Page 64 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 2: Risk and Return

Whether investing will ever be classified as a science is doubtful, but research, training and Notes
experience have developed investing into a discipline. Discipline means a structured, consistent
and orderly process without rigidity in either concept or methods.

Financial Analysis

Financial analysis is the informative and predictive function in investing. It provides information
about the past and present, and it quantifies expectations for the future. Capital budgeting
decisions, corporate financial polices, and informed selections of securities for investment are
all products of financial analysis. Analytical resources mobilized for these purposes include
economic, capital market, sector and specific security analyses.

Economic Analysis

Economic analysis provides both near-term and longer-term projections for the total economy
in terms of the nation's output of goods and services, inflation, profits, monetary and fiscal
policy, and productivity. It, thus, provides the foundation for capital market, sector, industry
and company estimates of the future.

Capital Market Analysis

Capital market analysis examines the industries and securities of individual companies primarily
to develop value and return expectations for securities and thus to distinguish over-priced
securities from under-priced ones.
Between capital market analysis and security analysis, incorporating some characteristics of
each is sector analysis. Broader than industry and company analysis, sector analysis may be
viewed as a bridge between capital market context; sectors consist of major groupings of stocks
(i.e. according to economic sector, growth rate, or cyclically in earnings) that either cut across or
combine several industries.

Comparative Selection of Securities

Selection among alternative investment opportunities requires appraisal of securities so that
their relative attractiveness in terms of return and risk can be judged at any time. This purpose
can be accomplished only if consistent analytical procedures are employed and industry and
company forecasts are based on an internally consistent set of economic and capital market
projections.

If Hindalco is considered for purchase, it must be considered more attractive than Nalco, Indian
Aluminium, or other issues with comparable investment characteristics. Thus, isolated analysis
and evaluation of an individual security are impractical and inappropriate. One security cannot
be effectively appraised apart from other securities, or apart from the general investment climate.
Consistency and comparability are so important that they should be the twin goals of the
investment analysis process. Consistency applies to data for an individual company across time,
whereas comparability seeks valid data on companies for each time period. Without consistency
and comparability, the investor cannot exercise sound judgment in identifying instances of
overvaluation and under-valuation.

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