Security Analysis, Guide for Company Secretary Students
Master Security Analysis for success in corporate governance. Learn economic, industry, and company analysis, ratio evaluation, technical approaches, and valuation methods.
Mridula Sharma11 Jun, 2024
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In the world of corporate governance and compliance, Security Analysis is a pivotal skill for Company Secretary (CS) students. Understanding financial statements, assessing risk, and ensuring the protection of shareholder interests are crucial for any aspiring Company Secretary. This article will provide an in-depth look at Security Analysis, offering practical insights and valuable tips that will help you excel in your CS Exams and professional career.
What Is Security Analysis?
Security analysis involves the valuation and examination of individual securities to make informed investment decisions. It aims to determine the intrinsic value of a security compared to its market value. Two main approaches to security analysis are fundamental analysis and technical analysis. Fundamental analysis involves evaluating the economic, industry, and company-specific factors to determine the value of a security. This three-level systematic process assesses the overall external and internal environment of a company before valuing its shares. The analysis includes:- Economic Analysis
- Industry Analysis
- Company Analysis
Economic Analysis
Analysis of the economy is crucial for understanding how the overall economic environment affects the performance of companies and securities. Key macroeconomic factors include:- Gross Domestic Product (GDP): Indicates the rate of economic growth, with higher GDP suggesting favorable conditions for investors.
- Savings and Investment: Economic growth requires substantial domestic savings to fuel investment, which impacts various asset classes including equities.
- Inflation: High inflation can diminish real growth and affect consumer demand, while mild inflation is generally beneficial for the stock market.
- Interest Rates: Lower interest rates reduce financing costs for firms, boosting profitability and stimulating investment.
- Budget: Government budget deficits may lead to inflation, while surpluses can cause deflation, impacting the stock market.
- Tax Structure: Tax incentives can influence investment decisions and savings behavior.
- Other Factors: These include the balance of payments, agricultural performance, infrastructure development, and demographic trends.
Industry Analysis
Industry level analysis focuses on understanding specific industries rather than the broader economy. Analysts examine factors such as industry composition, importance to the national economy, position in the industrial life cycle, and entry/exit barriers. Industry analysis considers technological changes, consumer preferences, and availability of substitutes, which influence the industry life cycle. The industry life cycle typically consists of three stages:- Pioneering Stage: Characterized by technological development and introduction of new products. Initial profitability attracts competition, leading to market saturation and strain on profits.
- Expansion Stage: Demand for products increases steadily, with less price and production volatility. Capital is readily available, leading to increased internal accruals.
- Stagnation Stage: Growth slows down or becomes negative, with limited product innovation and difficulty in accessing external capital. This stage is particularly challenging during economic slowdowns.
Company Analysis
Company analysis involves examining company-specific information after considering economic and industry forecasts. Internal sources, such as financial statements, provide key data like income statements, balance sheets, and cash flows. External sources supplement this information, providing unbiased insights and additional data not available internally. Traditional techniques include forecasting dividends and earnings using metrics like priceearning ratios to assess stock valuation for short-term horizons. Modern methods, such as regression analysis and decision tree analysis, build upon traditional approaches to overcome limitations and provide more robust insights for longer-term investment decisions.Fundamental Analysis Tools
Although the raw data of the Financial Statement has some useful information, much more can be understood about the value of a stock by applying a variety of tools to the financial data. At this juncture, it is imperative to understand various Ratios, Comparative Financial Statements, Trend Analysis, Common Size Statements, Fund Flow Analysis and Cash Flow AnalysisRatio Analysis
Ratio is a relationship between two figures expressed mathematically. Financial ratio provides numerical relationship between two relevant financial data. Financial ratios are calculated from the balance sheet and profit and loss account. Financial ratios may be divided into six groups- Liquidity Ratios
- Turnover Ratios
- Leverage Ratios
- Profit Margin Ratios
- Coverage Ratios
- Valuation Ratios
Technical Analysis
Technical analysis is a method used to forecast price direction by studying past market data, such as price and volume. It operates on the assumption that market prices are determined by the balance between supply and demand, leading to patterns in price and trading volume that repeat over time. Analysts familiar with these patterns can predict future price behavior. This analysis disregards intangible factors like investor sentiment and focuses on chart patterns to identify trends. It assumes that stock values move in trends that persist and change due to shifts in supply and demand equilibrium, which can be observed in market charts. The method acknowledges that markets operate randomly and incorporate all future events that affect share values.Dow Jones Theory
It is one of the earliest theories of technical analysis. The theory was formulated by Charles H. Dow of Dow Jones & Co. who was the first editor of Wall street Journal of USA. According to this theory, share prices demonstrate a pattern over four to five years. These patterns can be divided into three distinct cyclical trends- primary, secondary or intermediate and minor trends. Primary Trends: The primary trend, lasting from one to three years, signifies the overall direction of the market movement, either upward (bullish) or downward (bearish). It is the most significant trend in Dow theory and influences stock prices, secondary trends, and minor trends. An upward primary trend indicates a bullish market phase, while a downward primary trend indicates a bearish phase. Graph of Bullish Phase: In a bullish phase, after each peak, there is a fall but the subsequent rise is higher than the previous one. The prices reach higher level with each rise. After the peak has been reached, the primary trend now turns to a bearish phase. Graph of a Bearish Phase: In a bearish phase, the overall trend is that of decline in share values. After each fall, there is slight rise but the subsequent fall is even sharper. Secondary Trends: Secondary trends, as per Dow theory, move in the opposite direction of the primary trend, serving as corrections to it. They typically last between three weeks and three months, with retracements ranging from one-third to two-thirds of the primary trend's movement. Minor Trend: The last of the three trend types in Dow theory is the minor trend, which is defined as a market movement lasting less than three weeks. Minor trends are changes occurring every day within a narrow range. These trends are not decisive of any major movement. The minor trend is generally the corrective moves within a secondary move, or those moves that go against the direction of the secondary trend.Approaches to Valuation of Security
Security analysis begins with assessing the intrinsic value of security. There are three main schools of thought on the matter of security price evaluation. Advocates of different schools can be classified as- Fundamentalists;
- Technicians; and
- efficient market advocates.
- The Fundamental Approach:
- Technical Approach:
- Efficient Capital Market Theory:
Fundamental Approach to Valuation
The fundamental approach to valuation involves determining the intrinsic value of a security by analyzing various financial factors. This value represents the equilibrium point where supply and demand for the security stabilize. Money's time value is considered, using tools like compounding and discounting. Bond values are relatively straightforward, comprising present values of interest payments and the principal amount. Equity valuation is more complex due to uncertain earnings and dividend streams, which are discounted to derive the stock's value as the present value of future dividends. Capital Asset Pricing Mode (CAPM): CAPM explains the relationship between the Expected Return, Non-Diversifiable Risk (Systematic Risk) and the valuation of securities. Under CAPM price of a security is calculated with the help of expected return from security. Formula for Computing Expected Return: E(RP) = Rf +(Rm –Rf {ß} Where E(RP) = Expected Return on Portfolio RF = Risk Free Rate of Interest/ Return ß = Portfolio Beta RM = Expected Return on Market Portfolio Mastering Security Analysis is essential for CS students who aspire to build secure systems and protect sensitive data. By understanding the fundamentals, staying updated with the latest threats, and adopting best practices, you can become a proficient security analyst. Enroll in the PW Company Secretary Courses to gain the knowledge and skills needed to excel in this field.| Also Check: | |
| Introduction to Accounting | Capital Structure |
| Introduction to Accounting Standards | Introduction to Corporate Accounting |
| Capital Budgeting | Law relating to Evidence |
Security Anlaysis FAQs
What is Security Analysis?
Security analysis involves evaluating individual securities to make informed investment decisions by determining their intrinsic value compared to market value.
What are the main approaches to Security Analysis?
The main approaches to security analysis are fundamental analysis and technical analysis.
How does Economic Analysis impact Security Analysis?
Economic analysis helps understand how overall economic conditions affect company and security performance, considering factors like GDP, inflation, interest rates, and taxes.
What are the tools used in Fundamental Analysis?
Tools in fundamental analysis include ratio analysis, comparative financial statements, trend analysis, common size statements, fund flow analysis, and cash flow analysis.
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