Page 179 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes (ii) Market share/profit margin approach: This is derivative of industry forecast of market.
Once the total market is known, the market share of the individual company can be
determined either using historical tract second or subjective probabilities. The next step is
estimating net income after taxes and dividends. This can be done by cost analysis and
estimates in relation to quantity of sales or operating capacity. Breakeven analysis is the
appropriate tool to carry out such an analysis.
(iii) Projected financial statement: This method makes an item-wise analysis of revenues and
expenses and predicts them over a number of years, based on the variations in the key
determining variables. It is possible only when the forecaster has through information
about the inner working of the company.

Notes A simplified approach involves consideration of branch/divisional total in place of
item-wise amounts.
The above three approaches are not mutually exclusive. They are not without shortcomings.
They are based on subjective evaluations made at various stages of the analysis.

(iv) Regression and correlation analysis: These methods as applicable to industry analysis can
be used at company level. The methods permit analyzing the relationships between several
variables of company, industry and economy to develop more accurate forecasts.

Because of the facility of considering many variables and analysing them, this method is
more advantageous.
(a) Analysts are forced to think through various problems of company and the various
interrelationships, internal and external variables and company revenues and
expenses.
(b) Analysts can clearly explain the causal variables of changes and improve the
confidence in forecasts.

(v) Trend analysis: Trend analysis is a time series analysis that permits 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.
(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

174 LOVELY PROFESSIONAL UNIVERSITY