Security Analysis in Portfolio Management

There are different types of securities are available to an investor for investment. In Indian stock exchanges shares of more than 7000 companies are listed. Traditionally, the securities were classified into ownership such as equity shares, preference shares, and debt as a debenture bonds etc. Recently companies to raise funds for their projects are issuing a number of new securities with innovative feature. Convertible debenture, discount bonds, Zero coupon bonds, Flexi bond, floating rate bond, etc. are some of these new securities. From these huge group of securities the investors has to choose those securities, which he considers worthwhile to be included in his investment portfolio. So for this detailed security analysis is most important.

The aim of the security analysis in portfolio management is to find out intrinsic value of a security. The basic value is also called as the real value of a security is the true economic worth of a financial asset. The real value of the security indicates whether the present market price is over priced or under priced in order to make a right investment decision. The actual price of the security is considered to be a function of a set of anticipated capitalization rate. Price changes, as anticipation risk and return change, which in turn change as a result of latest information.

Security analysis in portfolio management refers to analyzing the securities from the point of view of the scrip prices, return and risks. The analysis will help in understanding the behavior of security prices in the market for investment decision making. If it is an analysis of securities and referred to as a macro analysis of the behavior of the market. Security analysis entails in arriving at investment decisions after collection and analysis of the requisite relevant information. To find out basic value of a security “the potential price of that security and the future stream of cash flows are to be forecast and then discounted back to the present value.” The basic value of the security is to be compared with the current market price and a decision may be taken for buying or selling the security. If the basic value is lower than the market price, then the security is in the over bought position, hence it is to be sold. On the other hand, if the basic value is higher than the market price the security’s worth is not fully recognized by the market and it is in under bought position, hence it is to be purchased to gain profit in the future.

There are mainly three alternative approaches to security analysis, namely fundamental analysis, technical analysis and efficient market theory.

1. Fundamental Analysis

The fundamental analysis allows for selection of securities of different sectors of the economy that appear to offer profitable opportunities. The security analysis will help to establish what type of investment should be undertaken among various alternatives i.e. real estate, bonds, debentures, equity shares, fixed deposit, gold, jewellery etc. Neither all industries grow at same rate nor do all companies. The growth rates of a company depend basically on its ability to satisfy human desires through production of goods or performance is important to analyze nation economy. It is very important to predict the course of national economy because economic activity substantially affects corporate profits, investors’ attitudes, expectations and ultimately security price.

According to this approach, the share price of a company is determined by these fundamental factors. The fundamental works out the compares this intrinsic value of a security based on its fundamental; them compares this intrinsic value, the share is said to be overpriced and vice versa. The mispricing security provides an opportunity to the investor to those securities, which are under priced and sell those securities, which are overpriced. It is believed that the market will correct notable cases of mispricing in future. The prices of undervalued shares will increase and those of overvalued will decline. Fundamental analysis helps to identify fundamentally strong companies whose shares are worthy to be included in the investor’s portfolio.

2. Technical Analysis

The second alternative of security analysis is technical analysis. The technical analysis is the study of market action for the purpose of forecasting future price trends. The term market action includes the three principal sources of information available to the technician — price, value, and interest. Technical Analysis can be frequently used to supplement the fundamental analysis. It discards the fundamental approach to intrinsic value. Changes in price movements represent shifts in supply and demand position. Technical Analysis is useful in timing a buy or sells order. The technical analysis does not claim 100% of success in predictions. It helps to improve the knowledge of the probability of price behavior and provides for investment. The current market price is compared with the future predicted price to determine the extent of mispricing. Technical analysis is an approach, which concentrates on price movements and ignores the fundamentals of the shares.

3. Efficient Market Theory

A more recent approach to security analysis is the efficient market hypothesis/theory. According to this school of thought, the financial market is efficient in pricing securities. The efficient market hypothesis holds that market prices instantaneously and fully reflect all relevant available information. It means that the market prices of securities will always equal its intrinsic value. As a result, fundamental analysis, which tries to identify undervalued or overvalued securities, is said to be a useless exercise.

Efficient market hypothesis is direct repudiation of both fundamental analysis and technical analysis. An investor can’t consistently earn abnormal return by undertaking fundamental analysis or technical analysis. According to efficient market hypothesis it is possible for an investor to earn normal return by randomly choosing securities of a given risk level.

Read More About: Efficient Market Hypothesis

Security Analysis Phase in Investement Portfolio Management