Page 144 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 4: Fundamental Analysis

Valuation Notes
The investor interested in growth shares can either employ (1) Comparative P/E ratios approach
or (2) Dividend Discount model for valuation of the stocks.

Guidelines for Investment

The following guidelines will be helpful to investors interested in growth stocks.
1. Tuning is not very important, but with appropriate timing one may be able to pick up
shares at the threshold of high growth rate.
2. Choice of stock should not be based on simple factor. Multiple criteria using different
appraisal techniques may be employed.
3. It is better to diversify investment in growth stocks industry-wise. Because different
industries grow at different by evening out differences.

4. One should hold the stock for more than 5 years to gain advantage.
Estimation of Future Price

Before attempting to discuss the approach that can be adopted for company level analysis, let us
about the objective of investor and how it can be quantified. It is to reiterate the proposition that
an investor looks for increasing his returns from the investment. Returns are composed of
capital gains and a stream of income in the form of dividends. Assuming he has equity shares for
a period of one year (known as holding period), i.e., he sells it at the end of the year, the total
returns obtained by him would be equal to capital gains plus dividends received at the end of
the year.

Where, R = (P – P ) + D
1 1 1–1 t
P = Price of the share at the end of the year
1
P = Price of the share at the beginning of the year
1–1
D = Dividend received at the end of the year
1
R = Return for the holding period, t
1
In order to calculate the return received by him on his original investment (i.e. purchase price),
total should be divided by P – 1. These are expressed in percentage terms and known as holding
t
period yield. Thus,
(P P 1) + D
HRY (%) = 1 1 1
P 1 1
The above computation is quite simple as long as the value of the variables is available.
In reality, however, the investor would know the beginning price of the share (called purchase
price) as this is the price paid to buy the shares, but the price at the end of the year (i.e. selling
price) as well as dividend income received would have to be estimated. This is where the
problem lies. How to estimate the future price of the share as well as dividends? This becomes
the main challenge. The series data relating to dividends paid by companies provide us useful
clues in estimating the dividends likely to be declared by companies. There is, it seems, a
dividends policy followed by most firms in general. Thus, an investor would be able to estimate
dividend for the year with reasonable degree of accuracy under normal circumstances.
It has been found the management is very conservative in increasing the amount of dividend
paid to shareholders. Managements generally do not increase the dividend unless this increase
is sustainable in the long run. This is to avoid further cuts if need count of dividend, in actual

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