Analysis of Investments and Management of Portfolios


Microanalysis and Microvaluation of the Stock Market

The components of market analysis; microvaluation analysis; valuation using the earnings multiplier approach; Estimating expected earnings per share; and finally Estimating the stock earnings multiplier are essential in the microanalysis and microvaluation of the stock market.

The Components of Market Analysis

In the study the market analysis section of the process of the top-down, three-step market-industry-company investment process is essentially important. In this process, two broad mechanisms affect the components of the market analysis. They are the macroanalysis of the relationship between the aggregate securities and the aggregate economy; and the specific microvaluation of the stock market employing the evaluation approaches.

A key indicator in the determination of the economic activities and the security markets is the stock market. The prices of shares show the expectations of earnings, interest rate and dividends. Stock market is affected by several major indicator series. During economic crisis, the prices of shares are always affected before the overall economy is affected.

Economic Series and Stock Prices

It has been approved that the changes in the prices of shares occurs before the changes in the overall economy. The economic series has two main sections, that is:

  • The sets of economic series suggested by the National Bureau of Economic Research and
  • The Alternative monetary series determined by the Federal Reserve.

Cyclical Indicator Approach to Forecasting the Economy

This approach states that the overall economy expands and contracts in a discernable period. The cyclical indicator category is divided into two broad categories namely; the leading indicators which are economic series that often changes before the aggregate economy changes. Coincident indicator is where the changes in economic series coincide with the changes in the business cycle. In lagging indicators, changes in economic series occur after those of the aggregate economy. Selected series have economic series that cannot be categorized into any of the three major groups, like the balance of payments, federal surplus as well as deficit. In cyclical approach, we also discuss composite series as well as ratio of series. The composite time series is a combination of all the economic series, e.g. the composite leading indicator index which is broadly reported in the press monthly as an indicator of the current and the future state of the economy. There is also composite coincident and lagging indicator series whose ratio can be used in the economic analysis.

Industry Analysis

Industry analysis is significant in the analysis of the growth of the aggregate economy. The objectives of industry analysis as well as the business cycle and industry sectors are considered to be very important in understanding industrial economics. The structural economic changes and alternative industries as well as evaluating the industry life cycle are also major points of concern. The reason for doing industry analysis is to venture into profitable investment opportunities. Another reason is that it is part of the three-step, top-down plan for valuing individual companies and choosing the stocks for a portfolio. In the cross-sectional industry performance, we find that there is broad distribution in the rates of return in different industries. Industry performance varies from year to year. The varied results imply that industry analysis is significant and necessary to reveal these substantial performance differences- that is, it helps in identifying both profitable and unprofitable business opportunities.

In the long run, there is no correlation between the annual industry performance and the frequent rise and fall in markets. There is a huge disparity in the performances of individual companies in an industry. It is because of this that we advocate for the importance of company analysis in addition to the industry analysis.

Company Analysis & Stock Valuation

In the company analysis and valuation of stocks, there is a relationship between company analysis and the valuation of stocks. The linkage between economic, industry and the company analysis is very important in the determination of the value of stocks. We also do the in-depth study of the company analysis as well as estimating the intrinsic value is done in the valuation of stocks to ensure accuracy. Analysis of growth companies is also a key component of the company analysis. Finally in the company analysis, measures of value added consist of another important element which is required. In the company analysis and stock valuation we find that, good companies are not necessarily good investments and that a stock of growth company may not be a growth stock. We define growth companies as those companies whish constantly have the above-average rise in sales and revenues. However, according to financial theorists, growth companies are those companies whose management and opportunities earn greater rates of return than the rate of return required by the firm.

In the study, we also find that growth stocks are not automatically considered as shares in the growth companies. Growth stocks have higher rates of returns than other stocks with similar risks. In Company analysis, we are concerned with two major strategic approaches of a firm. They are: The firms overall strategic approach. Here we analyze the industry competitive environment as well as the (Strengths, Weaknesses, Opportunities and Threats) SWOT analysis. We also analyze the firm’s valuation approaches.