Fundamental and technical
analysis of stock prices
A stock is a portion of the ownership of a corporation. It’s also called as equity or a share. It represents a claim on its proportional share in the corporation’s assets and profits.
Fundamental and technical analysis is the activity to evaluate the value of the stock and by using this evaluation to calculate the estimated invest revenue.
Ø Fundamental Analysis of stock price
Fundamental analysis is a method used to determine the value of a stock by analyzing the financial data that is ‘fundamental’ to the company. It calculates possible revenue throughout the investment based on the fact that intrinsic value of the company is moving along with stock price. Based on fundamental analysis method, if the intrinsic value of the company is higher than market price, people buy the stock and if intrinsic value is lesser than market price, people sell the stock.
It focuses on
1. Economic analysis
2. Industry analysis
3. Company analysis
Three Stage analysis Bottom-Up: Company analysis -> Industry analysis -> Economic analysis Top-Down: Economic analysis -> Industry analysis -> Company analysis |
Investors can use whether Bottom-Up or Top-down approach.
Bottom-Up: Investors begins with specific businesses, concerning their industry/region. They start with analyzing the business’ health like financial statement analysis including dividends paid, operating cash flow, new equity issues and capital financing.
The amount of debt is also one of the major considerations to analyze company’s health.
After that they analyze industry and economy regarding their businesses, they may concern.
Top-Down: The investors start with analyzing global economics, including both international and national economic indicators, such as inflation, GDP growth rates, exchange rates, productivity and energy prices. Then they narrow their focus on regional/industry analysis of price levels, total sales, and effects of competing products, entry or exit from the industry. Only after completing these process, the investors search the best business in that area according to the analysis data they have.
1. Economic analysis
1.1 Economic outlook
Usually, the market has close relationship to the stock price. According to the data so far, stock price is moving half year advance than the market. So before the real economy reaches peak, the stock price reflects it first and reaches peak half year earlier than the market. Same thing happens in recession, too, but there are so many variables, which affect the stock prices, so it isn’t always moving half year earlier than the market.
CI(Composite Index) is the data, which shows real economy condition into the objective form. It includes consumption, employment, finance, trading and etc and written in leading indicator, coincident indicator and lagging indicator.
1.2 Money supply(Monetary aggregates)
Three common monetary aggregates = M1, M2, M3(Discontinued since 2006, USA)
Relationship between Monetary aggregates and Stock price Corporate sector: Monetary aggregates↑ → Funding↑ → Facilities investment↑ → Profitability↑→ Stock price↑ Private Sector : Monetary aggregates↑→ Funding↑ → Buying stocks → Boom in stock market. → Stock price ↑ |
Commonly, increase in monetary aggregates rise the stock prices and decrease in monetary aggregates decrease the stock prices. In case, increase in monetary aggregates, leads high liquidityto the investors, which leads income effect, but on the other hands it will causes inflation and high interest rate(Fisher effect), which leads to decrease in the stock prices.
1.3 Interest rates
Interest rates should be controlled by the market itself, but it has mass influence over the market, but Federal Reserve controls the interest rates.
Relationship between Interest rates and Stock price Increased interest rate → Funding↓ → Facilities investment↓ Profitability↓ → Stock price ↓ Decreased interest rate → Funding↑ → Facilities investment↑ → Profitability↑ → Stock price↑ |
1.4 Inflation
Inflation leads to raise the nominal value of the real assets, which leads to raise the stock price. Moderate and continuous inflation will raise the real economy and improve company’s profitability and its assets, but rapid inflation will decrease savings and people will buy real estate or gold something like real assets, which causes to decrease the stock prices.
Relationship between inflation and stock prices Moderate inflation: Real economy↑ → Profitability↑ → Stock price ↑ Disinflation: Low price level& interest rates → Prefer Financial assets → Stock price ↑ Stagflation: High cost & low purchase power → Profitability↓ → Stock price ↓ |
1.5 Exchange rates
It is exchange ratio between local currency and foreign currency and it influence a lot on the stock price, when the company relies on high exports.
Relationship between exchange rates and stock prices Lower exchange rates: Appreciation → Export↓, Import↑ → Profitability↓ → Stock price ↓ higher exchange rates: Devaluation → Export↑, Import↓ → Profitability↑ → Stock price ↑ |
1.6 Commodity prices
The countries, which have such natural resources, in long term, the commodity prices and stock prices moves together, but countries like Korea, which has less natural resources, has negative the relationship.
Relationship between international commodity prices and stock prices(In Korea) Int’L commodity prices↑ → Local product prices↑ (Balance of payment↓, Average price level↑) → Selling↓ (Competitive price competitiveness↓) → Stock price↓ Int’L commodity prices↓ → Local product prices↓ → Selling ↑ Stock price↑ |
1.7 Foreign investors
Even if they expect that stock price will go down and they will buy stocks if they expect that exchange rate will be weaken and its profits from weaken exchange rate overwhelms losses.
Once, foreign investors’ money move into stock market, the stock prices will increase due to increased total demand for stock market, but on the other hands, if foreign investors leave the stock market, it will damage the stock market because of increasing in selling stocks.
2. industry analysis
It analyzes the structural competitive factors, which determine the competitive strength in the specific industry.
Barrier to enter, competitive strength of the existing companies, substitutability of product, Bargaining power and etc, all these are the structural competitive factors.
Structural competitive factors by M. Porter High entry barrier & low barriers to withdrawal : High profits & low risks High entry barrier & high barriers to withdrawal: High profits & high risks Low entry barrier & high barriers to withdrawal: Low profits & high risks Low entry barrier & low barriers to withdrawal: Low profits & low risks Entry Barrier: It is the factor, which make new companies to enter to other industry sectors. Competitive strength of the existing companies: The companies compete with other companies by providing new product, customer services, low product prices and etc to get advantageous position in the industry. |
Product life cycle theory It is the theory, which applied the life cycle theory into industry. |
|||
Stage |
Situation |
Profitability |
Risks |
Introductory stage |
l New product l Low selling, high advertisement cost |
Loss or low profits |
High |
Growing stage |
l Expansion of the market l Increase in selling |
High |
Low |
Maturity stage |
l sales volume peaks and market saturation is reached l increase in competitors entering the market |
Start to decrease |
Start to increase |
Saturation & decline stage |
l sales volume decline or stabilize l prices, profitability diminis |
Loss or low profits |
High |
3. Company analysis
In the company analysis, usually divided into three major parts, which are Qualitative analysis, Quantitative analysis and Financial ratio analysis.
3.1 Qualitative analysis
It analyzes about managerial structure, capability, efficiency of the company and products & its competitiveness in the market, whether it will grow or not in the future. It calculates the quality of financial flexibility such as each asset’s profitability, ability to generate cash, amount of debts, ability to generate cash from stock market and evaluate financial statement whether they made fraud or not.
This is the famous model for managing a portfolio of different business units(or major product lines), which developed in earlier 1970’s by Boston consulting group.
Categories |
Characteristics |
Growth |
Profitability |
Barking Dog |
Small market share in a mature |
Low |
Low |
Cash Cow |
Large market share in a mature, slow growing industry requires investment. |
Low |
High |
Rising Star |
Large market share in a fast growing industry. |
High |
High |
Question Mark |
Small market share in a high growth market, requires resources to grow market share. |
High |
Low |
3.2 Quantitative analysis
It is an analysis technique that is used to measure the evaluation of the performance or valuation of a financial instrument. It also can be used to predict real-world events such as changes in a share's price. For example, B/S Balance Sheet, It shows company’s financial condition at a specific term, including assets, liability and net worth.
3.3 Financial ratio analysis
It compares variables from Balance sheet and Profit & loss and calculates the financial ratio. It uses as a tool to evaluate the financial condition of the company by comparing with past data, industry average ratio data, rival company’s financial data.
Common examples of financial ratio analysis ROE(Return on equity): It is used as a general indication of the company’s efficiency on making profits.  |
|
PER(Price Earning Ratio): It shows how much profit the company make per share. 
|
PBR(Price to Book Ratio): It is a financial ratio used to compare a company’s book value to its current market price.  |
Financial ratio used in real stock market
Exchange rates (2010.12.03 17:53:00) \ = 5.42 HUF $1 = \1138.50 \ Korean Won $ US Dollar, HUF Hungarian Forint |
LS Corp. (006260, Korean stock = KOSPI) LS Corp is a holding company, which operated subsidiaries including LS Industrial System, LS Cable, LS-Kikko Copper and LS Mtron. Current stock price \102,500 3rd Dec 2010. Industry average PER = 16.35 |
Summary of Financial condition of LS(006260) |
||||
Recent Q. 2010.09 |
2007.12 |
2008.12 |
2009.12 |
2010.12(E) |
Applied accounting standard |
GAAP |
GAAP |
GAAP |
GAAP |
EPS(Hundred million Won) |
5,713 |
-940 |
6,718 |
7,659 |
BPS(Hundred million Won) |
46,071 |
47,535 |
51,969 |
58,639 |
PER |
15.77 |
N/A |
17.27 |
13.58 |
PBR |
1.96 |
1.61 |
2.23 |
1.77 |
Dividend Yield |
1.11 |
1.31 |
0.86 |
|
Sales(Hundred million Won) |
31,644 |
23,519 |
2,425 |
2,869 |
Operating profit(Hundred million Won) |
1,067 |
370 |
2,198 |
2,614 |
Operating profit margin(%) |
3.37 |
1.57 |
90.62 |
91.10 |
Net profit(Hundred million Won) |
1,840 |
-303 |
2,163 |
2,466 |
Net income(%) |
5.81 |
-1.29 |
89.18 |
85.96 |
ROA(%) |
6.11 |
-1.26 |
12.67 |
12.74 |
ROE(%) |
13.03 |
-2.06 |
14.19 |
14.15 |
Asset(Hundred million Won) |
31,922 |
16,180 |
17,971 |
20,736 |
Debt(Hundred million Won) |
17,010 |
1,648 |
2,009 |
1,847 |
Equity(Hundred million Won) |
14,912 |
14,532 |
15,962 |
18,889 |
Capital(Hundred million Won) |
1,610 |
1,610 |
1,610 |
|
Debt ratio(%) |
114.07 |
11.34 |
12.59 |
9.78 |
LS’s EPS, Net profit has been increased by the 10~15% annually on average except Dec 2008. Its debt ratio has decreased down to 9.78% in Dec 2010 from 114.07% in Dec. 2007. Its PBR is 1.77 and BPS is \58,639, which means even if the company bankrupts tomorrow you can still receive\58,639 per shares. Current PER is 13.58, which is still discounted if you compare the past years’ PER and the industry average PER.
The outlook for the next year’s profit is optimistic, the stock analyst experts are expecting the growth of 15% in Net profit and sales based on the company’s performance by expanding their aboard sales and high expected growth in the industry, which they deal with. Its fundamental is very strong since they have high ROE and debt ratio. Even Warrant Buffet usually invests, which has over 20% of ROE, low debt ratio, high market share and so on. So far the company positioned world’s 2nd or 3rdbiggest market shared company in the industry. The reason of low Net profit of this year is because the company invested money into new mass product lines. So next year’s net profit will be better than now.
So, According to the data, you can expect that it still has 10% potential growth in PER, 10~15% potential growth in next year’s net profit, so you can assume that next year’s stock price can grow 20~25% from now.
Ø Technical Analysis of Stock Prices
It is method to calculate to predict the stock price in the future by using chart, which includes stock price and volume. Also calculate to buying and selling point by analyzing the patterns of past stock stream. It doesn’t count fundamental analysis data.
The basic assumption
1. Stock prices are determined by supply and demand.
2. Stock prices move quite as long as trend moves.
3. Trend changes when supply and demand changes.
4. Some patterns are shown and it repeats.
Types of Chart
(Chart of LS)
Bar Chart: In Korea, we use Japanese bar chart.
There are two major parts in the chart, which is stock price and the volume. Volume indicates the number of stock has transacted during buying and selling process in certain period time.
Theories and Techniques
There are many theories for technical analysis such as Dow Theory, Elliott Wave Principle, OBV( On Balance Volume), VR(Volume Ratio), PL(Psychological Line), Stochastic, J.E. Granville’s law and so on.
I’m going to talk about Dow Theory and J.E. Granville’s law, which is the most common and popular theory.
Dow Theory
It was devised by Charles H. Dow, which that movements of the prices are a form of technical analysis that includes some aspects of sector rotation.
1. The market has three movements
A. Primary Movement: Last from less than a year to several years
B. Medium Swing: Last from ten days to three months
C. Short Swing: Hours to a month or more
2. Market trends have three phases(Increase, Decrease)
Investors are actively buying(Selling) stock against the general opinion of the market(Phase 1) with high supply, during phase 2 price change occurs rapidly. Phase3 investors begin to distribute their holdings to the market.
3. The stock market discounts all news
The stock prices will only change to reflect new information, which is not the information for everyone.
4. Trends are confirmed by volume.
A. Dow believed that volume confirmed price trends. When price movements are accompanied by high volume, he believed this represented the ‘true’ market view.
Problems with Dow theory
It takes too long time to know its phase of movement. It will be late when you realized that trend has changed.
Depends on who analyzes, they come up with different conclusion and it is relied on analyst’s experience and ability.
It gives you average trend of stock market, but it doesn’t consider the existing risks and doesn’t help you to give you information to make portfolios.
J.E. Granville’s law
He suggested buying & selling point strategy by using stock price and moving average.
Buying signal
When the stock is moving above moving average or seems like going to cross the moving average.
Selling signal
When the stock is moving under moving average or seems like going down to the moving average.
There are 4 major Average movements in Korea (20, 60, 120, 250 in days). The average movement with bigger number has stronger meaning on the chart. I’m going to explain how to use Granville’s law in the chart in real practice by applying it to LS Company’s chart.
In the chart above, if you see the red circle number 2, 3 and 5 you can see that the stock price is indicating that it’s going upward close to the average movements. In the red circle number 2 it has strong indication about trend since it’s rising rapidly about to cross many average movements.
The blue circle 1, 4 and 6, you can see that the stock price is indicating that it’s going downward crossing the average movement or already crossed average movement. Especially blue circles number 1 and 4 have strong indication of going down since the price is crossing the line. And 6 has strongest indication of doing down because the stock dropped so much just in one day. You should sell the stocks and watch its movement.
The green circle number 7 indicates complicate average movement. It seems like stock prices are touching average movement, but it bounces back. In this case, you should watch the average movement very carefully.
Ø Conclusion
For example, according to J.E Granville theory, the blue circle indicates decrease and this is the point people should sell or control the amount of stocks they have, but after all people know this theory, then people become smarter. They will sell their stocks at the moments red circle instead of the moments blue circle, because people know that all people will sell at moments blue circle and that will be late to sell and even if you sell that moment, the returns will be lesser than the moment when you sell at red circle.
As I mentioned above, too, the technical analysis doesn’t contain risks. It doesn’t explain why the stock market struggled during Oct, 2008 & Greek crisis in Feb and you can’t apply technical analysis to such cases like when North Korea announced that they have nuclear bomb Sept 2008, attached Korean Warship in March to explain. Recently, Dutch Bank withdrew the money about $ 1,754 million US dollars from Korean stock market and KOSPI Index struggled down about -2%. Well, if you know that Korean stock market is wealth about $ 0.8 trillion US dollar, Dutch Bank affected Korean stock a lot.
The left chart is KOSPI, which is Korean Index and right chart is DOW index, if you see the charts, they look similar and we call ‘coupling’. It happens because Korean economy is very relying on USA.
Sometimes, the psychologists can explain it better rather than any other experts. I don’t remember when, but there was article that one investment bank hired psychologists to invest in stock market and they did quite well, even better than any other experts. The Psychologist could explain IT bubble in 90’s. That time, people were so optimistic and they thought that other IT company can grow same as Microsoft, SUN and etc. They ignored fundamental analysis and technical analysis and they just invest into every IT company. Later, it collapsed because the companies didn’t make any money.
Although, technical analysis seems like having many problems, but that doesn’t mean that you should ignore technical analysis because fundamental analysis also has such problems and there are too many external variables, which influence the stock market. So, the best way to invest is using both analyses.
References
http://en.wikipedia.org/wiki/Stock Wikipedia ‘stock’
http://www.investorwords.com/4725/stock.html Stock definition
http://economics.about.com/cs/economicsglossary/g/stock.htm Definition of Stock
http://www.investorguide.com/igu-article-445-investing-strategies-fundamental-analysis.html Fundamental Analysis
http://en.wikipedia.org/wiki/Fundamental_analysis Wikipedia ‘Fundamental Analysis’
http://en.wikipedia.org/wiki/Technical_analysis Wikipedia ‘Technical Analysis’
http://www.womeninvesting.net/fundamental_technical_analysis.html Fundamental vs Technical Analysis
http://www.min.com.my/index.php?option=com_content&view=article&id=222:analyzing-stocks-through-fundamental-and-technical-analysis&catid=1:corporate&lang=en Analyzing Stocks through Fundamental and Technical Analysis
http://www.quickmba.com/strategy/matrix/bcg/ BCG matrix
Book ‘Certified Securities Investment Advisor’ ISBN 978-89-6009-333-1
Charts, indexs, exchange rates, B/S, P/L came from Eugene stock exchange program HTS (Korean)
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