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HOW TO DO EQUITY RESEARCH

Fundamental analysis is a method of evaluating a security in an attempt to assess its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors. Fundamental analysts study anything that can affect the security's value, including macroeconomic factors (e.g. economy and industry conditions) and microeconomic factors (e.g. financial conditions and company management). The end goal of fundamental analysis is to produce a quantitative value that an investor can compare with a security's current price, thus indicating whether the security is undervalued or overvalued.

1.     Understanding the business


S. No. Question Rational behind the question
1 What does the company do? To get a basic understanding of the business
2 Who are its promoters? What are their backgrounds? To know the people behind the business. A sanity check to eliminate criminal background, intense political affiliation etc
3 What do they manufacture (in case it is a manufacturing company)? To know their products better, helps us get a sense of the product’s demand supply dynamics
4 How many plants do they have and where are they located? To get a sense of their geographic presence. Also at times their plants could be located in a prime location, and the value of such location could go off balance sheet, making the company highly undervalued.
5 Are they running the plant in full capacity? Gives us an idea on their operational abilities, demand for their products, and their positioning for future demand
6 What kind of raw material is required? Helps us understand the dependency of the company. For example the raw material could be regulated by Govt (like Coal) or the raw material needs to be imported either of which needs further investigation
7 Who are the company’s clients or end users? By knowing the client base we can get a sense of the sales cycle and efforts required to sell the company’s products
8 Who are their competitors? Helps in knowing the competitors. Too many competing companies means margin pressure. In such a case the company has to do something innovative. Margins are higher if the company operates in – monopoly, duopoly, or oligopoly market structure.
9 Who are the major shareholders of the company? Besides the promoter and promoter group, it helps to know who else owns the shares of the company. If a highly successful investor holds the shares in the company then it could be a good sign.
10 Do they plan to launch any new products? Gives a sense on how ambitious and innovative the company is. While at the same time a company launching products outside their domain raises some red flags – is the company losing focus?
11 Do they plan to expand to different countries? Gives a sense on how ambitious and innovative the company is. While at the same time a company launching products outside their domain raises some red flags – is the company losing focus?
12 What is the revenue mix? Which product sells the most? Helps us understand which segment (and therefore the product) is contributing the most to revenue. This in turns helps us understand the drivers for future revenue growth.
13 Do they operate under a heavy regulatory environment? This is both good and bad – Good because it acts a natural barrier from new competition to enter the market, bad because they are limited with choices when it comes to being innovative in the industry
14 Who are their bankers, auditors? Good to know, and to rule out the possibility of the companies association with scandalous agencies
15 How many employees do they have? Does the company have labor issues? Gives us a sense of how labor intensive the company’s operations are. Also, if the company requires a lot of people with niche skill set then this could be another red flag
16 What are the entry barriers for new participants to enter the industry? Helps us understand how easy or difficult it is for new companies to enter the market and eat away the margins.
17 Is the company manufacturing products that can be easily replicated in a country with cheap labor? If yes, the company may be sitting on a time bomb – think about companies manufacturing computer hardware, mobile handsets, garments etc
18 Does the company have too many subsidiaries? If yes, you need to question why? Is it a way for the company to siphon off funds?


2.     Application of the checklist

S. No. Variable Comment What does it signify
1 Gross Profit Margin (GPM) 20% Higher the margin, higher is the evidence of a sustainable moat
2 Revenue Growth In line with the gross profit growth Revenue growth should be in line with the profit growth
3 EPS EPS should be consistent with the Net Profits If a company is diluting its equity then it is not good for its shareholders
4 Debt Level Company should not be highly leveraged Profits High debt means the company is operating on a high leverage. Plus the finance cost eats away the earnings
5 Inventory Applicable for manufacturing companies/td> A growing inventory along with a growing PAT margin is a good sign. Always check the inventory number of days
6 Sales vs Receivables Sales backed by receivables is not a great sign This signifies that the company is just pushing its products to show revenue growth
7 Cash flow from operations Has to be positive If the company is not generating cash from operations then it indicates operating stress
8 Return on Equity 25% Higher the ROE, better it is for the investor, however make sure you check the debt levels along with this
9 Business Diversity 1 or 2 simple business lines Avoid companies that have multiple business interests. Stick to companies that operate in 1 or 2 segments
10 Subsidiary Not many If there are too many subsidiaries then it could be a sign of the company siphoning off money. Be cautious while investing in such companies

TECHNICAL ANALYSIS

Technical analysis is a method of examining past market data to help forecast future price movements. Using different tools, indicators, and charts, traders can spot important price patterns and market trends, and then use that data to anticipate a market's future performance.

Technical analysis is based around a market's price history, rather than the fundamental data like earnings, dividends, news, and events. The belief is that price action tends to repeat itself and the patterns can be identified and used to define a market's trend.

We would like to highlight several of the most popular technical indicators and how you can use them.

The Moving Average Convergence/Divergence (MACD) Indicator

- This trend-following, momentum indicator shows the relationship between two moving averages. Learn how to identify Signal Line Crossovers, Centerline Crossovers, and positive and negative divergences to spot changes in trend direction, strength and momentum of a market.

Moving Averages

- These lagging indicators help gauge the direction of the current trend of a market. Discover how to track and identify trends, find potential support and resistance levels, and recognize possible changes in momentum.

Trend Lines

- One of the simplest technical indicators, Trend Lines are important for identifying and confirming trend direction. They can help predict levels of support and resistance and single out important chart movements and significant price points

Relative Strength Index (RSI)

- The RSI is a momentum oscillator that measures the strength and speed of a market's price movement by comparing current price to past performance. This indicator can be used to find overbought and oversold areas, support and resistance levels, and potential entry and exit signals

Fibonacci Retracements

- Fibonacci retracements can help traders identify significant price points and predict levels of support and resistance. Learn how this tool can be used to determine how much a market might retrace before resuming its trend.

PAST PERFORMANCE

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12 Rules for Successful Trading  


The following materials describe an investment in futures. You should be aware that Futures & options trading is not suitable for all individuals. The degree of leverage available can lead to large profits as well as large losses. Past performance is not indicative of future results. If you do not acknowledge the risks described above, the following materials should not be used for the purposes of making an informed decision regarding an investment in futures or options.

The 12 Golden Rules for Successful Trading

1. Adopt a definite trading plan.

Because of the emotional stress that is inherent in any speculative situation, you must have a predetermined method of operation, which includes a set of rules by which you operate and adhere to, thus protecting you from yourself. Very often, your emotions will tell you to do something totally foreign or negative to what your market trading plan should be. It is only by adhering to a preconceived formula that you can resist the emotional temptations and stresses that are constantly present in a speculative situation.

2. If you're not sure, don't trade.

If you're in a trade and feel unsure of yourself, take your loss or protect your profit with a stop. If you are unsure of a position, you will be influenced by a multitude of extraneous and unimportant details and will probably end up taking a loss.

3. You should be able to be right 40% and still potentially show  profits.

In speculating, it would be folly to expect to be right every time. An individual with the proper trading techniques should be able to cut his losses short and let his profits run so that even being right less than half the time could potentially still show profits. This point is re-emphasized in Rule Four.

4. Cut your losses and let your profits ride.

The basic failing of most speculators is that they put a limit on their profits and no limit on their losses. A man hates to admit he's wrong. Therefore, an individual will often let his loss ride, becoming larger and larger in hopes that eventually the market will turn around and prove him correct. Then after a while, he begins hoping for a small loss and gives up hoping for a profit. Human nature also dictates that an individual wants to take his profit right away and thus prove himself correct. There is an old saying, "You never go broke taking a small profit." But you'll certainly never get rich that way. Being satisfied with small profits is the wrong mental approach for making money in speculation. If you are correct when entering a speculative situation, you will know it almost immediately and will show a profit quickly. However, if you are wrong, you will show a loss and you should remove yourself from the situation quickly. Taking a small loss does not necessarily mean you were wrong in your thinking. It simply means that your timing was perhaps incorrect and that you should wait for the correct timing and situation to allow you to reenter the market. Remember, in any speculative situation, the market is the final judge. An individual must let the market tell him when he is wrong and when he is right. If you show a profit, ride it until the market turns around and tells you that you are no longer right, and, at that time, you should get out...but not before! On the other hand, the market will also tell you if you are wrong and it would be a serious mistake to argue with what it is saying.

5. If you cannot afford to lose, you cannot afford to win.

As we have stated in Rule Four, losing is a natural part of trading. If you are not in a position to accept losses, either psychologically or financially, you have no business trading. In addition, trading should be done only with surplus funds that are not vital to daily expenses.

6. Don't trade too many markets.

It is difficult to successfully trade and understand a specific market. It is next to impossible for an individual, especially a beginner, to be successful in several markets at the same time. The fundamental, technical, and psychological information necessary to trade successfully in more than a few markets is more than the individual has either the time or ability to accumulate.

7. Don't trade in a market that is too thin.

A lack of public participation in a market will make it difficult, if not impossible, to liquidate a position at anywhere near the price you want.

8. Be aware of the trend. ("The Trend is your friend")

It is vitally important that a trader be aware of a strong force in the market, either bullish or bearish. When this force is at its height, it would be folly to attempt to buck it. However, one must learn to recognize when a trend is about to run its course or is near a period of exhaustion. By an ability to recognize the early signs of exhaustion, the trader will protect himself from staying in the market too long and will be able to change direction when the trend changes.

9. Don't attempt to buy the bottom or sell the top.

It simply can't be done unless you have the aid of a crystal ball or some other tool which could be peculiar to the mystic. Be content to wait for the trend to develop and then take advantage of it once it has been established.

10. Never answer a margin call.

This rule acts as a stop loss when your position has weakened considerably. By dogmatically and arbitrarily adhering to this rule, you will be forced to get out of the market before disaster sets it. It is often difficult to admit you're wrong and get out of the market (which you probably should have done well before you received a margin call). However, the presence of a margin call should act as a final warning that you have let your position go as far as you conceivably can (unless the initial margin is out of line with the volatility of the contract).

11. You can usually sell the first rally or buy the first break.

Generally, a market which has just established a trend either up or down will have a reaction and good interim profits can be made by recognizing this reaction and taking advantage of it. For example, in a bull market, the first reaction will generally be met by investors waiting to buy the break. This support generally causes the market to rally. The reverse is true of a bear market.

12. Never straddle a loss.

A loss by itself is difficult enough to accept. However, to lock in this loss, thus making it necessary for you to be right twice rather than the once (which you previously found impossible) is sheer absurdity.

While the following are not specific trading rules, they are general observations which will aid the speculator in formulating an understanding of markets:

You must retain control of the situation and yourself. Do not allow your position to control you. It is a mistake to find yourself in a position larger than you can reasonable handle. When this occurs, you will find that the sheer size of the position, rather than the facts of the situation itself, affects your judgement.

The commodity does not know that you own it. You must remain impersonal in your trading. When you take a position and you are wrong, remember it is better to get out immediately! The market will not feed badly about it if you do, but you will if you don't.

The market always looks its worst at its bottom, and the best at the top. It is important to remember that before the market turns around, it is at its very worst. Therefore, be prepared to treat each day objectively by not allowing the emotional fever to carry over and cloud your judgment.

Treat paper profits as if they are your own money.  They are! Naturally, the opposite also holds true.