equity research & portfolio

7/23/2019 Equity Research & Portfolio

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Equity Research and Portfolio Management

Assignments - A

Question 1 i: Sweat equity is the best form of reward for those whocontribute to the growth of a company. Discuss.

AnswerSweat Equity, as the name suggests, is the equity issued in lieu of

contribution in terms of time given, efforts made and services rendered bythe employees of the company.It is used to refer to a form of compensation

by businesses to their owners or employees. The term is sometimes used in

partnership agreements where one or more of the partners contribute no

financial capital. In the case of a business startup, employees might, upon

incorporation, receive stock or stock options in return for working for below-

market salaries (or in some cases no salary at all).

The equity that is created in a company or some other asset as a direct

result of hard work by the owner(s)

The Companies Act provides for issue of sweat equity shares to employees

and/or directors of companies on favorable terms in recognition of their

work. Sweat equity makes employees part owners of the company and gives

them a share of profit earned.

Thus, it is the most suitable form of reward for those who contribute to the

growth of the company.

However, in India, as per SEBI and DCA regulations, sweat equity shares

can be issued only to employees or directors.


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Question 1 ii: Why do investors add real estate in their portfolio?

Answer

The main aim of an investor, while deciding on a portfolio is to maximize

return and minimize risk of holding an asset. The total return comprises of

the periodic receipts plus change in price of the asset or capital appreciation.

The risk in investment is the chance that the realized return may be lessthan the expected return.

In case of investment in real estate, the investor receives periodic receipts in

the form of rentals and the property generally appreciates over period of

time. Another reason to choose real estate in portfolio is its ability to serve

as an inflation hedge, since the owner can increase rentals during inflation.

Real estate also has the unique ability to reduce risk in the way properties

are leased. Portfolios that have followed a cash flow strategy and decided to

lock in rates in long-term leases have less risk exposure to market

movements, but they also have less inflation-hedging ability.

Question 1 iii: What are the steps taken by SEBI in the primary

market to protect investors?

Answer

SEBI has taken various steps and issued guidelines to protect the interest o

the investors in the primary market.

With the objective of boosting investor confidence in the primary market,

SEBI brought the concept of Anchor Investors. This allows an individual or

entity to subscribe up to 30% of the institutional share of an IPO, similar to

a pre-placement agreement. Since 50% of an IPO is typically reserved for


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institutional investors, this would mean up to 15% of the total offering could

be given to an anchor investor. This would thereby impute confidence to

the retail investors as they see a large investor taking a significant stake inthe IPO.

SEBI has recently introduced a new process applicable to retail individual

investors popularly referred to as ASBA (Application Supported by Blocked

amount) process. Under this process, the bid amount is blocked in the

investor account at the time of bidding. If and when an allotment is made,

his account will be debited and the money will be remitted to the company.

Therefore, the bid amount remains in his account earning interest during the

whole process period. Investors account will be debited only to the extent of

shares allotted, if any, and the remaining amount will be unblocked. There

will be no refund as such and therefore the investor will not encounter the

problems related to non-receipt of refund.

SEBI has increased the IPO card validity from 3 months to 1 year, so that

IPO Company can bring the IPO in the market at a right time (say in a bulltrend), This will provide better opportunity for the investors.

No listed company will be allowed to issue shares with superior voting rights.

There could also be no preferential issues with superior voting rights.

Question 2i: Discuss the dematerialisation and rematerialisation

processes in NSDL?

Answer

Dematerialization is the process of converting physical security holdings with

the depository into electronicform in which the share certificates are

shredded(i.e. its paper form is destroyed ) and a corresponding entry of the

number of shares (held in the certificates) is made in the account opened

with the DP(depository participant). The securities held in the demat form do


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not bear any distinguishing features like distinctive number, folio number

and so on. Once the scrip is dematerialized, it loses its identity in terms of

share certificate distinctive numbers and folio numbers.

Rematerialisation is a process by which a client can get his electronic

holdings converted back into physical holdings, that is, he can get back the

physical form of share certificates. To get the certificates back, he has to fill

up a Remat. Request Form and submit it to its DP, with whom he has an

account. The new certificates may not necessarily bear the same folio or

distinctive numbers as were previously existing. Rematerialisation is offered

for all those scrips which are eligible for demat in the depositories list of

securities available for dematerialization.

Question 2ii: Stock market indices are the barometers of the stock

market Discuss?

Answer

Stock market indices are the barometers of the stock market.

These help to recognize broad trend in the market. The investor can use the

indices to allocate the funds rationally among the stocks. Technical analysts

use the indices to predict the future of market.

The Dow Jones Industrial Average (DJIA), one of the most popular stock

market indices experienced a downfall in the early stages of 2004 which was

largely attributed to an increase in the Money Supply by the Federal Reserve

in the USA . The Technical Indicator Index (TII) studies incorporating the

Short Term Index and Intermediate Term Index from the period January to

May 2004 for the American equity markets showed largely negative or

bearish trends for both the indices as they closed at 3.50 and 48.48

respectively. Whereas the short-term index is a useful predictor of equity


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markets over the short run, the intermediate term index serves as a warning

system for trend changes of considerable magnitude.

Question 2 iii: How can increasing short interest give a bullish

interpretation. Why?

Answer

A bull market is associated with increasing investor confidence, and

increased investing in anticipation of future price increases.

Short interest is the total number of shares of a particular stock that have

been sold short by investors but have not yet been covered or closed out.

This can be expressed as a number or as a percentage.When expressed as a

percentage short interest is the number of shorted shares divided by thenumber of shares outstanding. For example, a stock with 1.5 million shares

sold short and 10 million shares outstanding has a short interest of 15%

(1.5 million/10 million = 15%).

Most stock exchanges track the short interest in each stock and issue reports

at month's end. These reports are great because, by showing what short

sellers are doing; they allow investors to gauge overall market sentiment

surrounding a particular stock. Or alternatively most exchanges provide an

online tool to calculate short interest for a particular security. For example

check out the Nasdaq's short interest calculator; it's very easy to use.

A large increase or decrease in a stock's short interest from the previous

month can be a very telling indicator of investor sentiment. Let's say that

Microsoft's (MSFT) short interest increased by 10% in one month. This


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means that there was a 10% increase in the amount of people who believe

the stock will decrease. Such a significant shift provides good cause for us to

find out more. We would need to check the current research and any recentnews reports to see what is happening with the company and why more

investors are selling its stock.

A high short-interest stock should be approached for buying with extreme

caution but not necessarily avoided at all cost. In fact, many investors use

short interest as a tool to determine the direction of the market. The

rationale is that if everyone is selling, then the stock is already at its low and

can only move up. Thus they feel that a high short-interest ratio is bullish -

because eventually there will be significant upward pressure on the stock's

price as short sellers cover their short positions (i.e. buy back the stocks

they borrowed to return to the lender).

Question 3i: Explain the utility of the economic analysis and state the economicfactors considered for this analysis.

Answer

Resources are scarce, while human wants and needs tend to be unlimited.

Economic analysis is the study of supply and demand, and the choices

(decisions) and incentives (pricing, taxes, etc.), so that scarce resources are

used efficiently.

The process of economic analysis involves identifying appropriate economic

indicators, collecting economic data, preparing or selecting an economic

forecast, interpreting the economic data, monitoring intervening forces and

using the economic analysis for decision making.

Decision makers use the results of an economic analysis for decision making.

Astute decision makers recognize that economic forces are uncontrollable


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and that current strategies may need to be adjusted to cope with or

overcome the economic changes. They approach with caution opportunities

and threats discovered as a result of economic scanning and analysis. Theypursue a proactive approach, however, knowing that an economic analysis

enables them to choose from alternative approaches , how to employ scarce

or uncommon resources and achieve objectives in the most efficient and cost

effective manner.

The economic factors considered for this analysis are unemployment rates,

personal income and expenditures, interest rates, business inventories,

gross product by industry, and numerous other economic indicators or

indices. Such measures of economic performance may be found in secondary

sources such as business, trade, government, and general-interest

publications.

Question 3ii: What is meant by fundamental analysis? How does fundamentalanalysis differ from technical analysis?

Answer

Fundamental analysis is the examination of the underlying forces that affect

the well being of the economy, industry groups, and companies. The term

simply refers to the analysis of the economic well-being of a financial entity

as opposed to only its price movements. As with most analysis, the goal is to

derive a forecast and profit from future price movements. It is performed on

historical and present data, but with the goal of making financial forecasts.

At the company level, fundamental analysis may involve examination of

financial data, management, business concept and competition. Also known

as quantitative analysis, this involves looking at revenue, expenses, assets,

liabilities and all the other financial aspects of a company. Fundamental

analysts look at this information to gain insight on a company's future


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performance At the industry level, there might be an examination of supply

and demand forces for the products offered. For the national economy,

fundamental analysis might focus on economic data to assess the presentand future growth of the economy. To forecast future stock prices,

fundamental analysis combines economic, industry, and company analysis to

derive a stock's current fair value and forecast future value. When talking

about stocks, fundamental analysis is a technique that attempts to

determine a securitys value by focusing on underlying factors that affect a

company's actualbusiness and its future prospects.

Technical analysis, on the other hand, looks at the price movement of a

security and uses this data to predict its future price movements.

Fundamental analysis is different from technical analysis as a technical

analyst approaches a security from the charts, while a fundamental analyst

starts with the financial statements.

Question 3iii: What industry life cycle exhibits the status of the industry andgives the clue to entry and exit for investors Elucidate.

Answer

There are typically five stages in the industry lifecycle. They are defined as:

i. Early Stages Phase - alternative product design and positioning,

establishing the range and boundaries of the industry itself.

ii. Innovation Phase - Product innovation declines, process

innovation begins and a "dominant design" will arrive.

iii. Cost or Shakeout Phase - Companies settle on the "dominant

design"; economies of scale are achieved, forcing smaller players to be


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acquired or exit altogether. Barriers to entry become very high, as

large-scale consolidation occurs.

iv. Maturity - Growth is no longer the main focus, market share

and cash flow become the primary goals of the companies left in the

space.

v. Decline - Revenues declining; the industry as a whole may be

supplanted by a new one.

Each stage shows the status of the industry and gives a clue for entry or exit

for investors.

Under the production and market introduction phases, revenues and

earnings are likely to be very low, which makes investments during these

phases more speculative in nature. Revenues and earnings are likely to be

low because there is little demand for the product, or the product is not

completed. Expenses are likely to be very large during these phases as a

company or industry spends a lot on marketing and research.

Through the growth phase, revenues and margins are likely to be on the rise

due to an increase in demand for a product and the pricing power the firm

has due to a small number of competitors. Stock prices are likely to rise

during this phase.

During the maturity and stability phase, revenues and margins are likely to

decline due to lower sales demand and more competition. Stock prices are

likely to decline during these phases.

Answer 4i)

Expected return on portfolio is

=XL E( ) + XM E )

) = 0.60*12 + 0.40*14 for95


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= 7.2 + 5.6

=12.8

=XL + XM E(

=0.60*18 + 0.40*12

=10.8 + 4.8

=15.60 .for96

%

( 1 ) . ( 2)

15 12 15 3 14 13 1 1

1 1 15 3 12 13 1 1

1 2

1/21 1

1 4.24

2/21 2

2 1.414

( , )


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( , )

0% 40%

+ + 2

+ + 2*0.*0.4* *4.24*1.414

.4 + 0.32 + 2.

Answer 5

Stock Price = Dividends(Div)

Expected Return(R) Growth Rate(G)

Or,

Stock Price = Div

(R G)

= 2

(0.14 0.06)

At a growth rate of 6% infinitely


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= 2

0.08

= 25Rs.


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Assignments B

Answer 1:

Present value of future cash flows for first four years including current year is

10 + 10/(1.14) + 10/ + (10+(0.25*10))/( +

(12.5+(0.25*12.5))/

= 10 + 8.77 + 7.69 + 8.44 + 15.625/1.688

= 10 + 8.77 + 7.69 + 8.44 + 9.25

= 44.15

5thYear = 405.76

Total = 449.91

Above amount is greater than initial outlay of 150, hence recommended to buy the

stock.

Answer 2:

In case of reorganization

PV of future cash flows is 16 + 16/1.18 +

= 16 + 13.56 + 11.49 + 97.38

= 138.43

In case of no reorganization


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PV of future cash flows is - 16 + 182.59

= 196.59

Hence, reorganization is better.

Answer 3:

Case A Total 25+21.19+17.95+15.22+429.82 = 509.18

Case B Something wrong in line highlighted in red i.e. Cash received from the

new investment is therefore, to reduce the dividend payments made in the 10% will also

be maintained because of other operations.

However if the question intent is (assumption is at my end) that growth is 10% all

through year 5 plus all extra cash as dividend + year six is 15% growth resumes

Total = 25+23.3+21.73 + (20.25+1.22)+(18.88+11.86)+(17.60+17.92)+546.87 =

704.63

Hence investment in case B is much better.


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Case Study

Answer 4:

Here market return (proxy Nifty) is not given. Lets assume 15% correction

Average Beta Infosys = 0.0265

Expected return from Infosys = 5.15+15*.0265=5.55%

Average Beta Hamdard = 0.044

Expected return from Hamdard = 5.15+15*0.044=5.81%

So returns from Hamdard are marginally higher. However D/E ratio is also higher.

Since investor is conservative, Infosys is a world class company and provide IT solution

so as per current scenario Infosys is recommended.

Since corporate tax is there on both cases (assumption); it has no bearing on

investment decision.


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Assignment - C

Q1 b) Genuine investments involve calculated risks which are consistent with the

expected returns.

Q2 c) the preferred time horizon

Q3 a) Offers straight interest payments and is redeemed at par.

Q4 d) 50%

Q5 b) Purchase of gold and art objects

Q6 d) Cannot exceed 10% of the share capital plus f ree reserves.

Q7 b) 24%

Q8 d) both a & c

Q9 a) 1

Q10 d) Both b and c

Q11 c) Favourable investments

Q12 b) 1.75

Q13 b) 14%

Q14 c) Return on the security and return on the market

Q15 d) CML is a relationship between total risk and required return.

Q16 a) Default risk

Q17 a) Variability of the security's returns

Q18 d) All of the above


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Q19 c) Rise

Q20 d) Both a and c.

Q21 b) Expansion stage

Q22 b) Growth industries

Q23 c) Book value

Q24 b) Equity/Debt

Q25 a) Steel and Iron

Q26 a) High P/E ratios

Q27a) Cash cow

Q28d) None of the above

Q29 b) High dividend pay out ratios

Q30 d) Low value addition

Q31 d) Both a and c.

Q32 d) Both a and b.

Q33 c) MACD

Q34 a) 0.2

Q35 c) Contrarian opinion theory

Q36 a) Exponential moving average

Q37 d) Breadth of market indicators

Q38 d) Chart patterns tend to repeat themselves.

Q39 c) Rs. 300


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Q40 d) 100

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