Advanced Financial Management

Question: Discuss about the Advanced Financial Management. Answer: Introduction There are two primary methods being used in the analysis and selection of the stocks namely fundamental and technical (Schlichting, 2013). This report is prepared to discuss various aspects of fundamental and technical analyses. There have been created two portfolios comprising 10 stocks each. The stocks of one portfolio have been selected based on the fundamental analysis and the stocks of other portfolio have been selected based on technical analysis. Various tools and techniques within the categories of fundamental and technical analysis have been applied in this report. The tools used under fundamental analysis are price earnings ratio, return on equity, and dividend yield. Further, the tools used under technical analysis are moving average, line charts, and support and resistance levels. Literature Review Analysis and selection of the right stocks, which prove to be worthy for the investor, is a tedious task. The investors for this purpose employ fundamental as well as technical analytical tools and techniques. The fundamental and technical analysis covers the analytical aspects broadly however still there remains the risk. This risk is explained in the theories of behavioral finance and efficient market hypothesis. The theories of behavioral finance state that the prices of stocks are sometimes affected by the behavioral influences (Ackert and Deaves, 2009). For example, when the stock market of US collapsed followed by the global financial crisis, the stock markets of other countries also slopped downward. This shows the behavioral influence that when the investors started selling their holdings in the US, the investors from other countries also started clearing out their positions in the wake of severe loss. The selling pressure broke the market causing significant downfall in the prices of stocks (Ackert and Deaves, 2009). Thus, it could be noted that when the events like global financial crisis encounters, even the stocks bought rigorously analyzing could be result in loss. In the situation like financial crisis, the investor becomes takes irrational decision while selling the stocks (Baker and Nofsinger, 2010). The theories of fundamental analysis are based on the assumption that the investor always act rationally. However, the theories of behavioral finance state that the investor could be irrational in the events like financial crisis. Thus, the views taken out of behavioral finance principles could contrast with the views taken out of the fundamental theories. Further, there is another crucial aspect of investment analysis that is the efficient market hypothesis. The theory of efficient market states that no one can beat the market. This implies that the investors can not make gains by exploiting the information gap in the market (Harder, 2010). The theory of efficient market hypothesis (EMH) is based on the belief that the stock market always remains efficient. The EMH theory states that all relevant information is available to all the market participants and the investors behave rationally. The theory further states that the current price prevailing on the stock market incorporates all the information and thus, there remains no scope to find the undervalued or overvalued stocks (Kurth, 2013). According to EMH, the stocks trading on the indices are fairly priced and it is impossible to find out the undervalued or overvalued stocks. Therefore, the efficient market theory contrasts with the principles of fundamental analysis. The dividend discount model and harry Markowitz theory of portfolio selection prescribe the fundamentals to compute the fair values of the stocks. According to these fundamental theories, the stocks could be undervalued or overvalued and thus, the investor can make profits by finding out the undervalued stocks and selling them in future at the high prices (Kurth, 2013). The proponents of the EMH claim that it is wastage of time to search and find out the undervalued stocks using fundamental analysis or to predict the future trend using technical analysis. However, the efficient market theory is criticized and its practical application is questioned (Kurth, 2013). There are people such as Warren Buffet who have shown that the efficient market theory is incorrect by beating the market on many occasions. Further, the assumption of EMH that information is available to all the market participants at all times also does not appear to be appropriate. Therefore, it could be inferred that despite being there EMH and behavioral influences, the fundamental and technical analyzes holds importance for the investors (Kurth, 2013). Rationale and Methodology The methodology means the overall approach used by the researcher in collecting the data and analyzing the same to make out meaningful conclusions. It is crucial for the researcher to adopt suitable methodology to carry out the research work in the right direction (Phillips and Stawarski, 2016). The current report aims to analyze two portfolios, one formed based on fundamental analysis and the other based on technical analysis. For this purpose, 20 stocks have been selected for two portfolios each comprising 10 stocks. The stocks selected for fundamental portfolio were based on the parameters like profit margin, return on equity, dividend yield, and price to earnings ratio. On the other hand, the stocks comprising the technical portfolio were selected based on the trend analysis by line chart, analysis of moving average, and the analysis of support and resistance levels. The list of stocks comprised in two portfolios is given in the appendix-1. The appendix shows name of the company along with the reasons for its selection. In regards to the fundamental portfolio, the stocks such as Singtel (Singapore Communications Limited) and StarHub Limited were selected based on the high profit margin and high return on equity respectively. Singtel is earning a profit margin of 23.25% while Starhub is providing a surprising return on equity of 178.51% (Appendix-1). Further, stocks such as Sembcorp Marine Ltd and Wilmar International Limited were found to be with low price to book value ratio, which depicts possibility of increase in price in future. The stocks of technical portfolio were selected by analyzing the trend in historical prices. Analysis of Singapore Airlines Ltds stock price is depicted in the chart given below: Figure 1: Singapore Airlines Daily Price Movement [Source: https://in.finance.yahoo.com/q?s=C6L.SI] It could be observed that the days price of stock is showing rising trend which shows stocks potential to provide high returns in short term. Further, other stocks were also analyzed for trend to make final choice about their selection. Results and Analysis Analysis of one Stock from Fundamental Portfolio The most commonly used fundamental stock evaluation techniques are dividend discount model and PE Multiple model. The stock namely Starhub Limited has been analyzed as under applying these methods: Dividend Discount Model The dividend discount model is used to compute the fair value of the stock. Based on the fair value computed the stock is analyzed as to whether it is undervalued or overvalued and based on this analysis, the decision for investment is made (Madura, 2014): Dividend Discount Model: Starhub Limited Dividend expected 0.198 Growth rate 3% Discount rate 6.70% Intrinsic Value 5.358 The outcome of the above analysis shows that the fair value of the stock is S$5.36 which is higher than the market price of S$2.83 prevailing as on November 28, 2016. As dividend discount model, the stock is overvalued. PE Multiple Model PE Multiple is also used to compute fair value of the stock using earnings per share and industry PE ratio (Madura, 2014): PE Multiple Model: Starhub Limited Industry PE ratio 5.1 EPS of Starhub Limited 0.2 Intrinsic Value 1.02 The results of PE Multiple Model show that the fair value of the stock is S$1.02 which is lower than the market price of S$2.83 prevailing as on November 28, 2016. As per PE Multiple, the stock is undervalued. Analysis of one Stock from Technical Portfolio Three techniques such as line chart, moving average, and support and resistance levels have been used to analyze one of the technical portfolio stocks namely Singapore Airlines Ltd. Line Chart: Figure 2: Stock of Price Trend Analysis The line chart presented above shows historical trend in the stocks price for the period beginning from November 28, 2016 to January 06, 2017. It could be observed that the price of stock was high at the beginning however it reduced in December 2016. Further, in the month of January the trend was observed changing as the price started rising again. The signals of rise in the price in the initial days of January suggested that the stock is worth investing. Moving Average: The simple moving average of Singapore Airlines Ltds prices computed over the historical period beginning from November 28, 2016 and ending on January 06, 2017 has been found to be S$9.57 (Refer Excel). This indicates that buying the stock when price of the stock is above S$9.57 will be beneficial for the investor. Further, when the price of stock goes below S$9.57, it is advisable to sale the stock because the price may fall further down in that case. In the current case, the price of Singapore Airlines Ltd increases to S$9.86 on January 10, 2017, therefore, it is advisable to buy the stock. Support and Resistance Levels: The stock of Singapore Airlines Limited trades in the range of S$9.60-11.67. Thus, the stocks resistance level can be taken as S$11.67 and its support level as S$9.60. This implies that the stocks price would go lower than S$9.60 rarely, but if it surpasses this level, the stock may fall severely down. Similarly, the stocks price would go max high to S$11.60, but once this level is broken, it is more likely that stock will rise high. Figure 3: Singapore Airlines Support and Resistance Activities in Fundamental Portfolio There have been two activities in the portfolio-1 (Fundamental) as depicted in appendix-2. Under the first activity, 1000 shares of SingTel (Singapore Communications Limited) were sold at the price of S$4 per share. This decision to sale 1000 shares was taken to book the profits because the stock achieved new levels reaching at S$4 (Appendix-2). Further, the second activity involves buying 2700 shares of Sembcorp Marine Ltd on January 20, 2017. These 2700 shares of Sembcorp Marine Ltd were bought using the amount received on sales of 1000 shares of SingTel. In buying Sembcorp Marine Ltd on January 20, 2017, it was considered that the share is undervalued and it will pick up in coming months. Activities in Technical Portfolio There have been four activities in portfolio-2 as depicted in the appendix-3. Under the first activity, the 800 shares of Singapore Airlines Ltd were sold on February 01, 2017 at the price of S$10.06. Since, the price of stock increased by 2.14% in less than a months period, thus, it was considered appropriate to book the profits. In the second activity, 15,527 shares of Hyflux Limited were bought using the funds collected from sale of 800 shares of Singapore Airlines Limited (Appendix-3). The price of Hyflux Limited was observed to be slopping down, thus, decision to buy taken to increase the holdings cheaply. In the third activity, 18,000 shares of Hyflux Limited were sold at the price of S$0.6272. The analysis of trend in price showed that the stock was at its peak when reached at S$0.6272 and therefore decision to sell was taken. Under the fourth activity, the cash received on sale of 18,000 shares of Hyflux Limited was used in buying 7162 shares of Far East Orchard Limited. The decision to increase the holdings in Far East Orchard Limited was taken because the company was looking strong to grow in future. Evaluation of Performance of both the Portfolios It could be observed that the fundamental portfolio provided a holding period return of 6.39% which is higher than the expected market return of 5% (Appendix-2). Thus, it could be inferred that the fundamental portfolio beat the market and proved the efficient market hypothesis wrong which states that market can not be beaten. Further, the technical portfolio earned a holding period return of 9.69% which is also higher than the market expectations and thus, it also beat the market comfortably (Appendix-3). Conclusion The report presented here covers the analysis of stocks based on the fundamental and technical parameters. This report provides learning on critical aspects of fundamental and technical analysis covering the knowledge of various tools and techniques such as dividend discount model, PE Multiple model, and line chart analysis, moving average, and support and resistance levels. Further, the report also provides leaning as to how to formulate a portfolio of stocks and monitor the progress throughout. The report covers decision making for the sale and purchase of stocks during the period so that the overall performance of portfolio could be improved. In regards to the performance of portfolios, it was observed that both the portfolios outperformed the market by earning holding period returns higher than the market expectations. The fundamental portfolio earned a return of 6.39% while the technical portfolio earned a return of 9.69% as against the market expectations of 5%. References Ackert, L and Deaves, R. 2009. Behavioral Finance: Psychology, Decision-Making, and Markets. Cengage Learning. Baker, H.K. and Nofsinger, J.R. 2010. Behavioral Finance: Investors, Corporations, and Markets. John Wiley Sons. Harder, S. 2010. The Efficient Market Hypothesis and Its Application to Stock Markets. GRIN Verlag. Kurth, S. 2013. Critical Review about Implications of the Efficient Market Hypothesis. GRIN Verlag. Madura, J. 2014. Financial Markets and Institutions. Cengage Learning. Phillips, P.P. and Stawarski, C.A. 2016. Data Collection: Planning for and Collecting All Types of Data. John Wiley Sons. Schlichting, T. 2013. Fundamental Analysis, Behavioral Finance and Technical Analysis on the Stock Market. GRIN Verlag.