Analysis of Stocks

NISHANT KUMAR
Nishant Kumar
ASSISTANT
AssistantPROFESSOR
Professor
ARKAArka
JAIN UNIVERSITY
Jain University
 Analysis of Stocks

Fundamental Analysis

Fundamental analysis (FA) measures a security's intrinsic value by examining

related economic and financial factors. An investment's intrinsic value is
determined by the financial health of the issuing company, as well as the general
market and economic climate. Fundamental analysts look at all potential
influences on a security's value, including microeconomic elements like
managerial efficiency and macroeconomic factors like the status of the economy
and marketcircumstances.

Nishant Kumar
Assistant Professor
Arka Jain University
 Points to Remember
 Fundamental analysis is a method of determining a stock's real or "fair market"
value.

 Fundamental analysts search for stocks currently trading at prices higher or

lower than their real value.
 If the fair market value is higher than the market price, the stock is deemed
undervalued, and a buyrecommendation is given.
 If the fair market value is lower than the market price, the stock is deemed
overvalued, and the recommendation might be not to buy or to sell if the stock is
held.
 In contrast, technical analysts favor studying the historical price trends of the
stock to predict short-term future trends.
 Fundamental analysis is usually done from a macro to micro perspective to
identify securities that are not correctly priced by the market. Analysts typically
study, in order.
 The overall state of the economy
 The strength of the specific industry

 The financial performance of the company issuing the stock

Intrinsic Value

One of the primary assumptions behind fundamental analysis is

A. stock's current price often does not fully reflect the value of the company
when compared to publicly available financial data.
B. A second assumption is that the value reflected from the company's
fundamental data is more likely to be closer to the true value of the stock.

For example, say that a company's stock was trading at 200, and after extensive
research on the company, an analyst determines that it ought to be worth 240.
Another analyst does equal research but decides it should be worth 260.

Nishant Kumar
Assistant Professor
Arka Jain University
 Many investors will consider the average of these estimates and assume that the
stock's intrinsic value may be near 250. Often investors consider these estimates
highly relevant because they want to buy stocks trading at prices significantly
below these intrinsic values. This leads to a third major assumption of
fundamental analysis: In the long run, the stock market will reflect the
fundamentals. The problem is, no one knows how long "the long run" really is. It
could be days or years. This is what fundamental analysis is all about. By focusing
on a particular business, an investor can estimate the intrinsic value of a firm and
find opportunities to buy at a discount or sell at a premium. The investment will
pay off when the market catches up to the fundamentals.

Quantitative and Qualitative Fundamental Analysis

 Quantitative: information that can be shown using numbers, figures, ratios, or

formulas

 Qualitative: rather than a quantity of something, it is its quality, standard, or nature

 Qualitative Fundamentals to Consider

There are four key fundamentals that analysts always consider when regarding a
company. All are qualitative rather than quantitative. They include:

The Business Model

What exactly does the company do? This isn't as straightforward as it seems. If a
company's business model is based on selling fast-food chicken, is it making its
money that way? Or is it just coasting on royalty and franchise fees?

Competitive Advantage
A company's long-term success is primarily driven by its ability to maintain a
competitive advantage— and keep it. Powerful competitive advantages, such as
Coca-Cola's brand name and Microsoft's domination of the personal computer
operating system, create a moat around a business allowing it to keep
competitors at bay and enjoy growth and profits. When a company can achieve a
competitive advantage, its shareholders can be well rewarded for decades.

Nishant Kumar
Assistant Professor
Arka Jain University
 Management

Some believe management is the most important criterion for investing in a

company. It makes sense: Even the best business model is doomed if the
company's leaders fail to execute the plan properly. While it's hard for retail
investors to meet and truly evaluate managers, you can look at the corporate
website and check the resumes of the top brass and the board members. How well
did they perform in previous jobs? Have they been unloading a lot of their stock
shares lately?

Corporate Governance
Corporate governance describes the policies in place within an organization
denoting the relationships and responsibilities between management, directors,
and stakeholders. These policies are defined and determined in the company
charter, its bylaws, and corporate laws and regulations. You want to do business
with a company that is run ethically, fairly, transparently, and efficiently.
Particularly note whether management respects shareholder rights and
shareholder interests. Make sure their communications to shareholders are
transparent, clear, and understandable. If you don't get it, it's probably because
they don't want you to.

Industry
It's also important to consider a company's industry: its customer base, market
share among firms, industry-wide growth, competition, regulation, and business
cycles. Learning how the industry works will give an investor a deeper
understanding of a company's financial health.

 Quantitative Fundamentals to Consider:

Financial Statements
Financial statements are the medium by which a company discloses information
concerning its financial performance. Followers of fundamental analysis use
quantitative information from financial statements to make investment decisions.
The three most important financial statements are income statements, balance
sheets, and cash flow statements.

Nishant Kumar
Assistant Professor
Arka Jain University
 The Balance Sheet
The balance sheet represents a record of a company's assets, liabilities, and equity
at a particular point in time. It is called a balance sheet because the three sections—
assets, liabilities, and shareholders' equity— must balance using the formula:

Assets = Liabilities + Shareholders' Equity

Assets represent the resources the business owns or controls at a given time. This
includes items such as cash, inventory, machinery, and buildings. The other side of
the equation represents the total financing value the company has used to acquire
those assets. Financing comes as a result of liabilities or equity. Liabilities represent
debts or obligations that must be paid. In contrast, equity represents the total value
of money that the owners have contributed to the business—including retained
earnings, which is the profit left after paying all current obligations, dividends,
and taxes.

The Income Statement

While the balance sheet takes a snapshot approach in examining a business, the
income statement measures a company's performance over a specific time frame.
Technically, you could have a balance sheet for a month or even a day, but you'll
only see public companies report quarterly and annually. The income statement
presents revenues, expenses, and profit generated from the business' operations for
that period.

Statement of Cash Flows

The statement of cash flows represents a record of a business' cash inflows and
outflows over a period of time. Typically, a statement of cash flows focuses on the
following cash-related activities:

 Cash from investing (CFI): Cash used for investing in assets, as well as the
proceeds from thesale of other businesses, equipment, or long-term assets
 Cash from financing (CFF): Cash paid or received from the issuing and borrowing
of funds

 Operating Cash Flow (OCF): Cash generated from day-to-day business operations

Nishant Kumar
Assistant Professor
Arka Jain University
 Technical Analysis

Technical Analysis can be defined as an art and science of forecasting future

prices based on an examination of the past price movements. Technical
analysis is not astrology for predicting prices. Technical analysis is based on
analyzing current demand-supply of commodities, stocks, indices, futures or
any tradable instrument.
Technical analysis involves putting stock information like prices, volumes
and open interest on a chart and applying various patterns and indicators to it
in order to assess the future price movements. The time frame in which
technical analysis is applied may range from intraday (1- minute, 5-minutes,
10-minutes, 15-minutes, 30-minutes or hourly), daily, weekly or monthly price
data to many years.
There are essentially two methods of analyzing investment opportunities in
the security market viz fundamental analysis and technical analysis. You can
use fundamental information like financial and non-financial aspects of the
company or technical information which ignores fundamentals and focuses on
actual price movements.

Nishant Kumar
Assistant Professor
Arka Jain University
 The basis of Technical Analysis (Dow Theory)

What makes Technical Analysis an effective tool to analyze price behavior is

explained by following principles given by Charles Dow:

 Market discounts everything

 Markets move in trends
 Volume confirms the trend
 Indices move in accordance with each other
 Market trend has three phases.
 There is no trend reversal without proper indication.

Candlesticks
Formation

Candlestick charts provide visual insight to current market psychology. A

candlestick displays the open, high, low, and closing prices in a format similar
to a modern-day bar-chart, but in a manner that extenuates the relationship
between the opening and closing prices. Candlesticks don’t involve any
calculations. Each candlestick represents one period (e.g., day) of data. The
figure given belowdisplays the elements of a candle.

Nishant Kumar
Assistant Professor
Arka Jain University
 A candlestick chart can be created using the data of high, low, open and closing
prices for each time period that you want to display. The hollow or filled portion
of the candlestick is called “the body” (also referred to as “the real body”). The
long thin lines above and below the body represent the high/low range and are
called “shadows” (also referred to as “wicks” and “tails”). The high is marked by
the top of the upper shadow and the low by the bottom of the lower shadow. If the
stock closes higher than its opening price, a hollow candlestick is drawn with the
bottom of the body representing the opening price and the top of the body
representing the closing price. If the stock closes lower than its opening price, a
filled candlestick is drawn with the top of the body representing the opening
price and the bottom of the body representing the closing price.

Each candlestick provides an easy-to-decipher picture of price action.

Immediately a trader can see and compare the relationship between the open and
close as well as the high and low. The relationship between the open and close is
considered vital information and forms the essence of candlesticks. Hollow
candlesticks, where the close is greater than the open, indicate buying pressure.
Filled candlesticks, where the close is less than the open, indicate selling
pressure. Thus, compared to traditional bar charts, many traders consider
candlestick charts more visually appealing and easier to interpret.

Nishant Kumar
Assistant Professor
Arka Jain University
 NIFTY (Daily) Candlestick Chart

Why candlestick charts?

What does candlestick charting offer that typical Western high-low bar charts do not?
Instead of vertical line having horizontal ticks to identify open and close, candlesticks
represent two dimensional bodies to depict open to close range and shadows to mark
day’s high and low.
For several years, the Japanese traders have been using candlestick charts to track
market activity. Eastern analysts have identified a number of patterns to determine
the continuation and reversal of trend.
These patterns are the basis for Japanese candlestick chart analysis. This places
candlesticks rightly as a part of technical analysis. Japanese candlesticks offer a quick
picture into the psychology of short term trading, studying the effect, not the cause.
Applying candlesticks means that for short-term, an investor can make confident
decisions about buying, selling, or holding an investment.

Nishant Kumar
Assistant Professor
Arka Jain University
 Candlestick analysis

One cannot ignore that investor’s psychologically driven forces of fear; greed and
hope greatly influence the stock prices. The overall market psychology can be tracked
through candlestick analysis. More than just a method of pattern recognition,
candlestick analysis shows the interaction between buyers and sellers. A white
candlestick indicates opening price of the session being below the closing price;
and a black candlestick shows opening price of the session being above the closing
price. The shadow at top and bottom indicates the high and low for the session.
Japanese candlesticks offer a quick picture into the psychology of short term trading,
studying the effect, not the cause. Therefore, if you combine candlestick analysis with
other technical analysis tools, candlestick pattern analysis can be a very useful way to
select entry and exit points.

One candle patterns

In the terminology of Japanese candlesticks, one candle patterns are known as

“Umbrella lines”. There are two types of umbrella lines - the hanging man and the
hammer. They have long lower shadows and small real bodies that are at top of the
trading range for the session. They are the simplest lines because they do not

necessarily have to be spotted in combination with other candles to have some

validity.

Hammer and Hanging Man Hammer Hanging Man Candlesticks

Nishant Kumar
Assistant Professor
Arka Jain University
 Hammer

Hammer is a one candle pattern that occurs in a downtrend when bulls make a
start to step into the rally. It is so named because it hammers out the bottom. The
lower shadow of hammer is minimum of twice the length of body. Although, the
color of the body is not of much significance but a white candle shows slightly more
bullish implications than the black body. A positive day i.e. a white candle is
required the next day to confirm this signal.
Criteria

1. The lower shadow should be at least two times the length of the body.

2. There should be no upper shadow or a very small upper shadow.

3. The real body is at the upper end of the trading range. The color of the body is not
important although a white body should have slightly more bullish implications.
4. The following day needs to confirm the Hammer signal with a strong bullish day.

Signal enhancements

1. The longer the lower shadow, the higher the potential of a reversal occurring.
2. Large volume on the Hammer day increases the chances that a blow offday has
occurred.
3. A gap down from the previous day’s close sets up for a stronger reversal move
provided the day after the Hammer signal opens higher.

Pattern psychology
The market has been in a downtrend, so there is an air of bearishness. The price
opens and starts to trade lower. However, the sell-off is abated and market returns to
high for the day as the bulls have stepped in. They start bringing the price back up
towards the top of the trading range. This creates a small body with a large lower
shadow. This represents that the bears could not maintain control. The long lower
shadow now has the bears questioning whether the decline is still intact.
Confirmation would be a higher open with yet a still higher close onthe next trading
day.

Nishant Kumar
Assistant Professor
Arka Jain University
 Hanging man

The hanging man appears during an uptrend, and its real body can be either black
or white. While it signifies a potential top reversal, it requires confirmation during
the next trading session. The hanging man usually has little or no upper shadow.

Fig: Soybean Oil-December, 1990, Daily (Hanging Man and Hammer)

Nishant Kumar
Assistant Professor
Arka Jain University
 Two candles pattern

 Bullish engulfing

A “bullish engulfing pattern” consists of a large white real body that engulfs a small
blackreal body during a downtrend. It signifies that the buyers are overwhelming the
sellers Engulfing

Bullish engulfing

Description

The Engulfing pattern is a major reversal pattern comprised of two opposite colored
bodies. This Bullish Pattern is formed after a downtrend. It is formed when a small
black candlestick is followed by a large white candlestick that completely eclipses the
previous day candlestick. It opens lower that the previous day’s close and closes
higher than the previous day’s open.

Criteria

1. The candlestick body of the previous day is completely overshadowed by the next
day’s candlestick.
2. Prices have been declining definitely, even if it has been in short term.

3. The color of the first candle is similar to that of the previous one and the body of the
second candle is opposite in color to that first candle. The only exception being an
engulfed body which is a doji.

Nishant Kumar
Assistant Professor
Arka Jain University
 Pattern psychology

After a decline has taken place, the price opens at a lower level than its previous day
closing price. Before the close of the day, the buyers have taken over and have led to
an increase in the price above the opening price of the previous day. The emotional
psychology of the trendhas now been altered.
When investors are learning the stock market they should utilize information that has
workedwith high probability in the past.
Bullish Engulfing signal if used after proper training and at proper locations, can lead
to highly profitable trades and consistent results. This pattern allows an investor to
improve their probabilities of been in a correct trade. The common sense elements
conveyed in candlestick signals makes for a clear and concise trading technique for
beginning investors as well as experienced traders.

Bearish engulfing

A “bearish engulfing pattern,” on the other hand, occurs when the sellers are
overwhelming the buyers. This pattern consists of a small white candlestick with
short shadows or tails followed by a large black candlestick that eclipses or “engulfs”
the small white one.

Bearish Engulfing

Nishant Kumar
Assistant Professor
Arka Jain University
 MACD ANALYSIS

Nishant Kumar
Assistant Professor
Arka Jain University
 Moving average convergence divergence (MACD, or MAC-D) is a trend-
following momentum indicator that shows the relationship between two exponential
moving averages (EMA's) of a security’s price. The MACD is calculated by
subtracting the 26- period exponential moving average (EMA) from the 12-period
EMA.

 The MACD line is calculated by subtracting the 26-period exponential moving

average (EMA) from the 12-period EMA. The MACD signal line is a 9 period EMA of
the MACD line.
 MACD is best used with daily periods, where the traditional settings of 26/12/9
daysis the norm.
 The MACD triggers technical signals when the MACD line crosses above the signal
line (to buy) or falls below (to sell) it.
 MACD can help gauge whether a security is overbought or oversold, alerting traders
to the strength of a directional move.

Nishant Kumar
Assistant Professor
Arka Jain University
 MACD can also alert investors to a bullish/bearish divergence (e.g., when a new
high in price is not confirmed by a new high in the MACD, and vice versa),
suggesting a potential failure and reversal.
 After a signal line crossover, it is recommended to wait for 3-4 days to confirm that it
is not a false move.

Nishant Kumar
Assistant Professor
Arka Jain University