Page 140 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 4: Fundamental Analysis

(v) Trend analysis: Trend analysis is a time series analysis that permits Notes
identification of seasonal, cyclical and erratic fluctuations of the variables
under consideration over a time period. Analysts employ trends analysed by
plotting the data on a special kind of graph paper, semi-logarithmic or semi-
log paper, in order to reveal starkly different growth rates.
(vi) Decision trees: This can be used to forecast earnings and security values. Decision
tree is an advanced technique because it considers possible outcomes with
their probabilities and analyses them.
A decision tree contains branches, each one representing a possible outcome.
Probabilities of the end points of the branches add up to 1.
The decision tree of security analysis starts with sale. If sales are expected at
two levels, high and low, there will be two branches; on the other hand if
medium level sales are included, there will be three branches. Each one
indicates expected sales and their probabilities. For each sale branch, different
levels of earnings expected can be given with their probabilities. Finally, for
each of the earnings branch, different expected P/E ratios can be presented.
Based on the data MPS can be calculated for each alternative course of events
and outcomes.

The advantages of this method are:
(1) Stage-wise analysis of probable events and outcomes help improve
accuracy in forecasting, and

(2) Final recommendations can be made with more understanding and
confidence.
(vii) Simulation: This method can be applied to forecast earnings and also security
values. Simulation is a technique that systematically repeats the application
of a rule or formula to know outcomes indifferent situations. It answers the
question – what happens to the outcome, if one or more variables influencing
it change?

All that is to be done is to set up the formulae
Sales × Margin (%)
Example: EPS =
No. of shares outstanding
MPS = EPS × P/E
Now, data relating to variables viz., Sales, profit margin, number of shares
outstanding and P/E ratio are generated along with their probability
distributions as in the case of decision tree.
The formula is applied to compute MPS under varying conditions. Computer
programming will help analyse security values rapidly and accurately.

4.3.3 Determining Earnings – Multiplier (P/E) Ratio

So far, the focus has been on determining Earnings Per Shares (EPS). This is to be translated into
market price per share (MPS). As such, most of the fundamental security analysis work centres
on determining the appropriate multiplier.

Research Findings: Bing carried out a survey of practitioners’ stocks evaluation methods and
found that several approaches were in vogue. He found that analysts (1) used time horizon from

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