysis are the two main attentions in the financial markets. Mainly, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals. Let’s see how it works to determine the correct value of stock and how technical and fundamental analysis can be used together to analyze securities. 

Charts vs. Financial Statements

At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company’s value. In financial terms, an analyst attempts to measure a company’s fundamental value. In this approach, investment decisions are fairly easy to make - if the price of a stock trades below its intrinsic value, it’s a good investment.

Technical traders, on the other hand, believe there is no reason to analyze a company’s fundamentals because these are all accounted for in the stock’s price. Technicians believe that all the information they need about a stock can be found in its charts.

Time approach for both the technique

Fundamental analysis takes a relatively long-term approach to analyzing the market compared to technical analysis. While technical analysis can be used on a timeframe of weeks, days or even minutes, fundamental analysis often looks at data over a number of years.

The different timeframes that these two approaches use is a result of the nature of the investing style to which they each adhere. It can take a long time for a company’s value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until the stock’s market price rises to its “correct” value. This type of investing is called value investing and assumes that the short-term market is wrong, but that the price of a particular stock will correct itself over the long run. This “long run” can represent a timeframe of as long as several years, in some cases.

Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of time. Financial statements are filed quarterly and changes in earnings per share don’t emerge on a daily basis like price and volume information. Also remember that fundamentals are the actual characteristics of a business. New management can’t implement sweeping changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term timeframe, therefore, is because the data they use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts.

Trading Versus Investing

Not only is technical analysis more short term in nature that fundamental analysis, but the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price. The line between a trade and an investment can be blurry, but it does characterize a difference between the two schools. Some analyst see technical analysis as a form of black magic. Don’t be surprised to see them question the validity of the discipline to the point where they mock its supporters. In fact, technical analysis has only recently begun to enjoy some mainstream credibility. While most analysts on Wall Street focus on the fundamental side, just about any major brokerage now employs technical analysts as well.

Much of the criticism of technical analysis has its roots in academic theory - specifically the efficient market hypothesis (EMH). This theory says that the market’s price is always the correct one - any past trading information is already reflected in the price of the stock and, therefore, any analysis to find undervalued securities is useless. 

There are three versions of EMH. In the first, called weak form efficiency, all past price information is already included in the current price. According to weak form efficiency, technical analysis can’t predict future movements because all past information has already been accounted for and, therefore, analyzing the stock’s past price movements will provide no insight into its future movements. In the second, semi-strong form efficiency, fundamental analysis is also claimed to be of little use in finding investment opportunities. The third is strong form efficiency, which states that all information in the market is accounted for in a stock’s price and neither technical nor fundamental analysis can provide investors with an edge. The vast majority of academics believe in at least the weak version of EMH, therefore, from their point of view, if technical analysis works, market efficiency will be called into question. (For more insight, read What Is Market Efficiency? and Working Through The Efficient Market Hypothesis.)

There is no right answer as to who is correct. There are arguments to be made on both sides and, therefore, it’s up to you to do the homework and determine your own philosophy.

Combo Pack?

Although technical analysis and fundamental analysis are seen by many as polar opposites - the oil and water of investing - many market participants have experienced great success by combining the two. For example, some fundamental analysts use technical analysis techniques to figure out the best time to enter into an undervalued security. Oftentimes, this situation occurs when the security is severely oversold. By timing entry into a security, the gains on the investment can be greatly improved.
Alternatively, some technical traders might look at fundamentals to add strength to a technical signal. For example, if a sell signal is given through technical patterns and indicators, a technical trader might look to reaffirm his or her decision by looking at some key fundamental data. Oftentimes, having both the fundamentals and technicals on your side can provide the best-case scenario for a trade.

While mixing some of the components of technical and fundamental analysis is not well received by the most devoted groups in each school, there are certainly benefits to at least understanding both schools of thought.

Fundamentals of Stock Market: Tutorial-4

Introduction to technical analysis

Earlier as we mentioned there are two methods to determine the price of stock: 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. Technical people are only interested in the price movements in the market.

Despite hundreds of tools, technical analysis just studies supply and demand in a market in an attempt to determine what direction, or trend, will continue in the future. In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components. If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor.

In this tutorial, we’ll introduce you to the subject of technical analysis. It’s a big topic, so we’ll just cover the basics, providing you with the foundation you’ll need to understand more advanced concepts down the road.

Definition of technical analysis

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

Just as there are many investment styles on the fundamental side, there are also many different types of technical traders. Some rely on chart patterns; others use technical indicators and oscillators, and most use some combination of the two. In any case, technical analysts’ exclusive use of historical price and volume data is what separates them from their fundamental counterparts. Unlike fundamental analysts, technical analysts don’t care whether a stock is undervalued - the only thing that matters is a security’s past trading data and what information this data can provide about where the security might move in the future.

The field of technical analysis is based on three assumptions:

1.     The market knows everything

2.     Price moves in trends.

3.     History tends to repeat itself.

4.     Market predicts the real economy before few months

1. The Market knows Everything

A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of the company. However, technical analysis assumes that, at any given time, a stock’s price reflects everything that has or could affect the company - including fundamental factors. Which means market knows the fundamental of the companies also it knows what’s going on inside the company. Technical analysts believe that the company’s fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market.

2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption.

3. History tends to repeat itself

Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends. Although many of these charts have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves.

Not Just for Stocks Technical analysis can be used on any security with historical trading data, this includes stocks, futures and commodities, fixed-income securities, forex, etc. In this tutorial, we usually analyze stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is more frequently associated with commodities and forex, where the participants are predominantly traders. Nowadays Institutes are spending billions of dollars on mathematical modeling which use various math techniques like regression, Curve fitting n differential equations to predict the market movements. Mathematical models are the future of technical analysis.

Now that you understand the philosophy behind technical analysis, we’ll get into explaining how it really works. One of the best ways to understand what technical analysis is (and is not) is to compare it to fundamental analysis. We’ll do this in the next section.

Visit EP Knowledge Center to gain full knowledge about basics of Stock Market and Technical Analysis.

Fundamentals of Stock Market: Tutorial-3

Types of Analysis:

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 movements in the market.

Despite all the fancy and exotic tools it employs, technical analysis really just studies supply and demand in a market in an attempt to determine what direction, or trend, will continue in the future. In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components. If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor.

In this tutorial, we’ll introduce you to the tools of fundamental analysis. It’s a broad topic, so we’ll just cover the basics, providing you with the foundation you’ll need to understand more advanced concepts down the road.

Tools of Fundamental Analysis:

Fundamental analysis is the process of looking at a business at the basic or fundamental financial level. This type of analysis examines key ratios of a business to determine its financial health and gives you an idea of the value its stock. Many investors use fundamental analysis alone or in combination with other tools to evaluate stocks for investment purposes. The goal is to determine the current worth and, more importantly, how the market values the stock. This article focuses on the key tools of fundamental analysis and what they tell you. Even if you don’t plan to do in-depth fundamental analysis yourself, it will help you follow stocks more closely if you understand the key ratios and terms.

The basic tools are:

 

1)         Earnings per Share – EPS

2)         Price to Earning Ratio (P/E Ratio)

3)         Projected Earning Growth – PEG

4)         Price to Sell – P/S

5)         Price to Book – P/B

6)         Dividend Payout Ratio

7)         Dividend Yield

         Book Value

9)         Return on Equity

No single number from this list is a magic bullet that will give you a buy or sell recommendation by itself, however as you begin developing a picture of what you want in a stock, these numbers will become benchmarks to measure the worth of potential investments.

1)  Earnings per Share – EPS:

EPS = Net Earnings / Outstanding Shares

Using our example above, Company A had earnings of Rs100 and 10 shares outstanding, which equals an EPS of 10 (Rs100 / 10 = 10). Company B had earnings of Rs100 and 50 shares outstanding, which equals an EPS of 2 (Rs100 / 50 = 2).

So, you should go buy Company A with an EPS of 10, right? Maybe, but not just on the basis of its EPS. The EPS is helpful in comparing one company to another, assuming they are in the same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some ratios.

2)  Price to Earning Ratio (P/E Ratio)

P/E = Stock Price / EPS

For example, a company with a share price of Rs 40 and an EPS of 8 would have a P/E of 5 (Rs40 / 8 = 5).

The P/E gives you an idea of what the market is willing to pay for the company’s earnings. The higher the P/E the more the market is willing to pay for the company’s earnings. Some investors read a high P/E as an overpriced stock and that may be the case, however it can also indicate the market has high hopes for this stock’s future and has bid up the price. Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean this is a sleeper that the market has overlooked. Known as value stocks, many investors made their fortunes spotting these “diamonds in the rough” before the rest of the market discovered their true worth.

What is the “right” P/E? There is no correct answer to this question, because part of the answer depends on your willingness to pay for earnings. The more you are willing to pay, which means you believe the company has good long term prospects over and above its current position, the higher the “right” P/E is for that particular stock in your decision-making process. Another investor may not see the same value and think your “right” P/E is all wrong

3)  Projected Earning Growth – PEG:

PEG = Price per Earnings / (projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 2 (30 / 15 = 2).

What does the “2” mean? Like all ratios, it simply shows you a relationship. In this case, the lower the number the less you pay for each unit of future earnings growth. So, even a stock with a high P/E, but high projected earning growth may be a good value. Looking at the opposite situation; a low P/E stock with low or no projected earnings growth, you see that what looks like a value may not work out that way. For example, a stock with a P/E of 8 and flat earnings growth equals a PEG of 8. This could prove to be an expensive investment.

A few important things to remember about PEG:

- It is about year-to-year earnings growth

- It relies on projections, which may not always be accurate

4)  Price to Sell – P/S:

P/S = Market Cap / Revenues

or

P/S = Stock Price / Sales Price per Share

Much like P/E, the P/S number reflects the value placed on sales by the market. The lower the P/S, the better the value, at least that’s the conventional knowledge. However, this is definitely not a number you want to use in isolation. When dealing with a young company, there are many questions to answer and the P/S supplies just one answer.

5)  Price to Book – P/B

Value investors use these indicators besides earnings growth. One of the metrics they look for is the Price to Book ratio or P/B. This measurement looks at the value the market places on the book value of the company. You calculate the P/B by taking the current price per share and dividing by the book value per share.

P/B = Share Price / Book Value Per Share

Like the P/E, the lower the P/B, the better the value. Value investors would use a low P/B is stock screens, for instance, to identify potential candidates.

6)  Dividend Payout Ratio:

You calculate the DPR by dividing the annual dividends per share by the Earnings per Share.

DPR = Dividends Per Share / EPS

For example, if a company paid out Rs1 per share in annual dividends and had Rs3 in EPS, the DPR would be 33%.The real question is whether 33% is good or bad and that is subject to interpretation. Growing companies will typically retain more profits to fund growth and pay lower or no dividends.

Companies that pay higher dividends may be in grown-up industries where there is little room for growth and paying higher dividends is the best use of profits (utilities used to fall into this group, although in recent years many of them have been diversifying).

Either way, you must view the whole DPR issue in the context of the company and its industry. By itself, it tells you very little.

7)  Dividend Yield:

If you are a value investor or looking for dividend income then there are a couple of measurements that are specific to you. For dividend investors, one of the telling metrics is Dividend Yield. This measurement tells you what percentage return a company pays out to shareholders in the form of dividends. Older, well-established companies tend to payout a higher percentage then do younger companies and their dividend history can be more consistent.

You calculate the Dividend Yield by taking the annual dividend per share and divide by the stock’s price.

Dividend Yield = annual dividend per share / stock’s price per share

For example, if a company’s annual dividend is Rs1.50 and the stock trades at RS25, the Dividend Yield is 6%.

  Book Value:

One way to determine a company’s value is to go to the balance statement and look at the Book Value. The Book Value is simply the company’s assets minus its liabilities.

Book Value = Assets - Liabilities

In other words, if you wanted to close the doors, how much would be left after you settled all the outstanding obligations and sold off all the assets. A company that is a viable growing business will always be worth more than its book value for its ability to generate earnings and growth.

Book value appeals more to value investors who look at the relationship to the stock’s price by using the Price to Book ratio.

To compare companies, you should convert to book value per share, which is simply the book value divided by outstanding shares.

9)  Return on Equity:

Return on Equity (ROE) is one measure of how efficiently a company uses its assets to produce earnings. You calculate ROE by dividing Net Income by Book Value. A healthy company may produce an ROE in the 13% to 15% range. Like all metrics, compare companies in the same industry to get a better picture.

While ROE is a useful measure, it does have some flaws that can give you a false picture, so never rely on it alone. For example, if a company carries a large debt and raises funds through borrowing rather than issuing stock it will reduce its book value. A lower book value means you’re dividing by a smaller number so the ROE is artificially higher. There are other situations such as taking write-downs, stock buy backs, or any other accounting slight of hand that reduces book value, which will produce a higher ROE without improving profits.

It may also be more meaningful to look at the ROE over a period of the past five years, rather than one year to average out any abnormal numbers.

Given that you must look at the total picture, ROE is a useful tool in identifying companies with a competitive advantage. All other things roughly equal, the company that can consistently squeeze out more profits with their assets, will be a better investment in the long run.

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Fundamental of Stock Market: Tutorial-2

How Stocks Trade & how price movement take place

Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. In the beginning most exchanges are physical locations where transactions are carried out on a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically. Most of the markets use this type of trading only.

The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. Really, a stock market is nothing more than a super-sophisticated farmers’ market linking buyers and sellers.

Before we go on, we should know the difference between the primary market and the secondary market. The primary market is where securities are created (by means of an IPO) while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies. The secondary market is what people are referring to when they talk about the stock market. It is important to understand that the trading of a company’s stock does not directly involve that company.

Stock prices change every day as a result of market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall.

Understanding supply and demand is easy. What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and just about any investor you ask has their own ideas and strategies.

That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth. Don’t equate a company’s value with the stock price. The value of a company is its market capitalization, which is the stock price multiplied by the number of shares outstanding. For example, a company that trades at Rs100 per share and has 1 million shares outstanding has a lesser value than a company that trades at Rs 50 that has 5 million shares outstanding (RS100 x 1 million = Rs100 million while Rs50 x 5 million = Rs 250 million). To further complicate things, the price of a stock doesn’t only reflect a company’s current value; it also reflects the growth that investors expect in the future.

The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, it isn’t going to stay in business. Public companies are required to report their earnings four times a year (once each quarter). Market watches with extreme attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection. If a company’s results surprise (are better than expected), the price jumps up. If a company’s results disappoint (are worse than expected), then the price will fall.

Of course, it’s not just earnings that can change the sentiment towards a stock (which, in turn, changes its price). It would be a rather simple world if this were the case! During the dotcom bubble, for example, dozens of internet companies rose to have market capitalizations in the billions of dollars without ever making even the smallest profit. As we all know, these valuations did not hold, and most internet companies saw their values shrink to a fraction of their highs. Still, the fact that prices did move that much demonstrates that there are factors other than current earnings that influence stocks. Investors have developed literally hundreds of these variables, ratios and indicators. Some you may have already heard of, such as the price/earnings ratio, while others are extremely complicated and obscure with names like Chaikin oscillator or moving average convergence divergence.

So, why do stock prices change? The best answer is that nobody really knows for sure. Some believe that it isn’t possible to predict how stock prices will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know is that stocks are volatile and can change in price extremely rapidly.

The important conclusion grasp about this subject are the following:

• At the most fundamental level, supply and demand in the market determines stock prices. 

•  Price times the number of shares outstanding (market capitalization) is the value of a company. Comparing just the share price of two companies is meaningless.

• Theoretically, earnings are what affect investors’ valuation of a company, but there are other indicators that investors use to predict stock price. Remember, it is investors’ sentiments, attitudes and expectations that ultimately affect stock prices.

• There are many theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything.

Visit EP Knowledge Center to gain full knowledge about basics of Stock Market and Technical Analysis.

Many of our readers and Paid subscribers often ask about the fundamentals of Stock market. Here we came with a new section EquityPandit.com Knowledge Center. EP Knowledge Center is a collection of few tutorials which would give you some basics about stock market and Technical analysis. These tutorials would be added every Sunday. The fundamentals remain same for every stock market in the world. Today in the first article we would like to explain the History of Indian Stock Market.

Fundamentals of Stock Market: Tutorial-1

History of Indian Stock Exchange:

The Bombay Stock Exchange (BSE) is known as the oldest exchange in Asia. It traces its history to the 1850s, when stockbrokers would gather under banyan trees in front of Mumbai’s Town Hall. The location of these meetings changed many times, as the number of brokers constantly increased. The group eventually moved to Dalal Street in 1874 and in 1875 became an official organization known as ‘The Native Share & Stock Brokers Association’. In 1956, the BSE became the first stock exchange to be recognized by the Indian Government under the Securities Contracts Regulation Act.

The Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE a means to measure overall performance of the exchange. In 2000 the BSE used this index to open its derivatives market, trading Sensex futures contracts. The development of Sensex options along with equity derivatives followed in 2001 and 2002, expanding the BSE’s trading platform.

Historically an open-cry floor trading exchange, the Bombay Stock Exchange switched to an electronic trading system in 1995. It took the exchange only fifty days to make this transition.

Capital market reforms in India and the launch of the Securities and Exchange Board of India (SEBI) accelerated the integration of the second Indian stock exchange called the National Stock Exchange (NSE) in 1992. After a few years of operations, the NSE has become the largest stock exchange in India.

Three segments of the NSE trading platform were established one after another. The Wholesale Debt Market (WDM) commenced operations in June 1994 and the Capital Market (CM) segment was opened at the end of 1994. Finally, the Futures and Options segment began operating in 2000. Today the NSE takes the 14th position in the top 40 futures exchanges in the world.

In 1996, the National Stock Exchange of India launched S&P CNX Nifty and CNX Junior Indices that make up 100 most liquid stocks in India. CNX Nifty is a diversified index of 50 stocks from 25 different economy sectors. The Indices are owned and managed by India Index Services and Products Ltd (IISL) that has a consulting and licensing agreement with Standard & Poor’s.

In 1998, the National Stock Exchange of India launched its web-site and was the first exchange in India that started trading stock on the Internet in 2000. The NSE has also proved its leadership in the Indian financial market by gaining many awards such as ‘Best IT Usage Award’ by Computer Society in India (in 1996 and 1997) and CHIP Web Award by CHIP magazine (1999).

Visit EP Knowledge Center to gain full knowledge about basics of Stock Market and Technical Analysis.