NISM Series XV - Research Analyst Certification Exam PDF

NISM SERIES XV - RESEARCH ANALYST CERTIFICATION EXAM  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN NISM XV – RESEARCH ANALYST...

NISM SERIES XV - RESEARCH ANALYST CERTIFICATION EXAM  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN NISM XV – RESEARCH ANALYST CERTIFICATION EXAMINATION SHORT NOTES BY PASS4SURE.IN I. Introduction To Research Analyst Profession Who is a Research Analyst? Research Analysts help their clients take investment decisions. Let us try to understand this with an example. Imagine you've decided to buy a new phone. What would be your process of selection? For the price range decided, you would short list a set of brands, compare various technical Specifications and depending upon what factors are important to you - whether it’s the Battery-life or the megapixels of camera, you take the decision. This process is very similar to Research Analysts. There is Research (collection of information from various sources) and then Analysis (processing of data to take decisions). To conclude, role of a research analyst is that of a selector - to do a comprehensive study of Companies evaluate their past performance; analyze how a company is expected to perform in future and make recommendations based on this analysis. Research Analysts are defined by the nature of analysis they do and whom they are serving to. Following are the three main types of Research Analysts. Types of Research Analysts Sell-Side Analysts: They typically publish research reports on the securities of companies or Industries with specific recommendation to buy, hold, or sell the same. Buy-Side Analysts: They generate recommendation reports for their internal consumption for and within money managers like mutual funds, hedge funds, pension funds, or portfolio managers Independent Analysts: They work for research firms separate from full service investment firms and sell their research to others on a subscription basis. They also provide customized research reports on specific requests. Apart from these three main categories, entities such as newspapers, media and consolidators of information also provide research reports.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Primary Responsibilities of a Research Analyst: Research Analysts’ primary role is to understand and evaluate the growth of industries and companies. Let us briefly look into the aspects which the Research Analysts have to deal with: Understanding economy: Changes in various macro-economic factors, Fiscal and Monetary Policies and their impact on the economy, FDI and FPI, Savings and investment patterns, Global factors, Import and Exports. Understanding Companies: This includes the analyzing companies based on their approach towards business. Based on their styles, product configuration, business model, customers segment, their financials the companies are studied by analysts in two dimensions - Qualitatively and Quantitatively. Important Qualities of a Research Analyst: ❖ Good with numbers ❖ Good Excel/spreadsheet and other data analytical tools ❖ Clarity in financial concepts ❖ Ability to read and comprehend financial statements and reports ❖ Ability to ask pertinent questions ❖ Attention to details ❖ Communication Skills – Written and Verbal II. Introduction To Securities Market Constituents of Securities Market Investors. Example: Retails investors, Mutual Funds. Borrowers/Seekers of funds. Example: Banks, Companies Intermediaries: Stock Brokers, Merchant Banks, Investment Banks Regulatory bodies: RBI, SEBI, AMFI  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Various Financial Instruments/Products: Equity Shares Equity shares are the shares that public companies issue to the public as the main source of long-term financing. They are units of ownership in the company. Debentures/Bonds/ Notes Debenture and bonds are issued by government and companies to raise capital. It is a loan which is issued at the fixed interest depending upon the reputation of the companies. When companies need to borrow some money to expand themselves they take the help of debentures. Foreign Currency Bonds Foreign currency bonds are bonds issued by a company in a currency that is different from the currency of its home country. Companies in emerging markets may prefer to issue bonds in USD or currencies of other economically matured countries as they carry significantly lower interest rates. External Bonds/ Masala Bonds External bonds, also referred as Euro bonds, are bonds issued in a currency that is different from the currency of the country in which it is issued. External bonds denominated in Indian rupees (INR) are referred as Masala bonds. These bonds are issued outside of India but are denominated in Indian Rupees. Warrants and convertibles Convertibles and warrants are long-term securities which can be changed into another type of security, such as common stock. These get converted into a whole new security at the end of their initial maturity. Indices A stock market index is a statistical measure which shows changes taking place in the stock market. The value of the stock market index is computed using values of the underlying stocks. In this way, a stock index reflects overall market sentiment and direction of price movements of the markets. Mutual Funds A mutual fund is formed when capital collected from different investors is invested in company shares, stocks or bonds. Shared by thousands of investors (including you), a mutual fund is managed collectively to earn the highest possible returns. The person driving this investment vehicle is a professional fund manager.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Preference Shares Preference shares, more commonly referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. They usually do not hold any voting rights. IDR’s, GDR’s ADR’s A depository receipt is where a certificate is issued by a depository bank, which purchases shares of foreign companies, creates a security on a local exchange backed by those shares. These instruments are used by large companies to raise money in the foreign markets. FCCB (Foreign Currency Convertible Bonds) A FCCB is a type of convertible bond issued in a currency different than the issuer's domestic currency. The money being raised by the issuing company is in the form of a foreign currency. It is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. Equity and Commodity Linked Debentures Equity Linked Debentures (ELDs) are floating rate debt instruments whose interest relies on the returns of the underlying equity asset such as S&P Sensex, individual stocks, Nifty 50 or any customized basket of individual stocks. Similarly, CLDs are floating rate debt instruments whose interest relies on the returns of the underlying commodity asset. Mortgage Backed Securities A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') which is secured by a mortgage or collection of mortgages. The mortgages are sold to a group of individuals (a government agency or investment bank) that securitizes, or packages, the loans together into a security that investors can buy. REITs/ InvITs Real Estate Investment Trust (REITs) and Infrastructure Investment Trusts (InvITs) are investment vehicles that pool money from various investors and invest in revenue generating real estate projects and infrastructure projects, respectively. Commodities Commodities are basic materials or goods that are largely homogenous in nature. These goods are interchangeable with other goods of the same type. Commodities may be hard or soft. Hard commodities are essentially natural resources that are mined or extracted. This includes all types of metals and crude oil. Soft commodities on the other hand refer to commodities that are grown i.e. agricultural products. Soft commodities include grains and pulses.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Precious Metals Precious metals such as gold and silver are viewed as an investment that can help preserve real value of money. Unlike many other commodities that have short life, these precious metals have very long life. Commodity ETFs Commodity ETF is an exchange traded fund that invests the pooled investment in a range of physical commodities. Investors can invest in commodity ETF by buying the units of the fund. Although commodity ETFs can be created for any set of commodities, Gold ETFs are the most common commodity Managed Future Contract Futures contract is a contract to buy or sell an asset at specified future date at a specific price. Since the price of the contract is pre-determined, the buyer of the contract tends to gain if the price of the product increases in future (the reverse is also true). Thus, an investor can gain out of price rise without buying the product. Warehouse Receipts Warehouse receipt is a document that shows proof of ownership of goods that are stored in a warehouse. Most of these warehouse receipts are negotiable. Thus, the title to the underlying goods can be transferred by simply transferring the receipts. Structure of Market & Issue of New Securities Primary Market Secondary Market Methods of Issue of securities:- Further Divided to 1) IPO 2) FPO Over the counter 3) Private Placement Markets (OTC) 4) Qualified Institutional Placement (QIP) 5) Preferential Issue 6) Rights Issue 7) Bonus Issue Exchange Regulated 8) Onshore & Offshore Offerings Market 9) Offer For Sale (OFS) 10) Sweat Equity 11) Employee Stock Option Scheme (ESOP)  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Three types of Participants in Financial Markets 2. INSTITUTIONAL PARTICIPANTS 1. MARKET INTERMEDIARIES Foreign Portfolio Investors Stock Exchanges P Note Participants Depositories Mutual Funds Depository Participant Insurance Companies Trading Members/ Stock Brokers/ Sub- Pension Funds Brokers Venture Capital Funds Authorised Person Private Equity Firms Custodians Hedge Funds Clearing Corporations Alternative Investment Funds – Three Merchant Banks Categories ( I, II & III) Underwriters Investment Advisors Employee Provident Fund (EPF) National Pension Scheme (NPS) Family Offices Corporate Treasuries 3. RETAIL PARTICIPANTS 4. PROXY ADVISORY SERVICES FIRMS Kinds Of Transactions Cash, Tom and Spot Trades/Transactions A cash/spot transaction is an agreement between two parties to carry out a trade at the prevailing market price for settlement on the spot date. The exchange rate at which the transaction is done is called the spot exchange rate. Forward Contract A forward contract is a un- regulated OTC traded customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non- standardized nature makes it particularly apt for hedging. Futures Future contracts are regulated derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price. Here, the buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date. Options Options are financial instruments that are derivatives or based on underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to. They are further divided to Call and Put Options.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Swaps A swap is a derivative in which two counter parties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. Trading, The buying and selling of financial instruments with an objective to earn profit on them is called trading. Hedging Hedging means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another. Technically, to hedge you would invest in two securities with negative correlations. Arbitrage Arbitrage is the simultaneous purchase and sale of an asset to profit from an imbalance in the price. It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Pledging of Shares Pledging of shares means taking loans against the shares that one holds.This is a way for the promoters of a company to get loans to meet their business or personal requirements by keeping their shares as collateral to lenders. Modes Of Holding ▪ Dematerialization ( Electronic Form) With the age of computers and the Depositories, securities no longer need to be in certificate form. They can be registered and transferred electronically. The electronic storage of securities is called Demat form. ▪ Rematerialized Form (Physical Form) Shares are units of ownership interest in a corporation or financial asset that provide for an equal distribution in any profits. Rematerialized shares are physical paper stock certificates. They have been replaced with electronic recording of stock shares, THESE ARE SHORT NOTES BASED ON THE NISM BOOK TO GET THE UPDATED QUESTION BANK WHICH CONTAIN RECENT IMP Q&As WITH EXPLANATIONS, PLEASE VISIT WWW.PASS4SURE.IN OVER 96% PASS OUT RATIO !!  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN III. Terminologies in Equity And Debt Market Important Terminologies (Equity Market) Face Value Face value is the nominal value of a security stated by the issuer. For stocks, it is the original cost of the stock shown on the certificate. Book Value Book value is the value of the share according to its balance sheet account balance. Market Value Market value is determined based on principles of supply and demand, often governed by what investors are willing to buy and sell a particular stock for at a specific point in time. Replacement Value The cost of replacing an asset in the case that it is damaged or destroyed. That is, the replacement value changes according to the market value of the asset Intrinsic Value Intrinsic value refers to the value of a company stock is determined through fundamental analysis without reference to its market value. It is also frequently called fundamental value. Earnings- Historical, trailing and Forward Historical earning refers to a company’s earnings in the past. Trailing earnings may describe the most recent 12 month period. These earnings will change each month as the nearest month is added to the calculation and the most distant month is dropped. Forward earnings are an estimate of a next period's earnings of a company, usually to completion of the current fiscal year and sometimes of the following fiscal year Market Cap Market Capitalization (Market Cap), is the amount of money required to buy out an entire company at its current market price. Market Cap= Market Price per share x No. Of Outstanding Shares  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Enterprise Value Enterprise value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. EV includes in its calculation the market capitalization of a company but also short-term and long-term debt as well as any cash on the company's balance sheet. Blue-chip /Midcap/ Small Cap Stock Blue-chip stocks represent the largest companies by market cap. Given the large size of their market cap, they attract large set of investors both retail and institutional and enjoy a high level of liquidity. These are also called large cap stocks. Mid cap stocks refer to those companies which enjoy a good level of liquidity but are medium in terms of market cap size. Small cap stocks are those stocks that are smaller in size and therefore do not enjoy much liquidity. Note: There is no specific size for the cut-off of large, mid or small cap stocks. It is therefore common to consider the top 50 to 100 stocks by market capitalization as large cap, the next 200 to 500 stocks as mid cap, and the remaining all as small cap stocks. Earnings Per Share (EPS) = Net Profit/ No. of outstanding shares Dividend Per Share (DPS) = Dividend Declared/ Face Value of share Price to Earnings Ratio (PE Ratio) = Market Price per share/Earnings per Share Price to Sales Ratio = Market Capitalization/ Annual Net Sales Price to Book Value Ratio = Current Market Price / Book Value Differential Voting Rights A DVR is just like a normal share of a company, except that it carries less than 1 voting right per share unlike a common share. Such an instrument is useful for issuers who wish to raise capital without diluting voting rights.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Important Terminologies (Debt Market) ❖ Face Value Face value is the nominal value or market value of a security stated by the issuer. For stocks, it is the original cost of the stock shown on the certificate. For bonds, it is the amount paid to the holder at maturity ❖ Coupon Rate A fixed-income security's coupon rate is simply just the annual coupon payments paid by the issuer relative to the bond's face or par value. The coupon rate is the yield the bond paid on its issue date ❖ Maturity Value In the case of a bond, the maturity value is the principal amount of the bond to be paid by the issuer to the owner at maturity. ❖ Principal Principal is a term that refers to the original sum of money put into an investment in a bond at the time of issue. ❖ Redemption Of a Bond At the time of redemption of a Bond, the contract between the issuer and the investor is over. The issuer of the bond repays the principal and also makes the final coupon payment and then the bond ceases to exist, or the bond ‘matures’. ❖ Holding Period Returns (HPR) HPR is the change in value of an investment, asset or portfolio over a particular period. It is the entire gain or loss, which is the sum income and capital gains, divided by the value at the beginning of the period. HPR = (End Value - Initial Value) / Initial Value. ❖ Current Yield This is a simple method of calculating return on a debt security in which the coupon is divided with the current market price of the bond and the result is expressed as percentage. ❖ Yield To Maturity (YTM) Yield to Maturity or YTM is a more comprehensive and widely used measure of return calculation of a debt security than current yield. This method takes into consideration all future cash flows coming from the bond (coupons plus the principal repayment) and equates the present values of these cash flows to the prevailing market price of the bond. ❖ Duration Duration measures the sensitivity of the price of a bond to changes in interest rates. Bonds with high duration experience greater increases in value when interest rates decline and greater losses in value when rates increase, compared to bonds with lower duration.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN ❖ Modified Duration (M Duration) Modified Duration measures the impact of changes in interest rates on the price of the bond. While Duration gives us sensitivity of bond prices to change in interest rates, Modified Duration gives us the magnitude of this change. ❖ Convexity The impact of change in interest rates on bond prices is inverse but not linear. This means when rates go up, bond prices go down; but they don’t fall as much as they would rise when rates go down by the same magnitude. Thus, rise in bond prices is more than its fall, for the same movement in interest rates in downward and upward directions respectively. This unique property of bond prices is known as Convexity. Types Of Bonds Zero Coupon Bonds Bonds which do not pay coupon in their entire term are known as Zero Coupon Bonds or simply ‘Zeroes’. Such bonds are issued at a discount to their face values and are redeemed at par. Thus, the return on these bonds is not in the form of periodic payment of interest but in the form of difference between the issue price and redemption value. Floating Rate Bonds These are bonds whose coupon is not fixed, as in the case of vanilla bonds, but is reset periodically with reference to a defined benchmark. Resetting the coupon periodically ensures that these bonds pay interest that reflect current market rates. Convertible Bonds A convertible bond or debenture is generally issued as a debt instrument with the option to investors to convert the amount invested into equity of the issuer company later. Principal Protected Note PPN is a relatively complex debt product which aims at providing protection of the principle amount invested by investors, if the investment is held to maturity. Typically, a portion of the amount is invested in debt in such a way that it matures to the principal amount on expiry of the term of the note. The remaining portion of the original investment is invested in equity, derivatives, commodities and other products which have the potential of generating high returns. Inflation Protected Securities These bonds have a fixed real coupon rate which is applied to the inflation adjusted principal on each interest payment date. On maturity, the higher of the face value or inflation adjusted principal is paid out to the investors. Thus, the coupon income as well as the principal is adjusted for inflation.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Foreign Currency Bonds Foreign currency bonds are bonds issued by a company in a currency that is different from the currency of its home country. Companies in emerging markets may prefer to issue bonds in USD or currencies of other economically matured countries as they carry significantly lower interest rates. External Bonds External bonds, also referred as Euro bonds, are bonds issues in a currency that is different from the currency of the country in which it is issued. For example, if a company issues a US dollar denominated bonds in Kuwait, it would be referred as an Euro bond as the currency of the bond (USD) is different from currency of the country in which it is issued (Kuwaiti Dinar). External bonds denominated Indian rupees (INR) is referred as Masala bonds. These bonds are issued outside of India but are denominated in Indian Rupees. Perpetual Bonds Perpetual bonds are bonds which do not have a stated maturity date. Thus, the issuer of perpetual bonds does not have any obligation to redeem it. The investors are entitled to periodic coupon. IV. Fundamentals of Research What is investing? Investment, in the context of securities market, involves upfront commitment of a sum of money to earn returns on it over a period of time. It involves thorough analysis of the underlying security in terms of safety/risk, income and growth potential. Active Investing Active investing involves identifying the specific security or set of securities that should be purchased or sold. It involves constant evaluation of every security in the investment portfolio so that investors can sell securities that are priced above their fair value. Passive Investing Passive investing involves investing in a broad set of securities that fairly represent the asset class the investor needs to invest. Typically, passive investing strategy follows indexing strategy where an investor buys all securities that are part of an index. The objective of a passive investor is to earn the rate of return that the select asset class provides.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN The role of research in investment activity The role of a fundamental research analyst comprises of two parts (i) Research and (ii) Analysis. While analysis involves analysing all the available information to arrive at a conclusion, research involves obtaining all the necessary information. For instance, a company’s annual report may be a treasure trove of information about a company. However, obtaining thorough insights into the company’s business and profitability involves a very detailed scrutiny of the annual report. And often, information in annual reports is not adequate. Insider Information vs Mosaic Information Insider information is a material non-public information that when published would immediately affect an investor’s decision to buy or sell the security. Whether an information can be considered insider depends on the source of the information (how reliable it is), its impact and its certainty. Often analyst collate information from different sources, which individually may not be significant but when put together with other public or non-public information may provide critical insight to the information. These are called as mosaic analysis. Such mosaic analysis is acceptable. Technical Analysis Technical analysis is based on the assumption that all information that can affect the performance of a share such as, company fundamentals, economic factors, and market sentiments are reflected in the stock prices. it is focused on forecasting the direction of prices through the study of patterns in historical market data - price and volume. Technicians (sometimes called chartists) believe that market activity will generate indicators in price trends that can be used to forecast the direction and magnitude of stock price movements in future. Technical Analysis is a specialized stream in itself and involves study of various trends- upwards, downwards or sideways, so that traders can benefit by trading in line with the trend. Identifying support and resistance levels, which represent points at which there is a lot of buying and selling interest respectively, and the implications on the price if a support and resistance level is broken, are important conclusions that are drawn from past price movements. According to technical analysis, there are three essential elements in understanding the price behaviour: 1. The history of past prices provides indications of the underlying trend and its direction. 2. The volume of trading that accompanies price movements provides important inputs on the underlying strength of the trend. 3. The time span over which price and volume are observed factors in the impact of long term factors that influence prices over a period of time. Fundamental Analysis Unlike technical analysis, fundamental analysis is focused on long term investing. Its premise is that since equity shares reflect part ownership of a company, in the long term, its value should be driven by the returns generated by a company on its share capital. If the short term movement in prices cause the price to significantly diverge from its fair value, it creates a profit making opportunity. Fundamental analysis involves comprehensive study on the company’s business as well as its governance style to understand the expected returns and reward for the shareholder.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Quantitative Research Fundamental research involves both quantitative and qualitative studies. However, some analysts approach equity analysis purely from a quantitative approach using econometric analysis. Quantitative approach can be used for both technical analysis and fundamental analysis. In technical analysis, analysts instead of reading charts, focus on the underlying data. However, applying pure econometric approach in fundamental analysis suffers from some major limitations. Primary among them is the availability of comparable information. Frequent changes in accounting standards and business models makes past data less useful to be compared with present market conditions. Behavioral Approach to Equity Investing Investment decisions have to be based on the analysis of available information so that they reflect the expected performance and risks associated with the investment. Very often the decisions are influenced by behavioural biases in the decision maker, which leads to less than optimal choices being made. V. Economic Analysis Branches Of Economics Micro-Economics Macro-Economics Economics is the study of how people make choices under conditions of scarcity and the impact of those choices for people at an individual level and society at macro level. Microeconomics is the study of the behavior of individuals and their decisions on what to buy and consume based on prevalent prices. The philosophy of Microeconomics is that prices and production levels of goods and services in an economy are driven by consumer demand. Accordingly, Microeconomics focuses on the drivers of decision making, as well as the ways in which individuals’ decisions affect the overall supply and demand and supply of Particular goods and services, in an economy, and in turn their prices. Basic Principles of Macroeconomics The focus of macroeconomics is on factors that influence aggregate supply and demand in an economy such as unemployment rates, gross domestic product (GDP), overall price levels, inflation, savings rate, investment rate etc. Most of these factors are highly affected by changes in the public policies. Two major influencers of the public policies in an economy are the government and the central bank. Decisions of the government, known collectively as fiscal policy and actions of the central bank, known collectively as monetary policy, affect the overall economy activity to a large extent.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Importance and uses of macroeconomics: 1. Macroeconomics helps us understand the general state of the economy – Domestic Production, Domestic Consumption, General Price levels, Growth, Quality of life etc. 2. Macroeconomics helps us understand drivers of income, savings, investments and employment in an economy. 3. Macroeconomic models help governments and central bankers formulate economic policies for achieving long run economic growth with stability. 4. Macroeconomics helps us understand various aspects of international trade of goods and services - exports, imports, balance of payment, exchange rate dynamics etc. 5. Macroeconomics also facilitates understanding on how inter-linkages across the economies work. Various Macroeconomic Variables: 1. National Income National income of an economy is defined through a variety of measures such as gross domestic product (GDP) and gross national product (GNP). (i) Product Method In this method, national income is measured as an aggregated flow of goods and services in the economy from the different sectors: agriculture, industry and services. Economists calculate money value of all final goods and services produced in the economy during a specified period. (ii) Income Method In this method, national income is measured as the aggregate income of individuals in the economy. Employees earn wages and salaries, Professionals earn their income based on their services, Entrepreneurs earn profits (including undistributed corporate profits) and Investors earn return on their capital and rent on their land. Sum of all these incomes for a specified period is called National Income for the economy. (iii) Expenditure Method. As all the goods and services produced in an economy are bought (consumed) by someone, National Income may also be calculated from the consumption end. The aggregate demand for goods and services is computed as the sum of private consumption, government spending, gross capital formation and net exports. 2. Savings and Investments Savings and Investments are two different components. Savings, defined as income over expenses, are computed for individuals, corporate and government separately. Economists arrive at National Saving by summing savings of these three constituents. Savings are to be channelized towards productive venues called investments Higher levels of savings and higher conversion of those savings in to investments are considered good for an economy. 3. Inflation Inflation is defined as the general increase in price levels of goods and services in the economy leading to an erosion of purchasing power of money. It explains the rise in the price of general goods and services. Generally, inflation is measured in two ways - at wholesale level in terms of Wholesale Price Index (WPI) and retail level in terms of Consumer Price Index (CPI).  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN 4. Unemployment Rate Unemployment rate refers to the eligible and willing to work unemployed population of the country in percentage terms. Higher employment means income, which improves the ability of people to spend, which implies potential growth in the economy. The reverse would be true for economy going through tough times and high unemployment rates. 5. Foreign Direct Investment (FDI) and Foreign Portfolio Investments (FPI) Foreign capital flows to a country can be either in active form known as Foreign Direct Investment (FDI) or passive form known as Foreign Portfolio Investment (FPI). FDI is welcomed by all the developing economies and has multiple benefits in addition to bring in capital to the country. FDI is long term in nature and stable money. FPIs money is considered as hot money as they can pull out the money at any time which could create systemic risk for the economy. 6. Fiscal Policies and their Impact on Economy Fiscal policy contains the measures of the Government which deal with its revenues and expenses. It influences aggregate demand, supply, savings, investment and the overall economic activity in the country. Fiscal Deficit → Government’s Expenditure > Government’s Revenue Current Account Balance = Receipts – Payments Types Of Fiscal Policies Neutral Fiscal Policy → Government’s Income= Government’s Expenditure Expansionary Fiscal Policy → Government’s Income < Government’s Expenditure Contractionary Fiscal Policy → Government’s Income > Government’s Expenditure 7. Monetary Policies and their Impact on the economy Monetary policies, administered by central bank in an economy, deal with money supply, inflation, interest rates for the purpose of promoting economic growth and managing price stability (inflation). Expansionary monetary policy: It is used to push the economy up by increasing the money supply steeply and reduction in the interest rates. Contractionary policy: It is intended to cool down the heated up economy through reduction in the money supply or slow increase in money supply and increase in the interest rates. Pass4sure – the best way to clear NISM exams  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN 8. International Trade, Exchange Rate and Deficit International trade refers to the total trade that a country does with all other countries in the world. Exchange rate refers to the value of one unit of a currency with respect to other currency/currencies. If imports are more than exports, then country will have a current account deficit and if exports are more than imports then it will have current account surplus. 9. Globalisation Globalization, simply stating, is the ability of the individuals and firms to produce anything anywhere and sell anything anywhere across the world. It also means that resources (people and capital) will flow to the places where they produce best and earn best. POSITIVES NEGATIVES Best Allocation of Global Resources Increase in Income distribution Integration of Economies High competition for business entities Beneficial for end customers Interlinked economies easily pass on risks Greater access to foreign culture from one to another 10. Role of Economic Analysis in Fundamental Analysis Economic analysis helps us understand what is happening to the external environment and how it is likely to affect a particular business. Studying the GDP growth rate can help us understand what is happening in the overall economy of the country. Understanding monetary policy and fiscal policy helps us understand whether policies support further growth of the economy or otherwise. Tracking metrics such as interest rates, inflation, public expenditure and fiscal deficit helps us understand the future direction of the monetary and fiscal policies. 11. Economic Trends Secular Trends A simple example of secular trend is digitalization of office space. Cyclical Trends Secular trends are often driven by Seasonal Trends disruptions caused by change in Cyclical trends can be Unlike cyclical trends, seasonal technology, culture, demography, observed at many different trends are highly predictable and consumer preferences among levels: fluctuations in the quantity of other factors. goods and services being a) Economic cycle produced or consumed, owing b) Commodity cycle to their nature. c) Inventory cycle  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN VI. INDUSTRY ANALYSIS 1. Role of Industry Analysis in Fundamental Analysis Economic analysis helps us understand whether business, in general, is likely to grow in the foreseeable future or decline. Industry analysis helps in understanding how each industry would be impacted under the current economic conditions. In Industry analysis, analysts also try to understand how the various players in the market (industry) are likely to react and how that may affect the prospect of the industry. 2. Defining the Industry The very first step in an industry analysis is to define the industry in which the company operates. Industry definition is not always an easy task. While there are several standard industry classification systems, such as National Industry Classification (NIC) system in India or North American Industry Classification System (NAICS) in US, they may not necessarily capture the substance of the industry. 3. Understanding Industry Cyclicality Economic cycles affect all businesses. However, they affect some businesses more than others. Based on the cyclical nature, industries can be classified into three categories : Defensive industries Semi – cyclical industries Deep cyclical industries 4. Market Sizing & Trend Analysis Industries that are underpenetrated have high growth potential as there is more headroom for growth. However, as industries mature, the new growth avenues decline and the overall growth rates, thus, come down. Therefore, while studying industry, it is important to analyze the potential size of the market and current size of the market. Market sizing can be done through either top-down approach or bottom-up approach. In a topdown approach, we measure the size of the market or industry starting from macro-economic factors and arrive up to the industry level. In bottom-up approach, we quantify the market by looking at individual companies and aggregating their data to arrive at the industry size. 5. Secular Trends, value migration and business life cycle As discussed earlier, secular trends are long term trends that cause displacement in production or consumption of goods and services. There are various factors that drive secular trends: Technological advancement Change in income levels Demographic changes Change in culture, and tastes and preferences Changes in regulation or government policy  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN 6. Value Migration In simple terms, value migration happens when a phenomenon creates long term advantage for one or more entities at the cost of other entities. Thus, the entity that gains witnesses an increase in its shareholder value, while the other entity loses. a) Geographic Migration Geographic migration of value happens when a secular trend helps a country or geography as compared to other. For instance, horizontal drilling and shale gas discovery shifted value to US based oil exploration at the cost of other oil producing countries as US had large amount of shale gas reserve and were able to extract them at a lower cost compared to other oil producing nation. b) Cross Industry Migration Cross industry migration happens when one industry gains at the cost of another. For example, advent of digital cameras resulted in massive decline of film rolls industry and saw big companies like Kodak having to shut down. c) Migration across value chain Some phenomenon can result in industries at the down end of value chain gain at the cost of those at the upper end or vice versa. For example, high competition intensity in the Indian telecommunication space resulted in significant fall in price of mobile services, which in turn led to significant decline in shareholder value for telecom companies. d) Migration across companies in the same industry Certain disruption may create new competitive advantage for one company or may remove a competitive advantage enjoyed by an existing player. This may result is value migrating from one company to another. 7. Business Life Cycle Business life cycle refers to the various stages through which a business transitions through its journey from its emergence till its eventual decline. Every industry goes through the cycle and in turn causes significant displacement in the economy. The labor force working in one industry will have to reskill themselves and move to a new industry or find themselves out of workforce. Similarly, capacity will need to be redirected to a different use.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Michael Porter’s Five Force Model for Industry Analysis Analyzing any industry requires looking at it from various angles and finally reaching to a conclusion about its attractiveness as an investment proposition. Market participants use different methods to make this analysis. Among the many methods used for doing such an analysis is the popular Porter’s 5 Forces model developed by Dr. Michael Porter in 1979. PESTLE Analysis (Political, Economic, Socio-cultural, Technological, Legal and Environmental Analysis) Political Factors: Factors like stability of government, political structure, approach to social schemes, freedom of press etc Economic Factors: Factors like GDP, Inflation, Income distribution, interest rates, consumption level etc Socio-cultural Factors: Factors like demographics, lifestyle, Preferences, culture etc Technological Factors: Factors like availability and cost of technology, R&D activities etc Legal Factors: Factors like legal architecture, efficiency of the legal system, Tax systems etc Environmental Factors: Factors like Pollution level, environmental awareness, conservation etc.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Boston Consulting Group (BCG) Analysis As per the analysis, business segments can be classified as: Stars: This is a business where market is growth is rapid and company has a large market share. Cash Cows: This segment requires low cash infusion, low growth and steady cash-flow. Question Marks: Business segments in a fast growing market, but having low market share. Dogs: Business segments, which have slow growth rates and intensive competitive dynamics Structure Conduct Performance (SCP) Analysis: Structure analysis: Industry structure refers to the competitive intensity in the industry (number of players), concentration of business in industry, relationship among the various players, market size, its growth rate, etc. It is similar to what we study as part of Porter’s 5 Forces model and the SWOT Analysis model. Conduct analysis: The conduct of this business depends on aspects such as pricing and product innovation. Each industry will have its peculiar behavior. So, while looking for an industry’s conduct, analysts have to study several factors such as business cyclical. Performance Analysis: While analyzing performance of an industry, analysts will look at several numerical ratios, which are dealt with in great detail in the unit on quantitative analysis. Based on structure and conduct of the industry, it would generate financials for the investors/owners. Businesses with High return on capital are the ones which create wealth for shareholders and owners in the long run.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Key Industry Drivers: Telecom IT/ BPO/ KPO Banking/ NBFC/ Housing Media Retail Airlines and other transportation and logistics Automobiles and capital goods Consumer goods 8. Taxation Taxes are tools that a government uses to earn income which can be used to meet its expenses. However, governments also use taxes as a tool to encourage or discourage certain businesses. For example, the state government of Kerala introduced a fat tax in 2017. They levied 14.5% additional tax on junk foods. This was done with the intention to discourage the junk food industry. Broadly, taxes charged by government can be classified into two categories (i) Direct taxes (ii) Indirect taxes. a) Direct Taxes Direct taxes refer to taxes where the incidence of the tax and liability for the tax are on the same person. In other words, the person who has to bear the tax is also the one who is obliged to pay the tax to the government. Corporate income taxes, in India, have four components: Income Tax MAT Surcharge Cess b) Indirect Taxes Indirect taxes are those taxes where the person bearing the tax is different from the person liable to collect such tax and transfer to the government. The tax is levied on the seller of the goods. However, the seller collects the money from the customer and deposits it into the account of the government. Therefore, it is the end consumer who bears the tax.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN India has various indirect taxes. However, in order to combine these taxes, government brought in GST and removed other taxes. However, some products (fossil fuels and liquor) and activities (imports) are still covered under the old system. Types of Indirect Taxes Goods and Service Tax (GST) Excise Duty Value Added Tax (VAT) Customs Duty Other Taxes Road tax Stamp Duty Security Transaction tax VII. COMPANY ANALYSIS- BUSINESS AND GOVERNANCE Role of company analysis in fundamental research Investing in shares involve careful and through analysis of a company’s business. However, a company is only a micro unit in its industry and in turn in the economy. Their fortunes will be driven by external conditions including overall macro-economic factors and industry specific factors. Although, these external factors affect every company in the industry, how an individual company performs also depend a lot on company specific factors. Each company has its unique way of doing business. Thus, it becomes imperative for analysts to understand the entire business model of the companies. Thus, once an analyst understands how an economy is performing and how a particular industry is likely to prosper, they have to find answers to company specific questions. Analysts should ensure that they go to the depth to find the relevant answers rather than accept superficial answers. Although many of the questions listed above are qualitative in nature, analysts should try to obtain the necessary data that substantiates their findings. Understand Business and Business Model Equity investing is all about part ownership in a business. Therefore, it is important to understand the business or business model of the company before investing in it. There are over 4000 companies listed and active on Indian exchanges. It is not possible to track and understand all of them. Investors should consider buying shares of a few companies they understand rather than invest in a number of companies they don’t understand. Further, each sector has its own unique parameters for evaluation. For the retail sector, foot falls and same store sales (SSS) are important parameters, whereas for banking it is Net Interest Income (NII)/ Net Interest Margin (NIM), etc. Further, each company will have its unique way of doing business. The efficiency with which products and services are produced and delivered to the customers may vary from one business to another and will significantly impact its earnings.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Pricing Power and Sustainability of This Power Pricing power means ability of the company to command pricing of its products or services. While companies would love to charge as much as they can to the customers, in practice, it may not be possible. Pricing is a function of many parameters, external and internal, least of which is the company’s will. Therefore, pricing power is generally a function of industry dynamics, elasticity of demand and branding and customer loyalty/addiction. Presence of strong brands and/or virtual monopoly plays an important factor in the pricing power. Competitive Advantage/ Points of differentiation over the Competitors Differentiation in product features/ Product differentiation Competitive pricing driven by operational efficiency/ Competitive pricing Better execution Strengths, Weaknesses, Opportunities and Threats (SWOT) Analysis Every business has its own strengths and weaknesses. It is good for the analysts to clearly understand and document both of these to have a clear picture of the situation. Similarly, opportunities to the business and potential risks to the business can be documented by the analysts in the form of opportunities and threats. In a way, SWOT analysis is nothing but a way of documenting strengths, weaknesses, opportunities and threats at one place in a concise manner. a) Strengths- Strengths refer to internal capabilities of the company that allows it to exploit external opportunities and withstand threats. Strengths of a company include the following: - Strong financial position - Highly valuable intellectual properties - Low customer concentration - Low cost or high margins - Support from parent company or government and - Strong execution capability and track record b) Weakness Weakness refers to internal issues that make the company vulnerable to external events or prevents it from exploiting an available opportunity. While identifying strengths and weakness, analyst should focus on those strengths or weaknesses that are related to the opportunities and threats. c) Opportunities Opportunities are created through external environment. Opportunities come in myriad ways and hence it is difficult to list all of them. d) Threats Threats are essentially risk that comes from external environment. While an analyst assesses the threat, it is very important to distinguish threats coming from external environment to risks on account of internal situation. For example, high customer concentration is a risk for a company. However, since it is internal to the company, it is a weakness and not a threat. Threats also come in myriad ways. In fact, events that create opportunity for one industry may create risk for another.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Although, SWOT analysis is a very good framework, analyst should be wary that as an outsider they may not be able to identify all strengths and weakness of a company. For instance, no company would publicly disclose the clout they have in the government or the strength of their lobby. Similarly, if a company has been intentionally hiding their financial woes through creative accounting, it is not easy for outsiders to identify such a fraud. Quality of Management Analysts should also pay attention to the quality of independent directors in a business Independent directors is a big fallacy where companies/promoters choose to keep their friends and others, without thought of relevance, as their independent directors. This is treated as more a tick mark exercise rather than a genuine exercise to bring some thinkers to the business to take it forward. Analysts should focus on the qualifications and experiences of these independent directors, how many meetings they attend and what are their contributions to the business. It may be good practice to interact with some of them to understand them better. Evaluating Management Competency The top management of a company typically include the CEO, CFO, COO, and other C level officers. Assessing their competency is a challenging task for an analyst. The top management of the company typically have several years of experience and come from varied discipline. It is least likely that an analyst would possess the necessary skills to assess the competency of all of them. Evaluating Corporate Governance Corporate governance refers to rules, processes, and procedures that are followed in the management and operations of a firm. The objective of a good corporate governance standard is to ensure that the company is run well to take care of all the stakeholders including shareholders, lenders, employees, suppliers, and customers. Regulatory standards on corporate governance focus on protection of investors with additional focus on minority or non-promoter shareholders. It is important to understand that the regulatory standards are the minimum standards a company must follow. Some companies may set higher standards for themselves. A company following strong corporate government standards would be able to prevent agency risk or at the very least detect and rectify them in time. Promoter Holdings A promoter group of shareholders are likely to have a higher level of control on the management. This, in turn, increases the likelihood of management acting in the best interest of shareholders. A promoter group of shareholders are likely to have a higher level of control on the management. This, in turn, increases the likelihood of management acting in the best interest of shareholders. Pledging of shares may be done by promoters as a way of raising funds in their normal course and thus does not necessarily signal any concern related to corporate governance or business fundamentals.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Risks in the business There are risks in every business, which may range from business aspects to operational aspects to execution aspect and others. The risks may be apparent and known or they may be unknown. Analysts should focus a lot on the risk aspects in various dimensions of the businesses. They should continuously ask question “What could go wrong in the business”. If promoters state that nothing could go wrong in the business, clearly they fall in to the category of “people who don’t know that they don’t know”. These types of promoters need to be avoided. A good businessman would always have cognizance of the risks in the business and the steps that need to be taken to protect the business from their effects. History of Credit Rating Credit rating refers to the rating of the ability of a borrower to service its debt related obligations. These ratings, which are provided by a credit rating agency, are issued at issuer level as well as at individual debt levels. Although credit rating pertains to debt, it is also of relevance to equity investors as a company can provide returns to equity investors only if the lenders are serviced first. Further, going through the historical evolution of credit rating of the company can also provide perspectives on how the management reacts to external feedback. Typically, credit rating reports specify what are the factors that have led to the rating agency conclude on a particular rating. It also specifies what the rating agency considers as key concerns. ESG Framework for Company Analysis Most investors focus on the profit generating ability of a business to make investment decision. However, over the last few years, the societal discussions about companies and businesses have also started focusing on sustainable development, and corporate social responsibility. This has given traction to investment theme that is focused on Environment, Social and Corporate governance (ESG). Initially this framework was used by handful of “Impact” investors. But this framework has gradually gained traction as these frameworks also provide commercial value. VIII. COMPANY ANALYSIS- FINANCIAL ANALYSIS Financial statement analysis plays a very important role in fundamental analysis. In order to be able to do a good financial analysis, an analyst need not be a great accountant. But the analyst should be able to read and interpret the financial statements. Introduction to financial statement – Balance sheet: It provides information on the financial position i.e. assets, liabilities, and equity at the end of the financial reporting period. Statement of profit and loss account: It provides information about the company’s financial performance i.e. income, expense and profits for a given period Statement of changes in shareholder's equity: Shareholder’s equity refers to the funds that belong to the shareholders. It can undergo change on account of various factors including profits earned, dividends paid, additional shares issued, buy back and certain income and other comprehensive income. Cash flow statement: Cash flow statement provides a summary of the various sources and uses of cash.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Common Balance Sheet Line Items : Assets: Assets represents items that are expected to provide future benefits The assets of a company are classified into current assets and non-current assets: a) Non-current asset represents assets that are likely to give benefits over the long term. In general, all assets other than current assets (explained below) are non-current assets. b) Current asset represents assets that are likely to benefit the organization within one operating cycle. In most cases, the tenure of the operating cycle is taken as one year. Non-current liabilities: It represents obligations of the company that have been fulfilled after one year. Current Liabilities: It represents obligations of a company that it needs to fulfil within one year Working capital: Working capital refers to the amount of money that is locked in day to day operations of the business. Basics of Profit and Loss Account (P/L) – Common profit and loss account line items : Revenue: Revenue represents the amount earned by a company by selling goods and services. Other income: Other income typically include non-operating income such as income from investments or profit or sale of assets. Expenses: In the case of manufacturing industries, companies report three more standard line items being (i) Cost of raw materials (ii) Purchase of stock-in-trade (iii) Change in inventory of finished goods. Cost of raw materials: This represents the amount of raw material consumed in the production process. Purchase of stock-in-trade: This represents amount spent towards purchase of goods that are sold to customers without any additional processing. Employee cost: Employee cost represents salaries, benefits, notional expenses towards stockbased compensation granted and staff welfare expenditure incurred towards employees. Depreciation : Depreciation refers to gradual and permanent reduction in value of assets on account of ageing, use and obsolescence. Amortisation: It refers to gradual write-off of intangible assets over the period of its life. Tax: Tax expense of an Indian company include three components: (i) Current tax, (ii) MAT and (ii) Deferred tax. Earnings per share (EPS): EPS is calculated by dividing the net profit attributable to equity shareholders by the average number of shares outstanding. Key metrics from profit and loss account - Gross profit: It is calculated by reducing the cost of goods sold from revenue. EBITDA: Earnings Before Interest Tax Depreciation and Amortisation EBIT - Earnings Before Interest and Taxes Basics of Cash Flows Operating cash flows – Cash flows from business operations (P/L items). Investing cash flows - Cash flows on account of assets (B/S items) Financing cash flows – Cash flows on account of liabilities (B/S items). Contingent Liabilities - Contingent liabilities are liabilities that may be incurred by an entity depending on the outcome of an uncertain future event. For example, a company may be fighting a court case, which may result into substantial loss for the company, if the case is lost.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Commonly used ratios : Profitability Ratios Return Ratios Leverage Ratios (+) EBITDA Margin (+) ROE (+) D/E Ratio (+) PAT Margin (+) ROCE (+) Interest Coverage Ratio Liquidity Ratios Efficiency Ratios (+) Current Ratio (+) Assets Turnover (+) Quick Ratio (+) Inventory Turnover 1. EBITDA Margin This ratio is useful in finding out the profitability of the company purely based upon its operations and direct costs. 2. PAT Margin PAT Margin Shareholders of a business get their dues only at the end, i.e. after paying all stakeholders. Hence, they would like to know how much of the business generated by the company actually comes their way. This is found by calculating PAT Margin. 3. ROE It Stands for Return On Equity. ROE communicates how a business allocates its capital and generates return. 4. ROCE It stands for Return on Capital Employed. This ratio uses EBIT and calculates it as a percentage of the money employed in the firm by way of both equity and debt. Higher the ratio, better the firm since it is generating higher returns for every rupee of capital employed. 5. Debt/ Equity Ratio It indicates the levels of debt in a business. This helps one analyse its outstanding obligations in comparison to its total assets. 6. Interest Coverage Ratio This ratio tells us how many times the earnings of the business can pay its interest obligation. Higher the ratio, higher is its repayment capability or ability to survive.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN 7. Accounts Receivable Turnover Ratio This ratio indicates how fast company converts its sale in to cash. Higher the ratio, better the firm, as it means that very small portion of its revenues are in the form of credit. 8. Inventory Turnover Ratio This ratio indicates how many times assets of the business are churned / put to use to generate revenues for the business. Other Major Points for comparison ❖ Peer Comparison ❖ Dividend and Earnings History ❖ History of Corporate Actions ❖ Ownership and Insider trades IX. Corporate Actions Philosophy of Corporate Actions : A company initiates several actions, apart from those related to its business, that have a direct implication for its stakeholders. These include sharing of surplus with the shareholders in the form of dividend, changes in the capital structure through the further issue of shares, buy backs, mergers and acquisitions and delisting, raising debt and others. In a company that has made a public issue of shares, the interest of the minority investors has to be protected. Dividend: Companies distribute part of the profits and retain part of the profits in the business. The part of the profits distributed is called the Dividend Rights Issue: When shares are issued to the existing investors of a company at a discounted price; it is called a Rights Issue. Bonus issue: A bonus issue, also known as equity dividend, is an alternative to cash dividend. Bonus shares are issued to the existing shareholders by the company without any consideration from them. Stock Split: A stock split is a corporate action where the face value of the existing shares is reduced in a defined ratio. A stock split of 1:5 means split of an existing share into 5 shares. Share Consolidation: Share consolidation is the reverse of stock split. In a share consolidation, the company increases the par value of its shares in a defined ratio and correspondingly reducing the number of shares outstanding to maintain the paid up/subscribed capital. Mergers and Acquisitions: Mergers, acquisitions and consolidations are corporate actions which result in a change in the ownership structure of the companies involved. In a merger, the acquirer buys up the shares of the target company and it is absorbed into the acquiring company and ceases to exist. In an acquisition or takeover, the acquiring company acquires all or a substantial portion of the stock of the target company.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Demerger/ Spin – off : A spin-off occurs when a company carves one or more of its existing business on to a separate company. In case of a spin-off, the shareholders on the record date will be eligible to receive shares in the new company in proportion to the shares they held in the parent company. Scheme of Arrangement : Scheme of arrangement is a court monitored settlement process between the company and its creditors or members. It typically involves reorganization of the share capital of the company. It may involve the existing shareholder’s relinquishing part of their ownership in favor of the creditors or consolidation or division of class of shares. Loan Re-Structuring: Loan or debt restructuring is a mechanism available to companies in financial distress who are unable to meet their obligations to their lenders to restructure their debt by modifying one or more of the terms of the loans. This may include the amount of loan, rate of interest, the mode of repayment. Buyback of Shares: A company may deploy excess cash on the balance sheet in various way. One of the ways is to that it would offer a choice to the shareholders to have the money through selling their shares back to the business or in kind in terms of enhanced value of each share in terms of Earning Per Share (EPS) and Book Value Per Share (BV). De-listing Of Shares: Delisting of shares refers to the permanent removal of the shares of a company from being listed on a stock exchange. Delisting may be compulsory or voluntary. Delisting and relisting of Shares : Delisting of shares refers to the permanent removal of the shares of a company from being listed on a stock exchange. Delisting may be compulsory or voluntary. A delisted share can come for relisting. SEBI through its regulations specifies the time limit post which a company can relist its shares. Share Swap: Swap, simply means, exchange of something. Accordingly, share swap means exchanging one set of shares with another set of shares. X. Valuation Principles Difference between Price and Value : Price and value are two different concepts in investing. While price is available from the stock market and known to all, value is based on the evaluation and analysis of the valuer at a point in time. Approaches to valuation : Cost based valuation: Under this approach, an asset is valued based on the cost that needs to be incurred to create it. Cash flow based valuation (intrinsic valuation): Intrinsic valuation approach assigns value to an asset based on what an investor would be willing to pay for the cash flow generated by the assets. Selling price based approach (relative valuation): Under this approach an asset is valued based on the price of other similar assets. Discounted Cash Flows Model for Business Valuation : There are three different approaches to DCF models – - Dividend discount model (DDM): Under this model, the expected future dividends of a company are discounted based on the cost of capital. - Gordon growth model (also referred as perpetual growth model) provides a way to value a dividend paying company where the dividend is expected to grow perpetually at a constant rate. - Free cash flow to equity model (FCFE) : The FCFE model provides an alternative to dividends. Under this model, equity is valued by discounting the free cash flow to equity share holders instead of the actual dividends paid by the company.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Earnings based Valuation Metrics Price to Dividend Ratio Price to Earnings Ratio Growth Adjusted PE Ratio (PEG Ratio) Enterprise Value to EBITDA Ratio Enterprise Value To Sales Ratio Asset based Valuation Metrics Return On Equity Return On Capital Employed Price To Book Ratio Enterprise Value (EV) to Capital Employed Ratio Net Asset Value Approach Other Metrics - Price/Embedded value , Price/Adjusted book value & EV/Capacity Relative Valuations (Trading and Transaction Multiples) Relative valuation is basically intuitive. We do this all the time in our personal lives. Here, we try to value an asset looking at how the market prices similar/comparable assets. Practically, all the earnings and assets based valuation parameters defined above can be looked at for each business historically for several years. One can also look at these parameters as comparison across the peers and/or industry ratios to build a sense whether something looks cheap or expensive. Sum Of The Parts Valuation Several businesses operate as a cluster/bundle of businesses rather than one business. For example, ITC, L&T and other corporations have different business under one umbrella. Best way to value these businesses is to value each business separately and then do the sum of those valuations. This method of valuing a company by parts and then adding them up is known as Sum-Of- Parts (SOP) valuation. Capital Asset Pricing Model Capital Asset Pricing Model - CAPM, which establishes the relationship between risk and expected return forms the basis for cost of equity. It has three components: the risk free rate of return (Rf); a return that reflects the return expected on a stock market portfolio (Rm); and a return that compensates for the business and financial risks specific to the stock of the company itself, known as the company's beta. Beta of a stock measures change in the stock prices with change in the benchmark index/stock market.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN XI. Fundamentals Of Risk and Return Concept of Return of Investment and Return on Investment : Investment means putting up capital in an identified investment product to earn returns from it. The investor expects two things from the investment: to earn a return and, more importantly to get back the capital invested. Return on Capital/investment (ROI) is the comparison of returns with the investment and can be defined for single period as: ❖ Return On Investment = Net Profit/ Investment *100 Simple Return: Simple Return is called single period return or absolute return. However, this computation does not take the period over which the return was earned into consideration. Annualized Return: The annualized return calculation does not take the time value of money into consideration. Time value of money is the concept that money has the ability to be invested to earn more money. Therefore, money received earlier is worth more than money received later. CAGR: CAGR (Compounded Annual Growth Rate) calculations assume that the periodic returns received from an investment can be re-invested to earn returns and this forms part of the total returns of the investment. It is calculated as the rate of return at which the original investment grows to the final investment value. XIRR: The underlying CAGR for multiple flows has to be calculated by using XIRR function in Excel. The procedure stated in the previous example can be followed here as well: separate columns should be created for inputting dates and corresponding matching cash flows. Risks in Investment: Inflation Risk Inflation risk represents the risk that the money received on an investment may be worth less when adjusted for inflation. Inflation risk is also known as purchasing power risk. Inflation risk is fairly less for equity shares. If prices go up as a result of inflation, then all else held constant, businesses will see increase in selling price of their product and thus its profit should go up in nominal terms. This is also likely to reflect as higher stock prices. Interest Rate Risk Interest rate risk refers to the risk that bond prices will fall in response to rising interest rates, and rise in response to declining interest rates. Bond prices and interest rates have an inverse relationship. Business Risk Business risk is the risk inherent in the operations of a company. It is also known as operating risk, because this risk is caused by factors that affect the operations of the company.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Market Risk Market risk refers to the risk of the loss of value in an investment because of adverse price movements in an asset in the market. Credit Risk Credit Risk or default risk refers to the possibility that a particular bond issuer will not be able to make expected interest rate payments and/or principal repayment. Debt instruments are subject to default risk as they have pre- committed pay outs. Liquidity Risks Liquidity risk refers to an absence of liquidity in an investment. Thus, liquidity risk implies that the investor may not be able to sell his investment when desired, or it has to be sold below its intrinsic value, or there are high costs to carrying out transactions. Call Risk Call risk is specific to bond issues with the possibility it will be called prior to its maturity. Re-Investment Risk Re-investment risk arises from the probability that income flows received from an investment may not be able to earn the same interest as the original interest rate. Political Risk Risk associated with unfavorable government actions - possibility of nationalization, change in tax structures, licensing etc. is called political risk. Country Risk Country risk refers to the risk related to a country as a whole. There is a possibility that it will not be able to honour its financial commitments. Measuring Risk We discussed many different sources of risk. An effective risk management technique involves measuring these risks. But before we measure, it is important to define risk. There are three ways in which risks are defined: Measure of uncertainty Measure of sensitivity Measure of loss Beta Beta is a measure of the systematic risk of a security or a by comparing the volatility in the investment relative to the market, as represented by a market index. It measures the risk of an investment that cannot be diversified away. Beta of 1 indicates that the security's price will move with the market. Beta of less than 1 means that the security will be less volatile than the market. And, beta of greater than 1 indicates that the security's price will be more volatile than the market.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Concept of Margin Safety Margin of Safety is the term popularized by Mr. Benjamin Graham and his followers, most notably Mr. Warren Buffett. In simple words, margin of safety refers to the difference between value and prices, when securities are bought at a price significantly below their intrinsic value. While Margin of safety allows an investment to be made with minimal downside risk, it doesn't guarantee a successful investment. There is no universal standard to determine how wide the "margin" in margin of safety should be. Each investor must come up with his or her own number. Calculating Risk Adjusted Returns In general, high risk investment strategy would produce higher returns. Therefore, when comparing two investment portfolio or strategy, it may not be appropriate to compare their absolute returns as a high risk strategy is likely to produce higher returns in the long run but it will also be more volatile during this period of holding. Jensen’s Alpha Alpha, in general, refers to the excess return earned on investment compared to its benchmark. Jensen’s Alpha = Return on portfolio – (Risk free rate + * market risk premium) Higher the Jensen’s Alpha, the better it is. Sharpe Ratio Sharpe ratio measures the risk premium earned per unit of standard deviation. The risk premium earned is calculated by subtracting risk free rate from the investment return. It is calculated as follows: Treynor Ratio Treynor ratio measures the risk premium earned per unit of Beta. The risk premium earned is calculated by subtracting risk free rate from the investment return. It is calculated as follows:  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Basic Behavioral Biases Loss-aversion bias Loss aversion refers to investor's tendency to strongly prefer avoiding losses to acquiring gains. The fear of loss leads to inaction. Confirmation Bias Confirmation bias, also called my side bias, is the tendency to search for, interpret, or prioritize information in a way that confirms one's beliefs or hypotheses. It is a type of cognitive bias and a systematic error of inductive reasoning. Ownership Bias Things owned by us appear most valuable to us. Sometimes known as the endowment effect, it reflects the tendency to place a higher value on a position than others would. It can cause investors to hold positions they would themselves not buy at the current level. Gambler’s Fallacy Predicting absolutely random events on the basis of what happened in the past or making trends when there exists none. It is the mistaken belief that if something happens more frequently than normal during some period, then it will happen less frequently in the future or vice versa Winner’s curse Tendency to make sure that a competitive bid is won even after overpaying for the asset. While behaviorally it is a win, financially, it may be a loss. Herd mentality This is a common behavior disorder in investing community. This bias is an outcome of uncertainty and a belief that others may have better information, which leads investors to follow the investment choices that others make. Anchoring Anchoring is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered when making decisions. Measuring Liquidity of Equity Shares One of the main objectives of stock exchanges is to provide liquidity i.e., the ease of buying and selling. However, not all shares are liquid. Liquidity can be achieved when there are large number of buyers and sellers for a given stock. Liquidity of a stock can be measured using the following metrics: (i) Stock turnover ratio: This ratio is calculated by dividing the number of shares traded during a given period by the number of outstanding free float shares. Mostly, the time frame used is one year. Free float shares refers to number of shares held by non-promoter group shareholders. (ii) Traded value turnover ratio: This ratio is similar to stock turnover ratio. It is calculated by dividing the traded value of the shares by the market capitalisation of the company. Pass4sure.in – the best way to clear NISM exams.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN XII. Qualities of a Good Research Report Research report is a multipurpose document and does the following: “Presents an investment idea - Provides market perspective - Detailed company analysis.” Writing research reports, to an extent, is a creative process. What an analyst does is to take in is a lot of financial information and give out is an understandable version of what that financial information mean. The process of converting numbers to views does demand for the certain qualities. As with many other creative processes, there is no single answer to this question but there are certain ground rules which one can follow to make a good report. Clarity of Idea Simplicity of delivery Presenting the argument clearly Narrative structure Create customized reports according to the reader type Like any other writing projects, compiling research reports also have three important steps - Planning, Drafting and Editing. Major sections of a report: Fact based selection Peer group analysis, shareholding pattern, company fundamentals, key financial indicators and financials. View-based selection Company Business, Key Strengths, Key concerns, Industry Overview. Rating Conventions In financial markets, while rating stocks, various conventions are used by the research analysts. These recommendations are typically made to reflect the analyst’s view on the total returns that the security will make over a specified time horizon, or the returns of the security relative to the returns of the market or to the peer group. Different research agencies may have different definitions for each term. Buy Overweight Hold Underweight Sell  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN Checklist Based Approach to the Research Reports To ensure consistency in the decision making process, it becomes imperative to note down important decision drivers in a disciplined and committed manner. Accordingly, checklists could be a great way for analysts to stay disciplined and methodical when it comes to researching new ideas, maintaining an existing portfolio and exiting positions. XIII. LEGAL AND REGULATORY ENVIRONMENT Regulatory infrastructure in Financial Markets - The regulators in the Indian Financial Market ensure that the market participants behave in a responsible manner so that securities market continues to be a major source of finance for corporate and government and the interest of investors is protected. 1. Ministry Of Finance Department of Economic Affairs Department of expenditure Department of revenue Department of Financial Services Department of Disinvestments 2. Ministry of Corporate Affairs The Ministry of Corporate Affairs is primarily concerned with administration of the Companies Act and other allied Acts, rules and regulations framed there-under mainly for regulating the functioning of the corporate sector in accordance with law. The Ministry also supervises three professional bodies, viz., ICAI, ICSI. ICWA 3. Reserve Bank Of India Monetary Authority Regulator and supervisor of financial system Manager of foreign exchange Issuer of currency Developmental Role Banking functions  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN 4. Securities And Exchange board Of India Securities and Exchange Board of India (SEBI) is the regulatory authority for the securities market in India. SEBI’s primary role is to protect the interest of the investors in securities and to promote the development of and to regulate the securities. SEBI’s regulatory jurisdiction extends over corporates in the issuance of capital and transfer of securities, in addition to all intermediaries and persons associated with the securities market. 5. Insurance Regulatory and Development Authority of India (IRDAI) IRDAI regulates the insurance sector in India in accordance with the terms of the IRDA Act, 1999. IRDAI is the licensing authority for insurance companies and defines the capital and net worth requirements for insurance companies. IRDAI’s mission is to regulate, promote and ensure orderly growth of the insurance sector, including the re-insurance business, while ensuring protection of the interest of insurance policyholders. 6. Pension Fund Regulatory and Development Authority (PFRDA) The PFRDA is the authority entrusted to act as a regulator of the pension sector in India under the PFRDA Act, 2013. It was constituted in October 2003 with the following responsibilities: (a) To promote old age income security by establishing, developing and regulating pension funds. (b) To protect the interests of subscribers to schemes of pension funds and related matters. The PFRDA has been assigned the responsibility of designing the structure of funds and constituents in the National Pension System (NPS). Important regulations in Indian Securities Market 1. Securities Contracts (Regulation) Act, 1956 The Securities Contracts (Regulation) Act, 1956 (SCRA), provides for direct and indirect control of virtually all aspects of securities market to SEBI – instruments, intermediaries, issuers and investors. It prevents undesirable transactions in securities by regulating the business of securities dealing and trading. The act covers a variety of issues 2. Securities and Exchange Board of India Act, 1992 The SEBI Act of 1992 was enacted “to provide for the establishment of a Board to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto”. SEBI Act, 1992, lays down that subject to the provisions of the SEBI Act, 1992, it shall be the duty of the Board to protect the interests of investors in securities and to promote the development of and to regulate the securities market, by such measures as it thinks fit 3. Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 The regulations prohibiting insider trading have been made pursuant to section 30 of the SEBI Act, 1992. The regulations define “insider” as any person who is a connected person or one in possession of or having access to unpublished price sensitive information. The regulations define unpublished price sensitive information (UPSI) that affect the company or its securities as those that is not generally available and which can materially affect the price of the securities.  NISM SERIES XV – RESEARCH ANALYST SHORT NOTES BY PASS4SURE.IN 4. SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulation, 2003 (amended in 2007, 2012 and 2013) The SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations prohibit fraudulent, unfair and manipulative trade practices in securities. These regulations have been made in exercise of the powers conferred by section 30 of the SEBI Act, 1992. This regulation defines fraud as inclusive of any act, expression, omission or concealment committed to induce another person or his agent to deal in securities. There may or may not be wrongful gain or avoidance of any loss. However, that is inconsequential in determining if fraud has been committed. 5. Securities and Exchange Board of India (Research Analyst) Regulations, 2014 (amended in December 2016) Timely and accurate information about investment products is an important ingredient for making investment decisions. Considering the volume and complexity of information it would be difficult for an investor for analyzing and grasping the information. In this context the Research Analysts play an important role. They make recommendations about whether to buy, hold or sell securities. Investors often rely on their advice. However, such advice from investment analysts is many times prone to conflicts of interest that may prevent them from offering independent and unbiased opinions. Since the prime objective is to protect investors and enhance confidence in the market, it is a major concern of regulatory authorities to identify and deal with conflicts of interest arising from the production and dissemination of research reports. 6 Insolvency and Bankruptcy Code (IBC) - is an act that consolidates all the laws related to reorganisation and insolvency proceeding against companies, partnership firms and individuals. The law stipulates time bound resolution of insolvency proceedings. Code of Conduct for Research Analysts : Code of conduct as defined in the Third Schedule of Research Analyst Regulations and deals with - Honesty and Good Faith, Diligence, Conflict of Interest, Insider trading, Confidentiality, Professional Standard, Compliance and Responsibility of senior management. Disclosures in research reports : A research analyst or research entity shall disclose all material information about itself including its business activity, disciplinary history, the terms and conditions on which it offers research report, details of associates and such other information as is necessary to take an investment decision. Contents of research report : Research analyst or research entity shall take steps to ensure that facts in its research reports are based on reliable information. Distribution of research reports : A research report shall not be made available selectively to internal trading personnel or a particular client or class of clients in advance of other clients who are entitled to receive the research report. Research analyst or research entity who distributes any third party research report shall disclose any material conflict of interest of such third party research