Review of Literature
Technical and fundamental analyses are the two basic methods used for analysing and selecting the stocks of a company. The report discuss the analysis of two portfolios which include 10 stocks each and are been analysed by applying both the methods respectively. The stocks of one portfolio are selected on the basis of fundamental analysis whereas the selection of other is based on technical analysis (Baradi & Mohapatra, 2014). Several aspects of both the approaches are explained and various tools and techniques are been applied in this report. For fundamental analysis, tools like return on equity, dividend yield and price earnings ratio are used. On the other hand, techniques like moving average, line charts and support and resistance levels are used under technical analysis. Furthermore, the report also explains that both the portfolios beat the market and has met the target of 5%.
For investors, analysing and selecting appropriate stocks is a very challenging and monotonous task. In order to choose the best stock, the investors are required to employ both technical as well as fundamental analytical tools and techniques. These methods cover the analytical part broadly but still the risk remains there. Such risk is explained by concepts like efficient market hypothesis and theories of behavioural finance (Ackert & Deaves, 2009). The theories states that the behavioural influences affect the stock prices to some extent such as the global financial crisis and collapse of US market affected the stock markets of other countries also, showing a downward slope. This was due to the behavioural influence that when the investors start selling their investments in US, the investors from other countries also started clearing out their positions in order to avoid the risk of loss. The market was not able to handle such selling pressure and as a result the stock prices reduced. Hence, it could be observed that at time of such global crisis, the stock bought may result in loss after properly analysing them. In such situations, investors generally take irrational decisions while selling their stocks (Ackert & Deaves, 2009).
The major difference between theories of fundamental analysis and theories of behavioural finance is the assumption on which they are based. It is assumed in fundamental analysis that investors will always act rationally whereas behavioural finance theories are based on the assumption that investors can be irrational when events like financial crisis takes place. Thus, it can be interpreted that views presented on fundamental analysis contrast with the ones that are taken out for behavioural finance (Baker & Nofsinger, 2010). Furthermore, there is another aspect that deals with the stock and investment analysis named as efficient market hypothesis. The EMH theory states that investors cannot make profits or gains by taking the advantage of information gap. In other words, as per the hypothesis no one can beat the market. EMH is based on the notion that the stock market will always remain efficient. It states that stakeholders behave rationally and all the information is available to the market as and when it arrives. The current prices of the stock reflect all the relevant data and there is no scope for the undervaluation and overvaluation of stocks (Harder, 2010).
Rationale and Methodology
According to the hypothesis, the stocks which are trading on the indices are priced fairly and no stock is undervalued or overvalued. Thus, it is said that the concept of EMH contrast with the ideologies of fundamental analysis. In order to calculate the fair value of stocks, the basics of dividend discount model and harry Markowitz theory of portfolio selection are used. According to these models, there can be fluctuation or gap in the value of stocks through which, the investors can make profits by identifying the undervalued stocks for selling them at high prices in future. The supporters of EMH argue that it is very time consuming to recognize the undervalued stock by predicting the future trends under technical analysis and by applying fundamental analysis techniques. However, EMH is also criticized on various grounds and its practical application is also questioned. People like Warren Buffet have proved that EMH is incorrect by beating the market several times. Furthermore, the assumption on which the hypothesis is based has also proved to be inappropriate because many of times the information is not available to the market participants. Thus, from the above literature review it can be said that technical and fundamental analysis holds some importance irrespective of the existence of concepts like behavioural finance and EMH (Kurth, 2013).
Fama and French model lay more emphasis on expanding the CAPM by adding size and value risk factors to the market risk factor in CAPM. It provides three factor models and according to that the small cap stock outperforms the market as compare to large-cap stocks (Fama & French, 2004).
This section deals with the overall approach used by the researcher in the study. It states the techniques used in data collection and analysis and making significant conclusions. It is very important for a researcher to adopt a suitable methodology for making its research effective and meaningful. The current report deals with analysing the two portfolios comprising of 10 stocks each. One portfolio consists of stocks which are selected on the basis of return on equity, profit margin, price earnings ratio and dividend yield. This is been evaluated by using fundamental analysis techniques. On the other hand, second portfolio goes under technical analysis and consists of the stock chosen on the basis of trend analysis, moving average analysis and examining support and resistance levels (Schlichting, 2013).
Appendix 1 shows the list of stocks chosen for fundamental analysis. The companies are selected on the basis of their financial performance in respect of generating high returns and making profits during the specific period of time. In addition, their price to book ratio is also considered while selecting the stocks for fundamental portfolio. On the other hand, the stocks of technical portfolio are selected on the basis of trends observed in their historical prices. Among the ten companies, analysis of Singapore Exchange Limited’s stock price is given below:
(Source: Capital IQ. 2018).
It can be observed that the share price of Singapore Exchange has shown fluctuations in a week. However the daily prices of the stock have shown a rising trend which means the stocks are capable of delivering high returns to the investors. Apart from this, other companies are also properly analysed and trends are been observed for the purpose of selecting them for a technical portfolio.
Analysis of one stock from fundamental portfolio
The two most common evaluation techniques are been applied for analysing the fundamental portfolio. They are known as PE Multiple model and dividend discount model. Mainly, the stock named as StarHub Limited is analysed. It is Singapore based info-communication Company that offers various services related to entertainment, information and communication.
The model is used for calculating and analysing the fair value of the company’s stock. Once the fair value is computed, the model helps in determining that whether a particular stock is overvalued or undervalued. Generally, for most of the investors, the investment decisions are based on this analysis only.
Dividend Discount Model: Starhub Ltd |
|
Dividend expected |
0.1445 |
Growth rate |
-15% |
Discount rate |
5.16% |
Intrinsic Value |
0.7168 |
From the above analysis, it can be said that the fair value of the stock is $0.7 which is lower than its current market price of $1.66 per share. This indicates that the stock is undervalued as per dividend discount model.
This method also includes the calculation of stock’s fair value by taking into account the earnings per share of the company and the Price to Earnings ratio of the industry within which the entity operates.
PE Multiple Model: Starhub Ltd |
|
Industry PE ratio |
10.44 |
EPS of Starhub Limited |
0.14 |
Intrinsic Value |
1.4616 |
The similar result is obtained from P/E multiple also. The fair value of StarHub stock is $1.46 which is less than its market prices of $1.66 as on 24th August 2018. This again indicates that the stock is undervalued.
The companies chosen for technical analysis are evaluated by using three techniques which are discussed below in detail. The company selected out of ten stocks for the purpose of analysis is Singapore Exchange Limited.
(Source: Capital IQ. 2018).
The above line chart shows the changes in the stock price of the company over the past three months and compares the same with the fluctuations in FTSE ST All-Share Index. It shows the changes for the period starting from 4th June 2018 to 24th August 2018. It can be interpreted that the prices remain stable during the month of June and has reduced slightly in by the end of the same month. However, the trend got reverse and an upward trend is noticed in the middle of July 2018. The price rises till July and then slightly reduces in August 2018. However, the stock prices are higher as compare to previous months. So, it can be said that the stock is worth investing.
A simple moving average for Singapore Exchange Limited is calculated by using the historical data of the past three months starting from June 4, 2018 to August 24, 2018. The average is worth $7.32 (Refer excel). This reflects that one should buy the stock only when the stock price is above $7.32 as it will be beneficial for the potential investors. In addition, when the price goes below the moving average, it is recommended to sale because it is expected that price may fall down in future. In current situation, the price of Singapore Exchange is $7.35 on 24 august 2018 which is more than the average. So, it will be advisable to purchase the stock.
(Source: Capital IQ. 2018).
It is seen that the stock of Singapore Exchange trades between the range $7.05-8.50. Therefore, the resistance level of the stock can be taken as $8.50 and the support level is $7.05. It means if the price goes lower than $7.05, the stock will fall to great extent. Similarly, if the stock price crosses the level of $8.50 then the stock will rise high.
This section provides with the analysis of both the portfolios by applying respective techniques. Most common methods are used for evaluating the worth of both fundamental and technical portfolio.
In portfolio 1, the trading of the companies is discussed which is shown in appendix 2. Under the fundamental portfolio, 1000 shares of Thai Beverages are sold at $0.76 on 22 June 2018 because of the fall in prices in future. Furthermore, total 1400 shares of Genting Singapore ltd are sold on 13 June and 23 July at higher prices in order to book the profit for now. Further, when the price goes up additional 2000 shares are also purchased at $1.29 on 25 July 2018. Apart from them, the shares of Singtel, StarHub and other companies are also traded.
The trading done under this portfolio is shown in appendix 3. In starting, 2000 shares of Singapore Exchange were purchased on 25 June at a price of $7.08. Out of the total shares, 1500 were sold on 26 July at $7.58 in order to gain the profit worth $477.14. The shares of Banyan Tree Holdings Limited were sold on 25 July numbered 500 at $0.57. This was due to the expected fall in company’s stock prices. 500 shares of Ascendas were purchased at $2.58 on 25 June and out of the total, 1000 shares were sold at higher price to book the profits. Other selected companies are also traded in technical portfolio.
From the analysis, it is interpreted that the return derived on fundamental portfolio is 5.31% which is already higher than the target return of 5%. Hence, it could be said that portfolio 1 has beat the market and has prove the EMH theory wrong. It can be interpreted that the fundamental portfolio uses semi-strong form of EMH. The form suggested that the fundamental analysis cannot be used to achieve higher gains. However, the same has been proved wrong as many stocks in the portfolio reported profits. It can be observed that the shares of SingTel were purchased as and when the price reaches to $3.22. However, some shares of the same company were sold later on at $3.33 to book the profits worth $156. Apart from this, the trading of Genting Singapore Limited also reported profits during the period. Therefore, it can be said that the semi-strong form of EMH proved to be wrong and the fundamental analysis can be used to generate high returns. On the other hand, the technical portfolio gives a return of 8.71% which is also above the expectations and the portfolio has beaten the market. Under this, weak form of efficiency is used which asserts that technical analysis is not accurate and sometimes the fundamental analysis can also get failed in the valuation of stocks. According to this, the portfolio cannot outperform the market. The methods used in this analysis include line chart which contains of the historical data of share prices. Share prices of Singapore Exchange Limited were analysed for the past years and it was observed that the company is worth investing. Moreover, its trading has also reported profits worth $477.14 when its shares were sold at $7.58. Apart from this, companies like Banyan Tree Holdings Limited and ComfortDelGro Corporation Limited has recorded profits on sale of their shares during the period. The assumption of weak form of EMH which states that past price movements does not affect the stock prices proved wrong in case of technical analysis. Prices of Singapore Exchange Limited do get affected by past trends. Thus, it can be said that both the portfolios have beaten the market and proved the forms of EMH wrong.
Conclusion
The above report concludes that the analysis is done on the basis of fundamental and technical methods. Techniques like PE Multiple Model, DDM, Line chart, moving average and others are been used for evaluating the performance of both the portfolios. Also, it is found that the both technical and fundamental portfolios have beaten the market by providing returns higher than the expected one. Furthermore, the report explains the reasons for the decisions taken regarding buying and selling of stocks in order to evaluate the overall performance of the portfolios. On a whole, the EMH theory is proved wrong as both the portfolios have beaten the market.
References
Ackert, L & Deaves, R (2009). Behavioral Finance: Psychology, Decision-Making, and Markets. USA: Cengage Learning.
Baker, H.K. & Nofsinger, J.R. (2010). Behavioral Finance: Investors, Corporations, and Markets. New Jersy: John Wiley & Sons.
Baradi, N. K., & Mohapatra, S. (2014). The Use of Technical and Fundamental Analyses By Stock Exchange Brokers: Indian Evidence. Journal of Empirical Economics, 2(4), 190-203.
Capital IQ (2018). Singapore Exchange Limited (SGX:S68). Retrieved from: https://www.capitaliq.com/CIQDotNet/company.aspx?companyId=2445989
Fama, E. F., & French, K. R. (2004). The capital asset pricing model: Theory and evidence. Journal of economic perspectives, 18(3), 25-46.
Harder, S. (2010). The Efficient Market Hypothesis and Its Application to Stock Markets. Germany: GRIN Verlag.
Kurth, S. (2013). Critical Review about Implications of the Efficient Market Hypothesis. GRIN Verlag.
Schlichting, T. (2013). Fundamental Analysis, Behavioral Finance and Technical Analysis on the Stock Market. Germany: GRIN Verlag.