Investment Analysis and

Portfolio Management
Unit – 3
FUNDAMENTAL AND TECHNICAL ANALYSIS
Unit - 3 Fundamental and Technical Analysis:
Economy, Industry and Company Analysis,
Fundamental Analysis, Technical Analysis –
Chart types, techniques and importance. Dow
Theory, Efficient Market Hypothesis – Strong,
Weak and Semi Strong Efficiency in Markets,
Behavioural Finance.
FUNDAMENTAL ANALYSIS
Fundamental analysis (FA) measures a security's intrinsic value by examining related economic
and financial factors. Intrinsic value is the value of an investment based on the issuing
company's financial situation and current market and economic conditions.

Fundamental analysts study anything that can affect the security's value, from macroeconomic
factors such as the state of the economy and industry conditions to microeconomic factors like
the effectiveness of the company's management.

The end goal is to determine a number that an investor can compare with a security's current
price to see whether the security is undervalued or overvalued by other investors.
Fundamental analysis is a method of determining a stock's real or "fair market" value.

Fundamental analysts search for stocks currently trading at prices higher or lower than
their real value.

If the fair market value is higher than the market price, the stock is deemed
undervalued, and a buy recommendation is given.

If the fair market value is lower than the market price, the stock is deemed overvalued,
and the recommendation might be not to buy or to sell if the stock is held.

In contrast, technical analysts favor studying the historical price trends of the stock to
predict short-term future trends.
Economic Analysis
Economic analysis refers to the systematic examination and evaluation of various economic factors, trends, and
data to gain a better understanding of the functioning and performance of an economy. It involves the study of
both macroeconomic and microeconomic aspects of an economy. Here are key components of the concept of
economic analysis:
• Macroeconomic Analysis: This aspect of economic analysis focuses on the broader factors that influence an
entire economy. It includes the examination of indicators such as Gross Domestic Product (GDP), inflation,
unemployment rates, interest rates, fiscal and monetary policies, and international trade dynamics.
• Microeconomic Analysis: Microeconomic analysis deals with the study of individual economic agents, such
as firms, households, and industries. It explores factors like market structures, supply and demand, pricing,
competition, and consumer behavior.
• Data and Metrics: Economic analysis relies on collecting and analyzing economic data and metrics, often
presented through various economic indicators and reports. These data sources help in tracking economic
performance and identifying trends.
• Forecasting and Predictions: Economic analysis is used for making predictions and forecasts about future
economic conditions, which can be valuable for businesses, investors, policymakers, and government
institutions.
Macroeconomic Analysis
▪ Global Economy Analysis

• affects export, price competition and profits

• exchange rate: purchasing power and earnings

▪ Domestic Economy

• The ability to forecast the macroeconomy can translate into great investment performance outperform other
analysts to earn extra profits

▪ Many variables can affect economy

▪ Gross Domestic Product (GDP): measures the economy’s total output of goods and services

▪ Employment rate: measures the extent that the economy is operating at full capacity

▪ Inflation: measures the general level of prices increase Phillip’s curve

▪ Interest Rate: high interest rate reduces PV of cashflows, thus stock values

▪ Budget Deficit: large deficit means more borrowing, which implies higher interest rate.

▪ Sentiment: consumers and producers confidence

Significance of Informed
Decision

Economic Making

Consumer Policy
Analysis Behaviour Formulation

Job Market Economic Investment

and Labor
Analysis Decisions
Forces

International Risk
Trade Management

Market
Analysis
Types of Fundamental Analysis
1. Qualitative analysis
Qualitative analysis involves the study of a company’s goodwill, consumer behavior, demand,
and company recognition in broader markets. It aims to unearth answers to questions like how it
is perceived, how management decisions or announcements create a buzz in the market, and
how it is different from its substitutes. In addition, its brand value and other common factors
depict its socio and economic position in the market.
2. Quantitative analysis
Quantitative analysis is inclined towards statistics, reports, and data. It is solely based on its
financial statements, quarterly performance, balance sheets, debt, cash flow, etc. It involves
analyzing numbers, ratios, and values to understand the price of the shares and the company’s
overall financial health.
Procedure for Fundamental Analysis

Understanding the macro-economic environment

and developments

Analysing the prospects of the industry to which

the firm belongs

Assessing the projected performance of the

company and the intrinsic value of its shares
 Key Economic Indicators
1. Gross Domestic Product (GDP)
• The measure of the economy’s total production of goods and services
• Rapidly growing GDP indicates an expanding economy with ample opportunity for a firm to increase sales
• Another economy’s output measure is industrial production - a measure of economic activity narrowly focused on the manufacturing
side of the economy
2. Employment
• Unemployment rate is the percentage of the total labor force (those who are working or seeking employment) to find work
• The rate measures the extent to which the economy is operating at full capacity
• Analysts also look at the factor capacity utilization rate, which is the ratio of actual output from factories to potential output
3. Inflation
• Inflation is the rate at which the general level of prices is rising
• High rates of inflation are associated with overheated economies, where demand for goods and services is outstripping productive
capacity, which leads to upward pressure on prices
• Government stimulates their economies enough to maintain nearly full employment, but not so much as to bring on inflationary
pressure
 4. Interest rates
• High interest rates reduce the present value of future cash flows, reducing the attractiveness of investment opportunities
• Real interest rate is key determinant of business investment expenditures
• Demand for housing & high-priced consumer durables such as automobiles, is highly sensitive to interest rates because interest rates affect interest
payments

5. Budget deficit
• Budget deficit of the government is the difference between government spending and revenues
• Any budgetary shortfall must be offset by government borrowing
• Large amounts of government borrowing can force up interest rates by increasing the total demand for credit in the economy
• Economists generally believe excessive government borrowing will crowd out private borrowing and investing by forcing up interest rates and choking
off business investment

6. Sentiment
• Consumers’ and producers’ optimism or pessimism concerning the economy is an important determinant of economic performance
• If consumers have confidence in their future income levels, they will be more willing to spend on big-ticket items
• Business will increase production and inventory levels if they anticipate higher demand for their products
 CENTRAL GOVERNMENT POLICY
1. Fiscal policy
• It refers to the government’s spending & tax actions

• It is part of demand-side management, a direct way to stimulate or slow the economy

• Decrease in government spending deflate the demand for goods and services

• Increase in tax immediately drain off income of consumers and result in rapid decrease in consumption

• It is created slowly because fiscal policy requires large amount of compromise between executive & legislative institutions

• To summarize the impact of government fiscal policy - look at the government’s budget deficit or surplus (it is simply difference between revenues and expenditures)

• Large deficit = government spends more than it should be taken. The effect is the increasing demands for goods (via spending)

2. Monetary policy
• Refers to the manipulation of the money supply to affect the macro economy

• Works largely through its impact on interest rates

• Increases in money supply lower short-term interest rate, encouraging investment and consumption demand

• However, higher money supply leads to a higher price level, and does not have a permanent effect on economic activity

• other tool is the discount/interest rate that charges banks on short-term loans and the reserve requirement
Company Analysis
An company analysis is a study of the variables which influence the future price of a company’s
shares. It is an assessment of company’s competitive position, earning capacity and
profitability. It is a method of finding out the intrinsic value of a company’s share. This requires
internal as well as external information of the company. Internal investment consists of data
and events of the company. External information consists of demand, supply, pricing, etc.
The basic financial statements which are used as tools of company analysis are the income
statement, the balance sheet and the statement of changes in financial position. The accuracy
of financial statement can be identified from the report of auditors. The most frequently used
tools for company analysis are as follows:
1. Trend analysis
2. Ratio analysis
3. Fund flow analysis
4. Common size statement analysis
5. Technical analysis
TREND ANALYSIS
It is a dynamic method of analysis showing the changes over a period of time. It makes easy to
understand the changes in an item over a period of time and to draw conclusion regarding the
changes in data. The trend should be studied at least over a period of 5 years. It indicates a
direction in which a concern is going and on this basis forecast for future can be made.
RATIO ANALYSIS
Balance Sheet Ratios

Current ratio: Current ratio is also known as solvency ratio or working capital ratio. Standard
current ratio is 2:1 current ratio indicates the short-term financial position of the firm. It is
expressed as pure ratio.

It is calculated as:
Current ratio = Current assets/ Current liabilities
Current Assets Current Liabilities
Debtors Creditors
Cash and bank balance Bills payable
Bills receivable Outstanding expenses
Stock Bank overdraft
Prepaid expenses
Quick ratio: Quick ratio is also known as liquidity ratio or acid ratio. Standard quick ratio is 1:1
greater the ratio, stronger the financial position. It indicates the solvency and financial soundness
of the business. It is expressed as pure ratio.
It is calculated as:
Quick ratio = Quick assets/Quick liabilities

Quick Assets Quick Liabilities

Debtors Creditors
Cash and bank balance Bills payable
Bills receivable Outstanding expenses
Debt assets ratio: This ratio indicates the percentage or the proportion of the total assets created by the
company through short-term and long-term debt.
It can be calculated as:
Debt assets ratio = Debt / Assets
where, Debt= all liabilities including the short-term or long-term, Assets = all assets, i.e., fixed and
current.

Debt equity ratio: It shows the proportion of debt to assets. It is expressed pure ratio.
It can be calculated as:
Debt equity ratio = Debt/ Equity
where, Debt= all liabilities including long-term and short-term Equity = net worth + preference capital.
Stock to working capital ratio: Stock to working capital ratio express the relationship between closing
stock and working capital. This ratio expressed as pure ratio or percentage ratio.
It can be calculated as:
Stock to working capital = Closing stock/Working capital x 100
Proprietors’ ratio: This ratio indicates the proportion of proprietors’ funds to the total assets of the firm.
It can be calculated as:
Proprietors’ ratio = Proprietors' funds/ Total assets
Capital gearing ratio: This ratio includes the relation between fixed income bearing securities to funds
on which no fixed returns are to be paid. It is expressed as pure ratio.
It can be calculated as:
Capital gearing ratio = Preference capital + Debentures + Term loans/ Equity share capital + Reserves and
surplus
TECHNICAL ANALYSIS
▪ Technical analysis is a study of market data in terms of factors affecting supply and demand schedules, such as prices,
volume of trading, etc. It is a simple and quick method of forecasting behaviour of share prices.

▪ The financial data and past behaviour of share price of a company are presented on charts and graphs in order to find
out the history of price movements.

▪ It helps to explain and forecast changes in share prices.

▪ Technical analysis provides a simplified picture of price behaviour of a share. The analysis believe that the price of the
share depends upon the supply and demand in the stock market. They get the important information about price and
volume of a share in the stock market.

▪ Investors, who use technical analysis, start checking the market action of the share if it is favourable. They also
examine the fundamental factors about the company and make sure that the company is sound and profitable.
 Key Assumptions to Technical Analysis

https://www.youtube.com/watch?v=37wji6rGKo4&list=PLX2SHiKfualH_xMbGM-3zWC4
7s9gUjGR_&index=5
Key Assumptions of Technical Analysis
The price of security is related to demand and supply factors operating in the
market.

There are rational as well as irrational factors which affects the supply and
demand factors of a security.

The prices of securities behave in a manner that their movement is continuous in a

particular direction for some length of time.

Trends in the price of securities have been seen to change when there is a shift in
the demand and supply factors.

Whenever there are shifts in demand and supply, they can be detected through
charts prepared specially to show the action of the market.
FUNDAMENTAL Vs TECHNICAL ANALYSIS

https://www.youtube.com/shorts/WxGJ5YozMQg
 Line Charts
The line chart has the stock price or trading volume information on the vertical or y-axis and the corresponding time period
on the horizontal or x-axis). Trading volumes refer to the number of stocks of a company that were bought and sold in the
market on a particular day. The closing stock price is commonly used for the construction of a line chart.

Once the two axes have been labelled, preparation of a line chart is a two-step process. In the first step, you take a
particular date and plot the closing stock price as on that date on the graph. For this, you’ll put a dot on the chart in such a
way that it is above the concerned date and alongside the corresponding stock price.

Let’s suppose that the closing stock price on December 31, 2014 was Rs 120. For plotting it, you’ll put a dot in such
a way that it is simultaneously above the marking for that date on the x-axis, and alongside the mark that says Rs
120 on the y-axis. You will do this for all dates. In the second step, you will connect all the dots plotted with a line.
That’s it! You have your line chart.
 Bar Charts
A bar chart is similar to a line chart. However, it is much more informative. Instead of a dot, each marking
on a bar chart is in the shape of a vertical line with two horizontal lines protruding out of it, on either side.
The top end of each vertical line signifies the highest price the stock traded at during a day while the bottom
point signifies the lowest price at which it traded at during a day. The horizontal line to the left signifies the
price at which the stock opened the trading day. The one on the right signifies the price at which it closed
the trading day. As such, each mark on a bar chart tells you four things. An illustration of the marks used on
a bar chart is given below:

A bar chart is more advantageous than a line chart

because in addition to prices, it also reflects price
volatility. Charts that show what kind of trading
happened that day are called Intraday charts. The
longer a line is, the higher is the difference between
opening and closing prices. This means higher
volatility.
 Candlestick Charts

Candlestick charts give the same information as bar charts. They only offer it in a better way. Like a bar
chart is made up of different vertical lines, a candlestick chart is made up of rectangular blocks with
lines coming out of it on both sides. The line at the upper end signifies the day’s highest trading price.
The line at the lower end signifies the day’s lowest trading price. The day’s trading can be shown in
Intraday charts. As for the block itself (called the body), the upper and the lower ends signify the day’s
opening and closing price. The one that is higher of the two, is at the top, while the other one is at the
bottom of the body.

What makes candlestick charts an improvement over bar charts is that they give information about
volatility throughout the period under consideration. Bar charts only display volatility that occurs within
each trading day. Candles on a candlestick chart are of two shades-light and dark. On days when the
opening price was greater than the closing price, they are of a lighter shade (normally white). On days
when the closing price was higher than the opening price, they are of a darker shade (normally black). A
single day’s trading is represented by Intraday charts. Higher the variation in colour, more volatile was
the price during the period. The appearance of candles on a candlestick chart is as follows:
DOW JONES THEORY

https://www.youtube.com/watch?v=YD-7lWtaKlc
DOW JONES THEORY
Dow theory proposed by Charles Dow is one of the oldest technical method which has been widely used.
The theory consists of three types of market movement:
(a) the major/ primary market trend,
(b) secondary intermediate trend and,
(c) minor movements
The major market trends last a year or more, the intermediate trends lasts for few months and minor
movements lasts only for hours to a few days. The determination of the major market trends is the most
important decision to the dow believer. The Dow theory is built upon the assertion that measures of stock
market tends to move together. It asserts that stock prices demonstrate patterns over four to five years and
these patterns are mirrored by indices of stock prices. The Dow theory implies two of the Dow Jones
averages, the industrial average is rising, then the transportation average should also be rising. Such
simultaneous price movements suggest the bull market. On the other hand, a decline in both the averages
are moving in opposite directions, the market is uncertain as to direction of future prices.
Dow Jones Theory
If investors believe in Dow theory, they will try to liquidate when a sell signal becomes apparent
which will drive down prices. Buy signals have the opposite effect. However, there are several
problems of Dow theory. It is not a theory but the interpretation of known data. It does not
explain why the two averages should be able to forecast future stock prices. There may
considerable lag between actual turning points and those indicated by the forecast. Again Dow
theory, can work only when a long wide upward or downward movement is registered in the
market. The theory does not attempt to explain a consistent patterns of the stock price
movements.
 Principles of Dow Jones Theory
1. The market discounts everything
2. The market has three trends:
• Primary/Major Market trends
• Secondary Market trends
• Minor Market trends

3. Market trends have three phases

• Accumulation phase
• Public Participation phase
• Distribution phase
4. The indices must confirm each other for a trend to be established
5. The trading volume must conform with the price trends
6. Trends persist until there is a clear reversal
Efficient Market Hypothesis
•The efficient market hypothesis (EMH) or theory states that share prices reflect
all information.
•The EMH hypothesizes that stocks trade at their fair market value on exchanges.
•Proponents of EMH posit that investors benefit from investing in a low-cost,
passive portfolio.
•Opponents of EMH believe that it is possible to beat the market and that stocks
can deviate from their fair market values.
Efficient Market Hypothesis
Efficient market hypothesis or EMH is an investment theory which suggests that
the prices of financial instruments reflect all available market information.
Hence, investors cannot have an edge over each other by analysing the stocks
and adopting different market timing strategies. According to this theory
developed by Eugene Fama, investors can only earn high returns by taking more
significant risks in the market.
Efficient Market Hypothesis :
Assumptions
• Stocks are traded on exchanges at the fair market values.

• This theory assumes that the market values of the stocks represent all the

available information.

• It also assumes that investors are not capable of outperforming the market

since they have to make decisions based on the same available information.
Efficient Market Hypothesis
https://www.youtube.com/watch?v=NPuXzpZLefk
Behavioral Finance
Behavioral finance is a field of study that combines elements of psychology with
traditional economics to understand how individuals make financial decisions. It
recognizes that people don't always act rationally when it comes to money, and
seeks to identify and understand the psychological factors that influence their
behavior.

One of the key premises of behavioral finance is that investors are not always
perfectly rational and often make decisions based on emotions, biases, and
cognitive errors. These irrational behaviors can lead to market anomalies,
bubbles, and crashes that traditional economic models struggle to explain.
Common Concepts of Behavioral
Finance
▪ Loss aversion: The tendency for people to strongly prefer avoiding losses over
acquiring gains of the same magnitude.
▪ Overconfidence: People's tendency to overestimate their knowledge, abilities,
and the accuracy of their predictions.
▪ Anchoring: The tendency to rely too heavily on the first piece of information
encountered when making decisions.
▪ Herd behavior: The tendency for individuals to follow the actions of the
majority, often leading to market trends that defy rationality.
▪ Confirmation bias: The tendency to search for, interpret, favor, and recall
information in a way that confirms one's preexisting beliefs or hypotheses.