Project- Portfolio Mgmt. & Investment Analysis-Working-08.02.11

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I n t r oduc t i on

We a l l d r eam of bea t i ng t he mar ke t and be i ng s upe r i nves t o r s and s pendan i no r d in ate amoun t o f t ime an d r e s our ces in th is end eavor .

C o ns e q ue n tl y, w e a r e e a s y p r ey f o r t h e m a gi c b u ll e ts a n d t h e s e cr e t

f o r m u l a e o f f e r e d b y e a g e r s a l e s p e o p l e p u s h i n g t h e i r w a r e s . I n s p i t e o f ou r bes t e f f o r t s , mos t o f us f a i l i n ou r a t t empt s t o be mor e t han ave r age

i nves t o r s . None t he l es s , we keep t r y i ng , hop i ng t ha t we can be mor e l i ke

t he i nves t i ng l egends ano t he r War r en Buf f e t t o r P e t e r Ly nch . We r ead

t h e w o r d s w r i t t e n b y a n d a b o u t s u c c e s s f u l i n v e s t o r s , h o p i n g t o f i n d i nt h em t h e k e y t o t h ei r s t oc k -p i ck i ng a b il i ti e s, s o t h at w e c a n r e pl i ca t e

t hem and become wea l t hy qu i ck l y .

In o ur s ea rc h, t ho ug h, we a re w hip sa we d b y c on tr ad ic tio ns a nd

a no ma li es . I n o n e c o rn e r o f t he i nv es tm en t t ow n sq u ar e, s ta n ds o neadv i s o r , y e l l i ng t o us t o buy bus i nes s es wi t h s o l i d cas h f l ows and l i qu i d

a s s e ts b e c a u s e t h a t w h a t w o r k e d f o r B u f f e t t . I n a n o t h er c o r n e r , a n o t h e r

i n v e st m e n t e x p e r t c a u t i on s u s t h a t t h i s a p p r o a c h w o r k e d o n l y i n t h e o l dw or ld , a nd t ha t i n t he n ew w or ld o f t ec h no lo gy , w e h av e t o b e t o n

c o m p a n i e s w i t h s o l i d g r o w t h p r o s p e c t s . I n y e t a n o t h e r c o r n e r , s t a n d s a

s il ve r t on gu e d s al es pe rs on w it h v iv id c ha rt s a nd p re se n ts y ou w it he v i d e nc e o f h i s c a p a c i ty t o g e t y o u i n a n d o u t o f m a r k e t s a t e x a c t l y t h e

r i gh t t i mes . I t i s no t s u r p r i s i ng t ha t f ac i ng t h i s cacophony o f c l a i ms and

coun t e r c l a i ms t ha t we end up mor e conf us ed t han eve r .

I n t h i s i n t r o d u c ti o n , w e p r e s e nt t h e a r g u me n t t h a t t o b e s u c c e ss f u l w i t ha ny in ve st me nt s tr a te gy , yo u h av e t o b eg in w ith a n in ve st me nt

ph i l os ophy t ha t i s cons i s t en t a t i t s co r e and whi ch ma t ches no t on l y t he

m a r k e t s y o u c h o o s e t o i n v e s t i n b u t y o u r i n d i v i d u a l c h a r a c t e r i s t i c s . I no t he r wor ds , t he key t o s ucces s i n i nves t i ng may l i e no t i n knowi ng wha t

makes P e t e r Ly nch s ucces s f u l bu t i n f i nd i ng ou t mor e abou t y our s e l f

Mos t i nves t o r s l eave t he mor e t echn i ca l a s pec t s o f po r t f o l i o management

t o t he i r f i nanc i a l cons u l tan t s . However , th i s need no t be t he cas e . Thea ve ra ge e du ca te d p er s on c an c er ta in ly g ain a g ra sp o f th e to pic

s u f f i c i en t enough to make h i s o r he r own i nves t men t dec i s i ons . The key

t o l e a r n i n g i s g a i n i n g t h e k n o w l e d g e a n d t h e n p r a c t i c e a p p l y i n g i t t oy o u r o w n p o r t f o l io i n s m a l l a m o u n t s u n t i l y o u f e e l c o n f i d e n t e n o u g h t o

m a n a g e i t c o m p le t e l y o n y o u r o w n . T h i s a r ti c l e w i l l b r i ef l y d e s c ri b e

s o m e o f t h e c o n c e p t s b e h i n d p o r t f o l i o t h e o r y a s w e l l a s s o m e g e n e r a lt e c h n iq u e s a p p l ie d b y p o r t f o li o m a n a g e rs . T h e r e a r e m a ny g o o d b o o k s

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t ha t can g i ve mor e i n dep t h i n f o r mat i on i f y ou f ee l t h i s i s s omet h i ng y ou

woul d l i ke t o know mor e abou t .

T h e f i r s t i m p o r t a n t f a c t o f p o r t f o l i o m a n a g e m e n t i s u n d e r s t a n d i n g t h et wo m ai n d ec is io n s, w hi ch a re r el at ed b ut c om pl et el y s ep a ra te f or

pu r pos es o f p r ac t i ca l i t y . Thes e t wo dec i s ions a r e

1 ) Br oad- bas ed as s e t a l l oca t i on and

2) S pec i f i c s ecur i t y s e l ec t i on

T h e m o s t i m p o r t a n t t h i n g a n i n v e s t o r c a n d o i s g o t h r o u gh t h e i n - d e pt h p r o c e s s o f d e t e r m i n i n g a p o r t f o l i o a s s e t m i x a t t h e v e r y o n s e t o f e a c h

y ea r and aga i n any t i me t he r e i s a s i gn i f i can t change t o t he i r po r t f o l i o .

I t i s o n l y a f t e r t h i s m i x i s d e t e r m i n e d t h a t t h e p r o c e s s o f c h o o s i n gi nd iv id ua l i nv es tm en ts s ho ul d b e m ad e. A ss et c la ss es a re b y f ar a

b i g g e r f a c t o r i n o v e r a l l p e r f o r m a n c e t h a n i n d i v i d u a l s e c u r i t y s e l e c t i o n

a s t i m e i n v es t e d i n c re a s e s . O r t o p u t t h i s i n a m o r e p r a g ma t i c w a y , i td o e s n t m a t t e r i n a 1 0 - y e a r p e r i o d o f t i m e w h i c h s t o c k y o u c h o s e a s

m uc h a s i t m a tt er s t h at y ou c ho se s to ck . T hi s d o es n t m e an a n

i nd iv id ua l s e c ur it y c a n t m ak e a d if fe re n ce . I t j u st m ea n s t h at i t b ec om es l es s i mp o rt an t o v er a p er io d o f f iv e y ea rs o r s o s in ce a l l

s e c u ri t i e s o f a g i v e n c l a s s t e n d t o m o v e t o w a r d a n a v e r a ge p e r f or m a n c e

whi ch ba l ances ou t ex t r eme movement s i n s pec i f i c pe r i ods o f t i me .

A no th er i mp or ta n t f ac t o f p o rt fo li o m an a ge me n t i s t ha t o ne m ak e sa na ly ti ca l d ec is io ns a nd n ot m ak e d ec is io ns b as ed o n h un ch es o r

emot i on . T h i s k i n d o f p r a g m at i c a n d a n a l yt i c a l a p p r o a ch w i l l k e e p t h e

ave r age i nves t o r f r om mak i ng dec i s i ons t o move money compl e t e l y i n o r

ou t o f a s ecur i t y o r an a s s e t c l a s s bas ed upon t he l a t e s t mar ke t r umor s o r t h e f iv e o c l oc k n e w s . R e g a r dl e s s o f w h a t in s i g h t w e f e e l i n c l in e d t o

f o l l o w , t h e n u m b e r s a n d t h e d a t a o f p a s t p e r f o r m a n c e g i v e s u s c l e a r

i nd ic at io ns t ha t m ov in g i n a nd o ut o f a ss et c la ss es o r i nd iv id ua ls e c u r i t i e s d u r i n g a d v e r s e p e r i o d s h u r t s m o r e t h a n i t h e l p s i n t h e l o n g

r u n . A n d i f a d e c i si o n i s m a d e t o d i ve s t o u t o f a s p e c if i c s e c u ri t y , i t is

a l w a ys a d v i s e d t o d o l l a r- c o s t a v e r a g e o u t o f t h e i n v e s t m en t i n t h e s a m emanner t ha t one s hou l d have do l l a r - cos t ave r aged i n .

D o l la r c o s t a v e r a g in g i s a t e c h n i q u e b y w h i c h a n i n v e s t o r d i v i d e s t h e

g i v e n i n v e s t m e n t o v e r a p e r i o d o f t i m e a n d i n v e s t s t h a t a m o u n t o n a

r e gu l ar b a s i s a s o p p o se d t o b u yi n g i n a l l a t o n c e. T h is t e c h n iq u e i scover ed i n mor e de t a i l i n a p r ev i ous a r t i c l e .

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Object ives o f Port fo l io Management: -

T he o b je c ti ve o f p o rt fo li o m an ag e me n t i s t o i nv es t i n s ec ur it ie s i ss ecur i t i e s i n s uch a way t ha t one max i mi zes one s r e t u r ns and mi n i mi zes

r i s ks i n o r de r t o ach i eve one s i nves t men t ob j ec t i ve .

A g o o d p o r t f o l i o s h o u l d h a v e m u l t i p l e o b j e c t i v e s a n d a c h i e v e a s o u n d

b al an ce a mo ng t he m. A ny o ne o bj ec ti ve s ho u ld n ot b e g iv e n u n du ei m po r ta n c e a t t h e c o st o f o t he r s. P r es e nt e d b e lo w a r e s o me i m po r ta n t

ob j ec t i ves o f po r t f o l i o management .

1 . Stable Current Return: -

Once i nves t men t s a f e t y i s gua r an t eed , t he por t f o l i o s hou l d y i e l d a s t eady

c ur r en t in co me . Th e c ur re nt r etu rn s s ho ul d a t l e as t ma tc h th eo p p o r t u n i t y c o s t o f t h e f u n d s o f t h e i n v e s t o r . W h a t w e a r e r e f e r r i n g t o

he r e cu r r en t i ncome by way o f i n t e r es t o f d i v i dends , no t cap i t a l ga i ns .

2 . Marketabi l i ty : -

A good por t f o l i o cons i s t s o f i nves t men t , wh i ch can be mar ke t ed wi t hou td i ff i cu l ty . I f t h er e a r e t o o m a ny u n li s te d o r i n ac t iv e s h ar e s i n y o ur

po r t f o l i o , y ou wi l l f ace p r ob l ems i n encas i ng t hem, and s wi t ch i ng f r om

o n e i n v e s t m e n t t o a n o t h e r . I t i s d e s i r a b l e t o i n v e s t i n c o m p a n i e s l i s t e don ma j o r s t ock exchanges , wh i ch a r e ac t i ve l y t r aded .

3 . Tax Planning: -

S in ce t ax at io n i s a n i mp or ta nt v ar ia bl e i n t ot al p la nn in g, a g oo d

p o r t f o l i o s h o u l d e n a b l e i t s o w n e r t o e n j o y a f a v o r a b l e t a x s h e l t e r . T h e

p o rt fo l io s h ou l d b e d e v el o pe d c o n si d er i ng n o t o n ly i n co m e t a x, b u tc a p i ta l g a i n s t a x , a n d g i f t t a x , a s w e l l . W h a t a g o o d p o r t f o li o a i m s a t i s

t ax p l ann i ng , no t t ax evas i on o r t ax avo i dance .

4 . Apprec ia t ion in the va lue o f capi ta l :

A g o od p o rt fo li o s ho u ld a pp re ci at e i n v a lu e i n o rd er t o p ro te ct t hei nves t o r f r om any e r os i on i n pu r chas i ng power due t o i n f l a t i on . I n o t he r

w o r d s , a b a l a n c e d p o r t f o l i o m u s t c o n s i s t o f c e r t a i n i n v e s t m e n t s , w h i c h

t end t o appr ec i a t e i n r ea l va l ue a f t e r ad j us t i ng f o r i n f l a t i on .

5 . L iquid i ty :

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T h e p o r t fo l io s h ou l d e n su r e t h at t h er e a r e e n o ug h f u n ds a v a il a bl e a t

s h o r t n o t i c e t o t a k e c a r e o f t h e i n v e s t o r s l i q u i d i t y r e q u i r e m e n t s . I t i sdes i r ab l e t o keep a l i ne o f c r ed i t f r om a bank f o r us e i n cas e i t becomes

neces s a r y t o pa r t i c i pa t e i n r i gh t i s s ues , o r f o r any o t he r pe r s ona l needs .

6 . Safe ty o f the inves tment:

The f i r s t i mpor t an t ob j ec t i ve o f a po r t f o l i o , no ma t t e r who owns i t , i s t oe n s u re t h a t t h e i n v e st m e n t i s a b s o lu t e l y s a f e . O t h e r c o n s id e r a ti o n s l i k e

i ncome , g r owt h , e t c . , on l y come i n t o t he p i c t u r e a f t e r t he s a f e t y o f y our

i nves t men t i s ens u r ed .

I nv e st me n t s af et y o r m in im iz a ti on o f r is ks i s o n e o f t he i mp o rt an to b je c ti v es o f p o rt f ol i o m a na g em e nt . T h er e a r e m a ny t yp e s o f r is k s,

w h i c h a r e a s s o c i a t e d w i t h i n v e s t m e n t i n e q u i t y s t o c k s , i n c l u d i n g s u p e r s t oc ks . B ea r in mi nd th at th ere i s n o su ch th in g a s a z er o r is k

inve s t men t . Mo re o ve r , r e la t ive ly low r i s k in ves tmen t g ivec o r r e s p o n d i n g l y l o w e r r e t u r n s . Y o u c a n t r y a n d m i n i m i z e t h e o v e r a l l

r i s k o r b r i n g i t t o a n a c c e p t a b l e l e v e l b y d e v e l o p i n g a b a l a n c e d a n d

ef f i c i en t po r t f o l i o . A good por t f o l i o o f g r owt h s t ocks s a t i s f i e s t he en t i r eob j ec t i ves ou t l i ne above .

Scope o f Port fo l io Management: -

P o r tf o l i o m a n a g e m en t i s a c o n t i nu o u s p r o c e s s . I t i s a d y n a m ic a c t i vi t y .

The f o l l owi ng a r e t he bas i c ope r a t i ons o f a po r t f o l i o management .

a ) Moni t o r i ng t he pe r f o r mance o f po r t f o l i o by i ncor por a t i ng t he l a t e s tmar ke t cond i t i ons .

b ) I de nt if ic at io n o f t he i nv es to r s o bj ec ti ve , c on st ra in ts a nd

preferences .

c ) Mak i ng an eva l ua t i on o f po r t f o l i o i ncome ( compar i s on wi t h t a r ge t sand ach i evement ) .

d ) Mak i ng r ev i s i on i n t he por t f o l i o .

e ) I mpl emen t a t i on o f t he s t r a t eg i es i n t une wi t h i nves t men t ob j ec t i ves

P or tf ol io M an a ge me nt i s u se d t o s el ec t a p or tf ol io o f n ew p ro du c t

deve l opment p r o j ec t s t o ach i eve t he f o l l owi ng goa l s :

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Maxi mi ze t he p r o f i t ab i l i t y o r va l ue o f t he po r t f o l i o

P r ov i de ba l ance

S uppor t t he s t r a t egy o f t he en t e r p r i s e

P o rt f ol i o M a na g em e nt i s t h e r e sp o ns i bi l it y o f t h e s e ni o r m a na g em e ntt e a m o f a n o r g a n i z a t i o n o r b u s i n e s s u n i t . T h i s t e a m , w h i c h m i g h t b e

c a l l e d t h e P r o d u c t C o m m i t t e e , m e e t s r e g u l a r l y t o m a n a g e t h e p r o d u c t

p i p e l i n e a n d m a k e d e c i s i o n s a b o u t t h e p r o d u c t p o r t f o l i o . O f t e n , t h i s i st he s ame g r oup t ha t conduc t s t he s t age - ga t e r ev i ews i n t he o r gan i za t i on .

Theoret ica l Perspect ive

T he a rt a n d s ci en c e o f m ak in g d ec is io n s a b ou t i nv es tm en t m ix a n d p ol ic y, m at ch in g i nv es tm en ts t o o bj ec ti ve s, a ss et a ll oc at io n f or

i n di v id u al s a n d i n st i tu t io n s, a n d b a la n c in g r i sk a g a in s t p e rf o rm a nc e .

Po rt f ol i o m an ag eme nt i s a ll a bo ut SW OT a na lys is (S tre ng th s,

Weaknes s es , Oppor t un i t i e s and Thr ea t s ) i n t he cho i ce o f deb t vs . equ i t y ,d o m e s ti c v s . i n t e rn a t i o na l , g r o w th v s . s a f e t y , a n d m a n y o t h e r t r a d e o f f s

e n c o u n t e r e d i n t h e a t t e m p t t o m a x i m i z e r e t u r n a t a g i v e n a p p e t i t e f o r r i s k .

I n t h e c a s e o f m u t u a l a n d e x c h a n g e - t r a d e d f u n d s ( E T F s ) , t h e r e a r e t w o

for ms o f po rt f o l io mana gement : pas s ive and ac t ive . P as s i vem a na g em e nt s i mp l y t r ac k s a m a rk e t i n de x , c o mm o nl y r e fe r re d t o a s

i nd e xi ng o r i nd e x i nv es ti ng . A ct iv e m an a ge me n t i nv ol ve s a s in g le

m a n a g e r , c o - m a n a g e r s , o r a t e a m o f m a n a g e r s w h o a t t e m p t t o b e a t t h ema rk et r etu rn b y a ct i ve ly ma na gin g a fu nd ' s p or t fo lio t hro ug h

i n ve s tm e nt d e ci s io n s b a se d o n r e se a rc h a n d d e c is i on s o n i n di v id u a l

ho l d i ngs . C l os ed- end f unds a r e gene r a l l y ac t i ve l y managed .

P or tf ol io M an a ge me nt i s u se d t o s el ec t a p or tf ol io o f n ew p ro du c tdeve l opment p r o j ec t s t o ach i eve t he f o l l owi ng goa l s :

Maxi mi ze t he p r o f i t ab i l i t y o r va l ue o f t he po r t f o l i o

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P r ov i de ba l ance

S uppor t t he s t r a t egy o f t he en t e r p r i s e

P o rt f ol i o M a na g em e nt i s t h e r e sp o ns i bi l it y o f t h e s e ni o r m a na g em e ntt e a m o f a n o r g a n i z a t i o n o r b u s i n e s s u n i t . T h i s t e a m , w h i c h m i g h t b e

c a l l e d t h e P r o d u c t C o m m i t t e e , m e e t s r e g u l a r l y t o m a n a g e t h e p r o d u c t

p i p e l i n e a n d m a k e d e c i s i o n s a b o u t t h e p r o d u c t p o r t f o l i o . O f t e n , t h i s i st he s ame g r oup t ha t conduc t s t he s t age - ga t e r ev i ews i n t he o r gan i za t i on .

A l og ic al s ta rt in g p o in t i s t o c re at e a p ro d uc t s tr at eg y - m ar ke ts ,

c u s t om e r s , p r o d u c t s , s t r at e g y a p p r o a c h , c o m p e ti t i v e e m p h a si s , e t c . T h e

s econd s t ep i s t o under s t and t he budge t o r r e s our ces ava i l ab l e t o ba l anceth e p or t fo lio a ga in st . T hi rd , e ac h p ro je ct m us t b e a ss es se d f or

p r o f i t ab i l i t y ( r ewar ds ) , i nves t men t r equ i r emen t s ( r e s our ces ) , r i s ks , ando t he r appr opr i a t e f ac t o r s .

T h e w e i g h t i n g o f t h e g o a l s i n m a k i n g d e c i s i o n s a b o u t p r o d u c t s v a r i e sf r om c o mp a n y. B u t o r ga n iz a ti o ns m u st b a la n ce t h es e g o a ls : r i sk v s .

p r o f it a b i li t y , n e w p r o d u ct s v s . i m p r ov e m e n ts , s t r a te g y f i t v s . r e w a rd ,

m ar ke t v s. p ro du c t l in e, l on g -t er m v s. s ho rt -t er m. S ev e ra l t yp e s o f t echn i ques have been us ed t o s uppor t t he por t f o l i o management p r oces s :

Heur i s t i c mode l s

S cor i ng t echn i ques

Vi s ua l o r mapp i ng t echn i ques

T he e a rl ie st P or tf ol io M an ag em en t t ec hn iq ue s o pt im iz ed p ro je ct s'

p r o f i t ab i l i t y o r f i nanc i a l r e t u r ns us i ng heur i s t i c o r ma t hemat i ca l mode l s .H o w e v e r , t h i s a p p r o a c h p a i d l i t t l e a t t e n t i o n t o b a l a n c e o r a l i g n i n g t h e

p o r t f o l i o t o t h e o r g a n i z a t i o n ' s s t r a t e g y . S c o r i n g t e c h n i q u e s w e i g h t a n d

sco re c r i t e r i a to t ak e in t o acc oun t inv es t me nt r equ i re men t s , p r o f it a b i li t y , r i s k a n d s t r a te g i c a l i g nm e n t . T h e s h o r tc o m i n g w i t h t h i s

appr oach can be an ove r emphas i s on f i nanc i a l meas ur es and an i nab i l i t y

t o o pt im iz e t he m ix o f p ro je ct s. M ap pi ng t ec h ni qu e s u se g ra p hi ca l

p r es e n ta t io n t o v i su a li z e a p o rt fo l io ' s b a la n c e. T h es e a r e t yp i ca l lyp r e s en t e d i n t h e f o r m o f a t w o - d im e n s io n a l g r a p h t h a t s h o w s t h e t r a d e -

o f f' s o r b a la n ce b e tw e en t w o f a ct o rs s u ch a s r i sk s v s . p r of i ta b il i ty ,

ma rk et pla ce f i t v s. p ro du ct l in e c ov er ag e, f i na nc ia l r etu rn v s. probabi l i ty of success , e t c .

Our r ecommended appr oach i s t o s t a r t w i t h t he ove r a l l bus i nes s p l an t ha t

s h o u l d d e f i n e t h e p l a n n e d l e v e l o f R & : D i n v e s t m e n t , r e s o u r c e s ( e . g . ,

h e a d c o u n t , e t c . ) , a n d r e l a t e d s a l e s e x p e c t e d f r o m n e w p r o d u c t s . W i t h

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m ul ti pl e b us in es s u n it s, p ro d uc t l in es o r t yp e s o f d ev e lo p me n t, w e

r e c o m m e n d a s t r a t e g i c a l l o c a t i o n p r o c e s s b a s e d o n t h e b u s i n e s s p l a n .T h i s s t r a t e gi c a l l o c at i o n s h o u l d a p p o r ti o n t h e p l a n n ed R & D i n v e s t m e n t

i n t o bus i nes s un i t s , p r oduc t l i nes , mar ke t s , geogr aph i c a r eas , e t c . I t maya l s o b r e a k d o w n t h e R & D i n v e s t m e n t i n t o t y p e s o f d e v e l o p m e n t , e . g . ,t ec h no lo g y d ev e lo pm en t , p la tf or m d e ve lo pm en t, n ew p ro du c ts , a n d

upgr ades / enhancement s / l i ne ex t ens i ons , e t c .

O n ce t h is i s d o n e, t h en a p o rt f ol i o l i s ti n g c a n b e d e v el o pe d i n cl u di n g

the r e le van t p or t fo lio da ta . We fa vor us e o f t he dev elop men t p ro d uc ti vi ty i nd ex ( DP I) o r s co re s f ro m t he s co ri ng m et ho d . T he

d e v e l o p m e n t p r o d u c t i v i t y i n d e x i s c a l c u l a t e d a s f o l l o w s : ( N e t P r e s e n t

V al ue x P ro b ab il it y o f S uc c es s) / D e ve lo p me n t C os t R em ai ni ng . I t

f a c t o r s t h e N P V b y t h e p r o b a b i l i t y o f b o t h t e c h n i c a l a n d c o m m e r c i a l

s u c c e s s . B y d i v i d i n g t h i s r e s u l t b y t h e d e v e l o p m e n t c o s t r e m a i n i n g , i t p la c es m or e w ei gh t o n p ro je ct s n ea re r c om pl et io n a nd w it h l ow e r

uncommi t t ed cos t s . The s co r i ng me t hod us es a s e t o f c r i t e r i a ( po t en t i a l l yd if fe re nt f or e ac h s ta ge o f t he p ro je ct ) a s a b as is f or s co ri ng o r

e v a l u a t i n g e a c h p r o j e c t . A n e x a m p l e o f t h i s s c o r i n g m e t h o d i s s h o w n

wi t h t he wor ks hee t be l ow.

W ei gh ti ng f ac to rs c an b e s et f or e ac h c ri te r i a. T he e va lu at or s o n aP ro d uc t C om mi tt ee s co re p ro je ct s ( 1 t o 1 0 , w h er e 1 0 i s b es t) . T he

wor ks hee t comput es t he ave r age s co r es and app l i e s t he we i gh t i ng f ac t o r s

t o comput e t he ove r a l l s co r e . The max i mum wei gh t ed s co r e f o r a p r o j ec ti s 100 .

Once t he o r gan i za t i on has i t s p r i o r i t i zed l i s t o f p r o j ec t s , i t t hen needs t o

de t e r mi ne wher e t he cu t o f f i s bas ed on t he bus i nes s p l an and t he p l anned

l e v e l o f i n v e s t m e n t o f t h e r e s o u r c e s a v a i l a b l e . T h i s s u b s e t o f t h e h i g h p r i o r i t y p r o j e c t s t h e n n e e d s t o b e f u r t h e r a n a l y z e d a n d c h e c k e d . T h e

f ir st s te p i s t o c h ec k t ha t t he p ri or it iz ed l is t r ef le ct s t he p la nn e d

b r e a k do w n o f p r o j ec t s b a s e d o n t h e s t r a te g i c a l l o c a t i o n o f t h e b u s i n e s sp l an . P i e cha r t s s uch as t he one be l ow can be us ed f o r t h i s pu r pos e .

Ot he r f ac t o r s can a l s o be checked us i ng bubb l e cha r t s . F or exampl e , t he

r i s k- r e w a rd b a l a n ce i s c o m m o n l y c h e c k e d u s i n g t h e b u b b l e c h a r t s h o w n

ear l i e r . A f i na l check i s t o ana l y ze p r oduc t and t echno l ogy r oadmaps f o r p r o j ec t r e l a ti o n s h ip s . F o r e x a m p l e , i f a l o w e r p r i o r i t y p l a t f o rm p r o j e ct

w as o mi tt ed f ro m t he p or tf ol io p ri or it y l is t, t he s ub se q ue nt h ig h er

p r i o r i t y p r o j e c t s t h a t d e p e n d o n t h a t p l a t f o r m o r p l a t f o r m t e c h n o l o g yw ou ld b e i mp o ss ib le t o e x ec ut e u nl es s t ha t p la tf or m p ro je c t w e re

i nc l uded i n t he por t f o l i o p r i o r i t y l i s t . An exampl e o f a r oadmap i s s hown

below.

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F in a ll y, t hi s b al an ce d p o rt fo li o t ha t h as b ee n d e ve lo p ed i s c he c ke d

a g a i n s t t h e b u s i n e s s p l a n a s s h o w n b e l o w t o s e e i f t h e p l a n g o a l s h a v e b ee n a c hi ev e d - p ro je c ts w it hi n t he p la n ne d R &D i nv e st me n t a nd

r es our ce l eve l s and s a l e s t ha t have me t t he goa l s .

W i t h t h e s i g n i f i c a n t i n v e s t m e n t s r e q u i r e d t o d e v e l o p n e w p r o d u c t s a n d

t h e r i s k s i n v o l v e d , P o r t f o l i o M a n a g e m e n t i s b e c o m i n g a n i n c r e a s i n g l yi m p o r t a n t t o o l t o m a k e s t r a t e g i c d e c i s i o n s a b o u t p r o d u c t d e v e l o p m e n t

a n d t h e i n v e s t m e n t o f c o m p a n y r e s o u r c e s . I n m a n y c o m p a n i e s , c u r r e n t

y e a r r e v e n u e s a r e i n c r e a s i n g l y b a s e d o n n e w p r o d u c t s d e v e l o p e d i n t h el a s t one t o t h r ee y ea r s . Ther e f o r e , t hes e por t f o l i o dec i s i ons a r e t he bas i s

o f a c o m p a n y ' s p r o f i t a b i l i t y a n d e v e n i t s c o n t i n u e d e x i s t e n c e o v e r t h e

nex t s eve r a l y ea r s .

I NVES TMENT ANALYS I S

I n ve s tm e nt a n a ly s is i s a n o n g oi n g p r oc e ss o f e v a lu a ti n g c u rr e nt a n dp o t e n ti a l a l l o ca t i o n s o f f i n a n ci a l a s s e ts a n d c h o o s in g t h o s e a l l o c a t i on s

th at b es t f it th e i nv es to r' s n ee ds a nd g oa ls . T he tw o o pp os in g

cons i de r a t i ons i n i nves t men t ana l y s i s a r e g r owt h r a t e an d r i s k , wh i ch a r eu s ua l ly d i re c tl y p r op o rt io n a te i n a n y g i ve n i n ve s tm e nt v e hi c le . T h is

m ea ns t ha t i nv es tm en ts w it h a h ig h d eg re e o f c er ta in ty , s uc h a s

s e c u r i t i e s , o f f e r a v e r y m o d e s t r a t e o f r e t u r n , w h e r e a s h i g h - r i s k s t o c k i nv e st me n ts c ou ld d ou b le o r q ua dr up le i n v al ue o ve r a f ew m on th s.

T h r o u g h i n v e s t m e n t a n a l y s i s , i n v e s t o r s m u s t c o n s i d e r t h e l e v e l o f r i s k

t hey ' r e ab l e t o t o l e r a t e and choos e i nves t men t s accor d i ng l y .

B e y o n d w e i g h i ng t h e r e t u r n o f a n i n d i vi d u a l i n v e s t m e nt , i n v e s to r s m u s ta l s o c o n s i d e r t a x e s , t r a n s a c t io n c o s t s, a n d o p p o r tu n i t y c o s t s t h a t e r o d e

t he ir n et r et ur n. T ax es , f or i ns ta nc e, m ay b e r ed uc ed o r d ef er re d

d ep en d in g o n t he t yp e o f i nv e st me n t a nd t he i nv es to r' s t ax s ta tu s.T r a n sa c t i on c o s t s m a y b e i n c u r re d e a c h t i m e a n i n d i v i d u a l p u r c h a se s o r

se ll s sh are s o f s to ck o r m utu al fu nd s. Th es e f ee s a re u su al ly a

pe r cen t age o f t he do l l a r amoun t be i ng t r ans f e r r ed . S uch f ees may s i f t 3 -

6 p e r c e n t o r m o r e o f f t h e i n i t i a l i n v e s t m e n t a n d f i n a l r e t u r n . I f t h e yd o n' t s e em w a rr a nt e d, s u ch e x p en s es m a y b e a v o id e d b y c h o os i ng n o

l oad mut ua l f unds and dea l i ng wi t h d i s coun t b r oke r s , f o r i n s t ance . Much

m o r e n e b u l o u s i s o p p o r t u n i t y c o s t , w h i c h i s w h a t t h e i n v e s t m e n t c o u l dhave ea r ned had i t been dep l oy ed e l s ewher e . Oppor t un i t y cos t i s l a r ge l y

t h e d o w ns i de o f i n ve s ti n g t o o c o n se r va t iv e ly g i ve n o n e 's m e an s a n d

c i rc u ms t an c es . A g a in , b o th r is k a n d g r ow t h f a ct o r i n to o p p or tu n it yc o s t s. F o r e x a m p l e , l o w r i s k c o m e s a t a p r i c e o f l o w r e t u rn s , b u t i t m a y

b e w o rt h t he l os t o p po rt un it y i f t he i nv es to r i s r et ir ed a nd w il l b e

depend i ng on t he i nves t ed f unds f o r l i v i ng expens es i n t he nea r f u t u r e .

I NTERES T- BEARI NG I NVES TMENTS AND TREAS URI ES

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A m on g t h e l o we s t r i sk an d l o we s t r e tu r n i nv e st m en t s a r e i n te r es t -

b e a r in g n o t e s s u c h a s m o n e y m a r k e t f u n d s , c e r t i f ic a t e s o f d e p o s it f r o m b a n k s n o t e s a n d b o n d s . T h e s e p a y t h e i n v e s t o r a g u a r a n t e e d p e r i o d i c

i n t e r e s t p a y m e n t , o r , i n t h e c a s e o f T - b i l l s , a l u m p s u m b a s e d o n ag u ar a nt e ed d i sc o u nt r a te . T o c h o os e b e tw e en t h e v a ri o us o p ti o ns t h ei n ve s to r n e ed o n ly c o n si d er t h e c o mp a ra t iv e i n te r es t r a te ( s om e p a y

mor e t han o t he r s ) and t he t e r m ( many o f t hes e i nves t men t s a r e bas ed on

f i xed pe r i ods s uch as t h r ee mont hs o r a y ea r ) . Thes e s o r t s o f i nves t men t s

a r e p o p u l a r b e c a u s e t h e y a r e f a i rl y l i q u i d th e y c a n b e b o u g h t a n d s o l da t a n y p o i n t i n a f i n a n c i a l c y c l e w i t h o u t a d v e r s e t i m i n g e f f e c t s a n d

t h e y o f f e r a n e a r ly r i s k -f r e e o p t i o n f o r i n v e s to r s w h o n e e d c e r t a i n t y o f

r e t u r n .

MUTUAL F UNDS

M ut ua l f un d s l ur e i nv e st or s w it h t he p ro mi se o f s to ck m ar ke t- l i ke

r e tu r ns i n a l o we r r i sk a n d m o re n o v ic e -f r ie n dl y e n v ir o nm e nt . T h es e

f un ds p oo l t he ir m em be rs ' i nv e st me n ts i n p ro fe ss io n al ly m an ag e d por t f o l i os o f s t ocks , bonds , and o t he r i nves t men t s . As a r e s u l t , t hey can

p r ov i de i nd i v i dua l i nves t o r s w i t h t he k i nd o f i nves t men t d i ve r s i f i ca t i on

t h a t w o u l d o t h e r w i s e r e q u i r e a m u c h g r e a t e r a m o u n t o f m o n e y t o b e

i n v e s t e d a n d m u c h m o r e e f f o r t i n r e v i e w i n g t h e m a n y c h o i c e s . I n t h e1 9 80 s a n d 1 9 90 s m u tu a l f u nd s w e re i n cr e as i ng l y u s ed f o r e m pl o ye e -

managed r e t i r emen t s av i ngs p r ogr ams .

Mos t f unds have an i nves t men t ob j ec t i ve and , a s w i t h s t ocks , t he cho i ces

r a n g e f r o m c o n s e r v a ti v e , l o w r i s k f u n d s t h a t m i r r o r a m a r k e t i n d e x l i k et h e S t a n d a r d & P o o r ' s 5 0 0 t o h i g h - s t a k e s a g g r e s s i v e g r o w t h f u n d s t h a t

f o c u s o n s m a l l a n d u n p r o v e n c o m p a n i e s . A l s o l i k e s t o c k s , m a n y f u n d s

pe r f o r m poor l y i n a g i ven y ea r o r even o ve r a pe r i od o f y ea r s , a f ac t t ha tf un d m ar ke te rs s om et im es g lo ss o ve r. T hu s c h oo si ng m ut ua l f un d s

i nvo l ves many o f t he s ame cons i de r a t i ons a s choos i ng s t ocks .

F UTURES AND OTHER DERI VATI VES

Whi l e i nves t men t s l i ke o i l f u t u r es and op t i ons a r e o f t en s een as s ome o f t h e r i s k i e st f o r m s o f i n v e s tm e n t , i r o n i c al l y a k e y u s e f o r t h e s e m a r k e t -

t ra d ed c on tr ac ts i s f or h ed gi ng a ga in st a d ve rs e m ov e me n ts i n c as h

m a r k e t s . I n o t h e r w o r d s , i n v e s t o r s b u y f u t u r e s o r o p t i o n s c o n t r a c t s i np a r t t o r e d u c e t h e i r r i s k o f f a c i ng a d e v a s t a t i ng p r i c e f a l l ( o r i n c r ea s e ,

a s t h e c a s e m a y b e ) i n a n o t h e r m a r k e t . C o l l e c t i v e l y , f u t u r e s , o p t i o n s ,

a n d s i mi l ar i n st ru m en t s a r e k n ow n a s d e ri v at i ve s b e ca u se t h ey d e ri v e

f ro m p ri ce m ov em en ts i n o th er m ar ke ts , i nc lu di ng c om mo di ti es ,c u r r e n c i e s , a n d s t o c k s . O f c o u r s e , m a n y i n v e s t o r s a l s o u s e d e r i v a t i v e s

f or s pe cu la ti on . B y n at ur e t he i nd iv id ua l c on tr ac ts a re s ho rt -t er m

i n ve s tm e nt s , a l th o u gh s o me i n ve s to r s, m a in l y c o rp o ra t io n s a n d o t he r

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i n s ti t u t io n s , m a i n ta i n a r e g u l ar p o r t fo l i o o f d e r i va t i v e s o n u n d e r ly i n g

commodi t i e s o r a s s e t s t ha t a f f ec t t he i r bus i nes s .

Ana l y z i ng f u t u r es and op t i ons i nvo l ves ana l y z i ng t he expec t ed d i r ec t i ono f p r i c e m o v e m e n t s f o r t h e u n d e r l y i n g g o o d s . H o w e v e r , i n c o n t r a s t t o

s t ock o r mut ua l f und ana l y s i s , wh i ch i s u s ua l l y bes t done wi t h an ey e t o

t h e l o ng t e rm , d e ri v at i ve a n al y si s r e qu i re s m a ki n g a s h or t- t er m ( l es st han a y ea r ) f o r ecas t o f wha t mi gh t happen t o p r i ces i n t he cas h mar ke t s .

I f t h e f o r e c a s t p r o v e s a c c u r a t e t h e i n v e s t o r c a n m a k e m o n e y , b u t i f i t ' s

w r o n g t h e l o s s e s c o u l d b e s u b s t a n t i a l . W i t h t h e p r a c t i c e o f b u y i n g o nm a r g in , w h i c h i n v o lv e s t a k i n g o u t a l o a n t o i n c r e a s e t h e a m o u n t o f t h e

i nves t men t , t he p r o f i t s o r l o s s es can be mul t i p l i ed .

S ECURI TI ES

A s e c u r i t y i s a f i n a nc i a l a s s e t r e p r e se n t i ng a c l a i m o n t h e a s s e t s o f t h e

i s s u i ng f i r m and on t he p r o f i t s p r oduced by t he a s s e t s . The t e r m s ecur i t ya n al y si s p e rt a in s t o t h e p r oc e ss o f i d en t if y in g d e s ir a bl e i n ve s tm e nt

o p p o r t u n i t i e s i n s u c h f i n a n c i a l a s s e t s . I n t h e c a s e o f c o r p o r a t e s t o c k s

a n d b o n d s , t h e a n a l y s i s f l o w s f r o m t h e i n t e rp r e t at i o n o f a c c o u n ti n g a n df in a n ci a l d a ta r e ga r di n g o p e ra t io n s, p r of i ta b il i ty , n e t w o rt h , a n d t h e

l i k e . I n v e s t m e n t a l t e r n a t i v e s a r e i d e n t i f i e d b a s e d o n ( 1 ) t h e i n v e s t o r ' s

r i s k / r e w a r d r a t i o , ( 2 ) a s p e c i f i e d t i m e h o r i z o n , a n d ( 3 ) c u r r e n t m a r k e tpr ices .

S ecur i t y ana l y s t s , i n e s s ence , a r e t he ca t a l y s t s wh i ch d r i ve t he e f f i c i en t

mar ke t hy po t hes i s . Tha t i s , " s mar t " money wi l l l og i ca l l y and e f f i c i en t l y

d i s t r i b u t e i t s e l f i n s u c h a w a y t h a t s e c u r i t y p r i c e s r e f l e c t a l l a v a i l a b l ei n f o r m a t i o n . A s n e w i n f o r m a t i o n b e c o m e s a v a i l a b l e , a n a l y s t s a s s e s s i t

a n d r e co m me n d m a rk e t p r ic e a d ju s tm e nt s a c c or d in g t o c h an g e s t h ey

a n t i ci p a t e f o r p r i c e l e v e l s . T h e c u m u l at i v e i m p a c t o f p r i c e a d j u s t m en t sm ov e s t he m ar ke t t o e qu il ib ri u m s o t ha t t he p ri ce o f a n y s ec ur it y

appr ox i mat es t r ue i nves t men t va l ue .

S ecur i t y ana l y s t s ope r a t e i n t h r ee a r enas , each r e f l ec t i ng a d i f f e r en t s e t

o f g oa ls a nd o bj ec ti ve s. I nv es tm en t b an ki ng a nd b ro ke ra ge f ir msr e p r e s e n t t h e " s e l l " s i d e o f s e c u r i t y a n a l y s i s . T h e i r c l i e n t s a r e f e e a n d

commi s s i on pay i ng i ns t i t u t i ona l and i nd i v i dua l i nves t o r s .

I n v e st m e n t m a n a g e m e n t o r g a n i z a t io n s c o n d u c t s e c u r i t y a n a l y s is f o r t h e

p o r t fo l i o s t h e y m a n a g e. S i n c e p o r t fo l i o m a n a g e rs p u r c h a se s e c u r it i e s,t hey r ep r es en t t he "buy " s i de o f t he s t r ee t .

F in a ll y , a n u mb e r o f i n ve s tm e nt p u b li s hi n g s e rv i ce s p r ov i de s e cu r it y

ana l y s i s f o r a l l i nves t o r s s ubs c r i b i ng t o t he i r r epor t s . The mos t popu l a r

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i n v e s t m e n t s e r v i c e s a r e a v a i l a b l e t h r o u g h V a l u e L i n e I n c . , S t a n d a r d &

P oor ' s , Moody ' s I nves t o r s S e r v i ce , and Dun & Br ads t r ee t .

Methodology and Procedure o f Work

T h e r e a r e t w o b a s i c m e t h o do l o g i es : f u n d a me n t a l a n a l y s is a n d t e c h n ic a l

a n a l ys i s . I n t h e i r o w n w a y , e a c h a p p r o a ch e s i n v e s t m e n t d e c i s i o ns f r o m

t he t op - down and f r om t he bo t t om- up .

THE TOP - DOWN AP P ROACH.

T h e t o p- d o wn a p p ro a c h, t h e t r ad i ti o na l m e th o d ol o gy , b e g in s w i th a

b r oad pe r s pec t i ve and ends wi t h a s pec i f i c ana l y s i s o f a s t ock o r a bond .The t op - down appr oach i n i t i a l l y ana l y zes macr oeconomi c da t a , f i l t e r s i ti n t o mor e s pec i f i c s ec t o r s , and f i na l l y d i s t i l l s t he r e s u l t s w i t h r e s pec t t o

a s pec i f i c s ecur i t y .

A n al y st s d e te r mi n e t h e i m po r ta n t e c o no m ic c o nd i ti o ns a n d f o rc e s a t

w or k a nd t he ir p o te n ti al i mp a ct o n t he m ar ke ts . A na ly st s e x am in ec o r p o ra t e p r o f it a b i l it y , t h e d i r e c ti o n a n d m a g n i tu d e o f i n t e re s t r a t e s,

m o ne y s u pp l y, f i sc a l p o li c y, e m pl o ym e nt , m i gr a ti o n, e x p or t /i m po r t

t r e n d s , e t c . , t o e v a l u a t e t h e f u t u r e p e r f o r m a n c e o f i n d i v i d u a l e c o n o m i c

s ec t o r s and i ndus t r i e s .

S ec ur it y a na ly st s a ls o u ti li ze t he t op -d ow n a pp ro ac h t o a ll oc at e

a v ai l ab l e f u nd s w i th i n p o rt f ol i os b e tw e en s h or t -t e rm a n d l o ng - te r m

i n v e st m e n ts , b e t w e e n r i s k y a n d r i s k- f r e e s e c u r i ti e s , a n d b e t w e e n s t o c k sa n d b o n d s . S e c t o r - t o - s e c t o r a n d m a r k e t - t o - m a r k e t c o m p a r i s o n s p u r p o r t

t o i d e n t i f y w h e r e i n v e s t o r s s h o u l d l o o k f o r s u p e r i o r r e t u r n s . A n a l y s t s

r e co m me n d i n ve s ti n g i n f a vo r ab l e i n du s tr i es o r s e ct o rs , a n d s u gg e st

s pec i f i c s t ocks wi t h i n each s ec t o r .

THE BOTTOM- UP AP P ROACH.

A m aj or d ra wb ac k t o t he t op -d ow n a pp ro ac h i s t he l ik el ih oo d o f

ove r loo kin g c er t a in s t ocks tha t o ff e r s ign i f i can t in ves tmen t

o p po r tu n it i es b u t w h ic h a r e o u ts i de t h e f a vo r ab l e s e ct o rs . T o r e me d yt hi s, a n al ys ts a ls o u ti li ze t he b ot to m- up a pp ro ac h w h ic h i de n ti fi es

s uper i o r pe r f o r mer s wi t hou t r ega r d t o i ndus t r y .

T hi s a pp ro ac h i de nt if ie s a dv an ta ge ou s i nv es tm en ts a cc or di ng t o

p e r f or m a n c e a n d f i n a nc i a l c r i t er i a . T h e c r i te r i a a r e a p p l ic a b l e a c r o s si ndus t r y and s ec t o r s , e s t ab l i s h i ng pe r f o r mance and f i nanc i a l benchmar ks

w hi ch c om pa ni es m us t m ee t o r e xc ee d i n o rd er t o b e c on si de re d.

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Anal y s t s a l s o deve l op c r i t e r i a t o s epa r a t e t he t op pe r f o r mer s by va r i ous

degr ees o f r i s k , e .g . , cons e r va t i ve ve r s us aggr es s i ve .

Once t he s c r eens have f i l t e r ed ou t t he appr opr i a t e s ecur i t i e s , t he ana l y s tconduc t s a f undament a l ana l y s i s o f t he company .

F UNDAMENTAL ANALYS I S

F u n d a me n t a l a n a l y s ts l o o k f o r s u p e r io r r e t u rn s f r o m s e c u r i t ie s t h a t a r e

mi s p r i ced by t he mar ke t . To i den t i f y t hem t he ana l y s t engages i n va r i ousc a l c u la t i o n s u s i n g d a t a f r o m f i n a n c i al s t a te m e n t s a n d b a l a n c e s h e e t s t o

de t e r mi ne t he f u t u r e ea r n i ngs and d i v i dends o f a company , t he degr ee t o

w hi ch t he se e x ce ed t he e x pe ct ed a ve ra ge f or t he i nd us tr y, a n d t he p ot en ti al f or t he s to ck t o m ov e c lo se r t o a c or re ct o r f ai r v al ue .

F un da me nt al a na ly st s w ou ld r ec om me nd b uy in g u nd er va lu ed , o r u n de r pr i ce d , s t oc k s. W h en a s t oc k i s b e li e ve d t o b e o v e rv a lu e d , t h e

a na ly st w ou ld a dv is e s el li ng o r t ak in g a s ho rt p os it io n b ec au se t hemar ke t wou l d be expec t ed t o co r r ec t t he p r i ce downwar d i n t he f u t u r e .

THE OP ERATI NG ENVI RONMENT.

S ome o f t he ex t e r na l cond i t i ons a f f ec t i ng a company ' s pe r f o r mance a r e :

D e m o g ra p h i c c h a n g e s : s e x , a g e , a b s o l ut e n u m b e rs , l o c a t io n , p o p u l a ti o n

movement s , educa t i ona l p r epa r a t i on .

E c on o mi c c o n di t io n s: e m pl o ym e nt l e ve l , r e gi o na l p e rf o rm a nc e , w a gel eve l s , s pend i ng pa t t e r ns , cons umer deb t , cap i t a l i nves t men t .

Gover nment f i s ca l po l i cy and r egu l a t i on s pend i ng l eve l s , t he magn i t ude

o f e n ti tl em e nt s, d e bt , w a r a n d p ea c e, t ax p o li ci es , e nv ir on me nt al

r egu l a t i ons .

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Compet i t i on : mar ke t pene t r a t i on and pos i t i on , mar ke t s ha r e , commodi t y ,

commodi t i e s mar ke t i ng s t r a t eg i es , and n i che p r oduc t s .

V e nd o rs : f i na n c ia l s o u nd n es s , q u a li t y a n d q u a nt i ty o f p r od u c t, R & Dcapab i l i t i e s , a l t e r na t i ve s upp l i e r s , j u s t - i n - t i me capab i l i t i e s .

I ndus t r y - and f i r m- s pec i f i c cha r ac t e r i s t i c s i mpor t an t t o t he f undament a l

a n a l y s t a r e : p r o f i t a b i l i t y ; m a r k e t p r e s e n c e ; p r o d u c t i v i t y ; p r o d u c t t y p e ,s a l e s , and s e r v i ces ; f i nanc i a l r e s our ces ; phy s i ca l f ac i l i t i e s ; r e s ea r ch and

deve l opment ; qua l i t y o f management .

T h e a n a ly s t a p pr o ac h e s t h es e i n di c at o rs i n t w o w a ys : f i rs t , a s t re n d s

w i t h in a n i n d u s tr y , a n d s e c o n d l y a s f e a t ur e s o f a p a r t i c u l a r f i r m. T o d ot hi s, a n al ys ts u se a s er ie s o f r at io s c on st ru ct ed f ro m t he f in a nc ia l

s t a t e m e n t s . R a t i o s r e p r e s e n t t h e p e r c e n t a g e o r d e c i m a l r e l a t i o n s h i p o f one number t o ano t he r . Ra t i os f ac i l i t a t e t he us e o f co mpar a t i ve f i nanc i a l

s t at e me n ts , w h ic h p r ov i de s i gn i fi c an t i n fo r ma t io n a b ou t t r en d s a n dr e la t io n s hi p s o v er t w o o r m o re y e ar s . A n al y st s c o mp a re a c o mp a n y' s

r a t i os t o i ndus t r y r a t i os , a s we l l a s c r os s - s ec t i ona l l y t o o t he r compan i es .

S t r u c t u r a l a n a l y s i s c o m p a r e s t w o f i n a n c i a l s t a t e m e n t s i n t e r m s o f t h ev a r i o u s i t e m s o r g r o u p s o f i t e m s w i t h i n t h e s a m e p e r i o d . T i m e s e r i e s

ana l y s i s co r r e l a t e s r a t i os ove r t i me , meas ur ed i n y ea r s o r by qua r t e r s .

S in c e r at io s a re r el at iv e m ea su re s, t he y f ur ni sh a c om mo n s ca le o f

m e a s ur e m e n t f r o m w h i c h a n a l ys t s c o n s tr u c t h i s t or i c a l a v e r a g e s . T h u s ,a na ly st s a re a bl e t o c om pa re c om pa ni es o f d if fe re nt s iz e s a n d f ro m

di f f e r en t i ndus t r i e s bas ed on pe r f o r mance and f i nanc i a l cond i t i on by ( a )

e s t a b l i s h i n g a b s o l u t e s t a n d a r d s , ( b ) e x a m i n i n g a v e r a g e s , a n d ( c ) u s i n g

t r e n ds t o f o r e c as t f u t u re r e s u lt s . T o i n c r ea s e p r e d i ct a b i li t y , t h e a n a l ys tcons i de r s t he i mpac t o f ex t e r na l f ac t o r s on i n t e r na l t r ends .

P I ONEERS .

I n 1934 Ben j ami n Gr aham and Dav i d Dodd pub l i s hed S ecur i t y Ana l y s i s .

T h i s b o o k i s c o n s i d e r e d t h e b i b l e o f f u n d a m e n t a l p r a c t i t i o n e r s . I n t h e1 92 0s , G ra h am b ec am e a s uc ce ss fu l p or tf ol io m an ag er b y s tr es si ng

c a p i ta l p r e s er v a t io n b y i n v e s ti n g p r o p o rt i o n at e l y i n h i g h q u a l i t y s t o c k s

a n d i n l o w r i s k c r e d i t i n s t r u me n t s . W i t h D o d d , h i s s t u d e nt f r o m U C L A ,Gr aham l a i d ou t v i gor ous i nves t men t p r ocedur es i n t he book .

G r a h am a n d D o d d p r i m a r i ly a p p r a is e d s t o c k s a c c o r di n g t o t h e i r e a r n i n g

p ow e r. T he y r ec om me n de d a n e xt en si ve l is t o f f in an ci a l r at io s t o

meas ur e a company ' s pe r f o r mance accor d i ng t o :

P r o j ec t ed f u t u r e ea r n i ngs

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P r o j ec t ed f u t u r e d i v i dends

A met hod f o r va l u i ng expec t ed ea r n i ngs

The va l ue o f t he a s s e t

I n t h e b e l i e f t h a t i n v e s t o r s t e n d e d t o o v e r r e a c t t o n e a r - t e r m p r o s p e c t s ,Gr aham and Dodd des i gned f o r mul as t o keep t he d i s pa r i t y be t ween P / E ' s

f o r d i f f e r e n t c o m p a n i e s w i t h i n s h a r p f o c u s . A n a l y s t s c o n t i n u e t o a p p l y

t hes e p r i nc i p l e s t oday .

Analys i s o f Data

F in a n ci a l a n a ly s is i s n e c es s ar y i n d e te r mi n in g t h e f u tu r e v a lu e o f a

c om pa ny . F in an ci al a na ly si s c o nc en tr at e s o n t he c on d it io n o f t hef in a nc ia l s ta te me nt s: t he i nc om e s ta te me n t, t he b al an ce s he et , t hes ta te me nt o f c ha ng es i n s ha re ho ld er s' e qu it y, a nd t he f un ds f lo w

s ta te me nt s. F ro m t he se t he a na ly st d et er mi ne s t he v al ue s o f t he

ou t s t and i ng c l a i ms on t he company ' s i ncome .

F in an ci al a na lys ts me asu re p as t p er fo rm an ce , e va lu ate p re se ntc on di ti on s, a nd m ak e p re di ct io ns a s t o f ut ur e p er fo rm an ce . T hi s

i nf or ma ti on i s i mp or ta n t t o i nv e st or s l oo ki ng f or s up er io r r et ur ns .

C r e d it o r s u s e t h i s i n f o r ma t i o n t o d e t e rm i n e t h e r i s k a s s o c i at e d w i t h t h e

ex t ens i on o f c r ed i t .

RATI O ANALYS I S .

Th e mo st c omm on m eth od us ed b y a na lys ts i s f in an cia l r at i os .

C omp os it i on r at i os c om pa re th e s i ze o f th e c om po ne nts o f a ny

a c co u n ti n g c a te g o ry w i th t h e t o ta l o f t h at c a te g or y , f o r e x a m p le , t h epe r cen t age o f ne t i ncome t o ne t s a l e s . Compos i t i on r a t i os :

I nd i ca t e t he s i ze o f each o f t he componen t s r e l a t i ve t o t he i r t o t a l and t o

each o t he r .

Make h i s t o r i c compar i s ons and t r end i ng p os s i b l e .

Po in t t o c au se -a nd -e ff ec t r e la ti on sh ip s b etw ee n t he in div id ua lcomponen t s and t he i r t o t a l .

F UNDAMENTAL WEAKNES S ES .

A l t h o u g h w i d e l y u s e d , f i n a n c i a l a n a l y s i s d o e s h a v e s o m e f u n d a m e n t a l

weaknes s es . S i nce i t i s bas ed on da t a f r om f i nanc i a l r epor t s , i t s f i nd i ngs

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a r e s ub j ec t t o d i s t o r t i ons r e s u l t i ng f r om i n f l a t i on , w i l d bus i nes s s wi ngs ,

c h a n g e s i n a c c o u n ti n g p r a c ti c e s , a n d u n d i s cl o s e d i n n e r - wo r k i n gs o f t h ef ir m . M a na g e me n t c a n m a ni p ul a te i m po r ta n t k e y r a ti o s b y c h an g in g

i n v e n to r y v a l u a ti o n s , d e p r e ci a t io n s c h e d u le s , a n d e x p e n s e r e c o g n i t io np r ac t ic e s. F u rt h er m or e , s i nc e t h e f i na n ci a l s t at e me n ts a r e s t at i c, t h eana l y s t canno t accoun t f o r t he i mpac t o f s eas ona l va r i a t i ons . F i na l l y , t he

r a t i os a r e mean i ng l es s un l es s compar ed t o pe r f o r mance benchmar ks .

TECHNI CAL ANALYS I S

T e c h n ic a l a n a l y s i s e x a m i n es s t o c k p r i c e t r e n d s i n a n a t t e m p t t o p r e d ic t

fu tu re p ric es . T ec hn ic al a na ly st s b el i ev e th at a ll th e r e le va nti n f o rm a t i on a b o u t e c o n o m i c f u n d a m en t a l s o f a n i n d u s tr y a n d o f a s t o c k

a r e r e f l ec t ed i n t he d i r ec t i on and vo l ume o f p r i ces . Ther e f o r e , t echn i ca l

a n al y st s l o ok t o t h e p a st , f o r t h e y b e li e ve t h at m a rk e ts a r e c y c l ic a l,f o rm i ng s p ec i fi c p a tt e rn s , a n d t h es e p a tt e rn s r e pe a t t h em s el v es o v e r

t i m e . T h e y f u r t h e r b e l i e v e t h a t i t i s o n l y n e c e s s a r y t o c o m p a r e s h o r t -

t e r m a n d i n t e r m e d i a t e p r i c e m o v e m e n t s t o l o n g - t e r m t r e n d s i n o r d e r t o predic t market d i r ec t ion .

T w o m a j o r t e c h n i q u es f o r m t h e b a s i s o f t e c h n ic a l a n a l y s i s: t h e s t u d y o f

key i nd i ca t o r s , and t he cha r t i ng o f mar ke t ac t i v i t y .

KEY I NDI CATORS .

C om mo n k e y i nd ic at or s u ti li z ed b y t ec hn ic a l a na ly st s i nc lu de t hef o l l owi ng :

T r a d i n g v o l u m e i s b a s e d o n s u p p l y - d e m a n d r e l a t i o n s h i p s a n d i n d i c a t e s

m ar ke t s tr en gt h o r w e ak ne ss . R is in g p ri ce s w it h i nc re as ed b u yi ng

g e n e r a l l y s i g n a l s u p t r e n d s . D e c r e a s i n g p r i c e s w i t h i n c r e a s i n g d e m a n d ,a nd i nc re as in g p ri ce s w it h d e cr ea si ng v o lu me , s ig na l d o wn tr en d s.

Tr ad i ng vo l ume app l i e s bes t t o t he s hor t - t e r m ( t h r ee t o n i ne mont hs ) .

M a rk e t b r ea d th e x a mi n es t h e a c ti v it y o f a b r oa d e r r a n g e o f s e cu r it i es

t ha n d o h ig h ly p u bl ic iz ed i nd ic e s s uc h a s t he D ow J on es I nd u st ri alAver age . The b r ead t h i ndex i s t he ne t da i l y advances o r dec l i nes d i v i ded

b y t h e a m o u n t o f s e c u r i t i e s t r a d e d . T h e b r e a d t h i n d e x i s c a l c u l a t e d b y

e i t h e r t h e n u m b e r o f s e c u r i t i e s , t h e d o l l a r v o l u m e , o r n o m i n a l v o l u m e .Br ead t h ana l y s i s concen t r a t e s on change r a t he r t han on l eve l i n o r de r t o

e v a l u a t e t h e d i s p e r s i o n o f a g e n e r a l m o v e m e n t i n p r i c e s . T h e s l o p e o f

t he a dv a nc e/ de c li ne l in e i nd ic at es t he t re nd o f t he b re ad th i nd ex .

B r ea d th a n al y si s p o in t s t o t h e p r i m e t u rn i ng p o in t s i n b u ll a n d b e a r mar ke t s .

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C o n f id e n c e i n d i c e s e v a l u a t e t h e t r a d in g p a t t er n s o f b o n d i n v e s t o r s w h o

a r e r e g a r d e d a s m o r e s o p h i s t i c a t e d a n d m o r e w e l l - i n f o r m e d t h a t s t o c k t ra d er s a n d, t he re fo re , s po t t re nd s m or e q ui ck ly . O th er c on fi de n ce

t h e o ri e s m e a s u re t h e s e n t im e n t a m o n g a n a l ys t s t h e m s e l v e s, t h e b r e a d t ht r ends i n op t i ons and f u t u r es t r ad i ng , and cons umer conf i dence . Ana l y s t sc o ns i de r t h es e t o h a v e p r e d i ct i ve v a lu e i n t h e n e a r a n d i n te r me d ia t e

t e r m.

The pu t - ca l l r a t i o d i v i des t he vo l ume o f pu t s ou t s t and i ng by t he vo l ume

of ca l l s ou t s t and i ng . I nves t o r s gene r a l l y pu r chas e t he g r ea t e s t number o f pu t s a r ound mar ke t bo t t oms when t he i r pes s i mi s m peaks , t hus i nd i ca t i ng

a t ur na ro u nd . C al l v ol um e i s g re at es t a ro u nd m ar ke t p ea k s, a t t he

he i gh t s o f i nves t o r en t hus i a s mal s o i nd i ca t i ng a mar ke t t u r n .

T h e c a sh p o si t io n o f f u nd s g i ve s a n i n di c at i on o f p o te n ti a l d e ma n d .An al ys ts e xa min e th e v olu me a nd c om po si t io n o f c as h h eld b y

i ns ti tu t i on a l i nv es to rs , p e ns io n f un ds , m ut ua l f un ds , a nd t he l ik e.

B e c a u se f u n d m a n a g e r s a r e p e r f or m a n c e d r i v e n , a n a l y s ts e x p e c t t h e m t os e ar c h o u t h i gh e r r e tu r ns o n l a rg e c a sh b a la n c es a n d , t h er e fo r e, w i ll

i nves t mor e heav i l y i n s ecur i t i e s , d r i v i ng p r i ces h i ghe r .

S hor t s e l l i ng r ep r es en t s a bea r i s h s en t i men t . Ana l y s t s i n ag r eemen t w i t h

s h or t s e ll e rs e x pe c t a d o wn t ur n i n t h e m a rk e t. A n al y st s p a rt i cu l ar l ywa t ch t he ac t i on o f s pec i a l i s t s who make a mar ke t i n a s pec i f i c s t ock . I n

a d d i t i o n , a n a l y s t s l o o k a t o d d - l o t s h o r t s e l l e r s w h o i n d i c a t e p e s s i m i s m

w i th i n cr e as e d a c ti v it y. H o we v e r, m a ny t e ch n ic a l a n al y st s e x p re s s a

" c on t ra r ia n " v i ew r e ga r di n g s h or t s a le s . T h es e a n al y st s b e li e ve s h o rts e l l e r s ove r r eac t and s pecu l a t e becaus e o f t he po t en t i a l p r o f i t s i nvo l ved .

I n a d d it io n , t o c l os e t h ei r p o si t io n s, s h or t s e ll e rs w i ll p u rc h a se t h e

s e c u r i t i e s i n t h e f u t u r e , t h u s p u t t i n g u p w a r d p r e s s u r e o n p r i c e s . S h o r ts e l l i ng ana l y s i s i s bas ed on mont h - t o - mont h t r ends .

O d d- lo t t h eo r y f o ll o ws t h e t r en d s o f t r an s ac t io n s i n vo l vi n g l e ss t h an

r ou n d l ot s ( le ss t ha n 1 00 s ha re s) . T hi s t he or y r es ts o n a c o nt ra ri an

o p i n i o n a b o u t s m a l l i n v e s t o r s . T h e t h e o r y b e l i e v e s t h e s m a l l t r a d e r i sr ig ht m os t o f t he t im e, a nd b eg in s t o s el l i nt o a n u pw ar d t re nd .

H o w e v e r , a s t h e m a r k e t c o n t i n u e s t o r i s e , t h e s m a l l i n v e s t o r r e - e n t e r s

t he mar ke t a s t he s oph i s t i ca t ed t r ade r s a r e ba i l i ng ou t i n an t i c i pa t i on o f a t op and a pu l l back . Ther e f o r e , an i nc r eas e i n odd- l o t t r ad i ng s i gna l s a

downt u r n i n t he mar ke t .

O d d - l o t i n d i c e s d i v i d e ( 1 ) o d d - l o t p u r c h a s e s b y o d d - l o t s a l e s , ( 2 ) o d d -

l o t s hor t s a l e s by t o t a l odd- l o t s a l e s , and ( 3 ) t o t a l odd- l o t vo l ume ( buy s+ s a l e s ) by r ound- l o t vo l ume .

CHARTI NG.

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17/43

C h a r ti n g i s u s e f ul i n a n a l y z i n g m a r k e t c o n d i t io n s a n d p r i c e b e h a v i o r o f

i nd iv id ua l s ec u ri ti es . S ta n da rd & P oo r ' s T re nd li ne i s a w el l k n ow nchar t i ng s e r v i ce whi ch p r ov i des da t a on compan i es . Th i s da t a s hows t he

t r e n d o f p r i c e s , i n s i d e r s a l e s , s h o r t s a l e s , a n d t r a d i n g v o l u m e o v e r t h ei n t e r med i a t e and l ong- t e r m. Ana l y s t s have p l o t t ed t h i s da t a on g r aphs t of o r m l i ne , ba r , and po i n t - and- f i gu r e cha r t s .

C h a r t i n t e r p r e t a t i o n r e q u i r e s t h e a b i l i t y t o e v a l u a t e t h e m e a n i n g o f t h e

r e s u lt i n g f o r m a ti o n s i n o r d e r t o i d e n t i f y r a n g e s i n w h i c h t o b u y o r s e l l .

C h a r t i n g a s s i s t s i n a s c e r t a i n i n g m a j o r m a r k e t d o w n t u r n s , u p t u r n s , a n dt r end r eve r s a l s .

A n al y st s u s e m o v in g a v e ra g e s t o a n a ly z e i n te r me d ia t e a n d l o ng - te r m

s t o c k m o v e m e nt s . T h e y p r e d ic t t h e d i r e ct i o n o f p r i c es b y e x a m i n i n g t h e

t re n d i n c u rr e nt p r ic e s r e la t iv e t o t h e l o ng - te r m m o v i ng a v er a ge . Amovi ng- ave r age dep i c t s t he under l y i ng d i r ec t i on and degr ee o f change .

T he r el at iv e s tr en gt h o f a n i nd iv id ua l s to ck p ri ce i s a r at io o f t he

a v e r a g e m o n t h l y s t o c k p r i c e c o m p a r e d t o t h e m o n t h l y a v e r a g e i n d e x o f

t he t o t a l mar ke t o r t he s t ock ' s i ndus t r y g r oup . I t i n f o r ms t he ana l y s t s o f t he r e l a t i ons h i p o f s pec i f i c p r i ce movement s t o an i ndus t r y o r t he mar ke t

i n gene r a l . When i nves t o r s f avor s pec i f i c s t ocks o r i ndus t r i e s , t hes e wi l l

b e r e la t iv e ly s t ro n g . S t oc k s t h at o u tp e rf o rm t h e m a rk e t t r en d o n t h eups i de may s udden l y r e t r ea t when i nves t o r s ba i l ou t f o r ho t t e r p r os pec t s .

S to c ks t ha t o ut pe rf or m i n a d e cl in in g m ar ke t u su al ly a tt ra c t o th er

i nves t o r s and r emai n s t r ong .

A s a n al y st s c o ns t ru c t c h ar t s, c e rt a in t re n d s a p pe a r. T h e se t r en d s a r echa r ac t e r i zed by a r ange o f p r i ces i n whi ch t he s t ock t r ades .

T h e l o w e r e n d o f t h e r a n g e f o r m s a s u p p o r t b a s e f o r t h e p r i c e . A t t h a t

e n d a s t o c k i s a " g o o d " b u y a n d a t t r a c t s a d d i t i o n a l i n v e s t o r s , a n d t h u s

f or ms a s up p or t l ev el . A s t he p ri ce i nc re as es , a s to ck m ay b ec om e"una t t r ac t i ve" when compar ed t o o t he r s t ocks . I nves t o r s s e l l caus i ng t ha t

u p p e r l i m i t t o f o r m a r e s i s t a n c e l e v e l . M o v e m e n t s b e y o n d t h e s u p p o r t

a n d r e s i s t an c e l e v e l s r e q u i r e a f u n d a me n t a l c h a n g e i n t h e m a r k e t a n d / o r t he s t ock .

RANDOM WALK THEORI ES

R a n d o m- w a l k t h e o r is t s d o n o t b e l i e v e i n t h e c y c l i c a l n a t u r e o f m a r k e t s

a l t hough t hey ana l y ze t he s ame da t a a s do cha r t i s t s . Random wal k t heor y

m ai nt ai ns t ha t t ec hn ic a l a na ly si s i s u se le ss b e ca us e p a st p ri ce a ndvo l ume s t a t i s t i c s do no t con t a i n any i n f o r mat i on by t hems e l ves t ha t bode

w e l l f o r s u c c e ss . R a n d o m w a l k e r s b e l i e v e c h o o s in g s e c u r it i e s r a n d o m l y

wi l l r e s u l t i n r e t u r ns compar ab l e t o t echn i ca l and f undament a l ana l y s i s .

17


18/43

T h r o u g h a s e r i e s o f i l l u s t r a t i o n s , a c a d e m i c i a n s i n t h e 1 9 6 0 s a n d 1 9 7 0 s

d e m o n s t r a t e d t h a t t h e r e i s n o b a s i s i n f a c t f o r t e c h n i c a l a n a l y s i s . T h e yf o u n d t h a t p r i c e m o v e m e n t s w e r e r a n d o m a n d d i s p l a y e d n o p r e d i c t a b l e

p a t t er n o f m o v e m en t , a s d i d t h e F r e n c hm a n L o u i s B a c h e li e r a t t h e t u r nof t he cen t u r y . Ther e f o r e , p r i ces have no p r ed i c t i ve va l ue . S i nce a l l t hes t ud i es i nd i ca t ed r andomnes s i n p r i ce , t he p r oponen t s o f t h i s hy po t hes i s

ca l l ed i t t he " r andom wal k t heor y . "

Random wal ke r s us e t i me- s e r i e s mode l s t o r e l a t e e f f i c i en t mar ke t s t o t he

b eh av io r o f s to ck p ri ce s a n d i nv es tm en t r et ur ns . T he y b e li ev e t ha tc ha ng e s i n p ri ce s a re i nd ep e nd en t o f n e w i nf or ma ti on e n te ri ng t he

m a r k et , a n d t h a t t h e s e p r i c e s c h a n g e s a r e e v e n l y d i s t ri b u t e d t h r o u g h ou t

t h e m a r k e t . S i n c e t h i s m e a n s t h a t t h e d i s t r i b u t i o n o f p r i c e c h a n g e s i s

c o n s ta n t f r o m o n e p e r i od t o t h e n e x t , i n v e s to r s a r e n o t a b l e t o i d e n ti f y

" mi sp ri ce d" s ec ur it ie s i n a ny c on si st en t f as hi on . E xp er ie nc e a nde mp ir ic al e vi de nc e c on tr ad ic t t hi s a ss um pt io n, s ug ge st in g t ha t t he

r andom wal k p r oper t i e s o f r e t u r ns ( o r p r i ce changes ) a r e t oo r e s t r i c t i ve .

T e ch n ic i an s m a in t ai n t h e v a li d it y o f t h ei r p r ac t ic e s e s pe c ia l ly w i th

r e ga r ds t o t h e t i mi n g o f i n ve s tm e nt s . S i nc e c o mp u te r - ba s ed t r ad i ng

p r ogr ams i ncor por a t e s ome t i mi ng t echn i que i n t o t he i r ma t r i x , i n t r a - day

t r ad i ng has i nc r eas i ng l y become cha r ac t e r i zed by d r amat i c movement s i nt h e i n d i c e s . T h e s e m o v e m e n t s r e p r e s e n t a c o n s e n s u s a m o n g t r a d e r s o f

t he app l i cab i l i t y o f t echn i ca l t heor i e s des p i t e o f t he ev i dence o f r andom

w a lk e rs . A m a rk e t d r iv e n b y s i mi l ar l y c o n fi g ur e d i n di c es , n o m a tt e r wha t t he bas i s , becomes mor e p r ed i c t ab l e ove r t i me .

I n p r a c t i c e , c o m p u t e r p r o g r a m s e x e c u t e t r a d e s n o t o n l y i n a n t i c i p a t i o n

o f a m ar ke t m ov e, b ut t o p ro vi de f un d m an a ge rs t he o pp o rt un it y t o

change pos i t i ons ahead o f t he o t he r s .

DOW THEORY

A l th o u gh C h a rl e s D o w p ub l is h er o f t h e W a ll S t re e t J o ur n al w as a

f un da me nt al is t, h e p ub li sh ed a s er ie s o f a rt ic le s w hi ch l ai d t he

f o un d at i on f o r W i ll i am P . H a mi l to n ' s 1 9 08 w o rk t h at f o rm a li z ed t h eDow Theor y . Hami l t on t heor i zed t ha t t he s t ock mar ke t i s t he bes t gauge

o f f in a n ci a l a n d b u si n es s a c ti v it y b e c au s e a l l r e le v an t i n fo r ma t io n i s

i m m e d i a t e l y d i s c o u n t e d i n t h e p r i c e s o f s t o c k s , a s i n d e x e d b y t h e D o wJ o ne s I n du s tr i al A v er a ge a n d t h e D o w J o n es T r an s po r ta t io n A v er a ge .

Accor d i ng l y , bo t h ave r ages mus t conf i r m mar ke t d i r ec t i on becaus e p r i ce

t r e n d s i n t h e o v e r a l l m a r k e t p o i n t s t o t h e t e r m i n a t i o n o f b o t h b u l l a n d

bear ma rket s .

Thr ee movement s a r e a s s umed t o occur s i mul t aneous l y :

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19/43

A pr i mar y bu l l o r bea r i s h t r end , t y p i ca l l y l a s t i ng 28 t o 33 mont hs .

A s e co n d ar y t r en d g o e s c o u n te r t o t h e p r im a ry t r en d , t yp i ca l ly l a st s

th re e w ee ks t o th re e m on th s, a nd r ef l ec ts a l on g- t erm p rim arymovement .

D a y - t o - d a y a c t i v i t y m a k e s u p t h e f i r s t t w o m o v e m e n t s o f t h e m a r k e t ,

conf i r mi ng t he d i r ec t i on o f t he l ong- t e r m p r i mar y t r end .

T h e p r i m a r y t r e n d m u s t b e s u p p o r t e d b y s t r o n g d a y - t o - d a y a c t i v i t y t oe r as e t h e e f fe c ts o f t h e s e co n d ar y t r en d , o t he r wi s e, t h e m a r k e t w i l l

beg i n t o move i n t he oppos i t e d i r ec t i on . I f day - t o - day ac t i v i t y s uppor t s

t he s econdar y t r end , t he mar ke t w i l l s oon r eve r s e d i r ec t i ons and deve l opa new p r i mar y t r end .

I f t he cy c l i ca l movement s o f t he mar ke t ave r ages i nc r eas e ove r t i me , and

t he s ucces s i ve l ows become h i ghe r , t he mar ke t w i l l t r end upwar d . I f t he

s u c c e s s i v e h i g h s t r e n d l o w e r , a n d t h e s u c c e s s i v e l o w t r e n d l o w e r , t h e nt h e m a r k e t i s i n a d o w n t re n d . C o m p u t e r p r o g r a ms h a v e f u l l y i n t e gr a t e d

Dow t heor y i n t o t he i r dec i s i on - mak i ng ma t r i x .

P or t f o l i o i nves t men t

1 . P as s i ve i nves t men t f or t he s ol e- pu rp os e o f d e ri vi ng i ncome , a s

oppos ed t o pa r t i c i pa t i ng i n t he management o f t he i nves t ee f i r m u n d e r a

d i r ec t i nves t men t .

2 . I n v e s t m e nt i n a n a s s o r t m e nt o r r ange o f s ecur i t i e s , o r o t h e r t y pes o f

i n v e st m e n t v e h i c le s , t o s p r ead the r i s k o f p o s s i b l e l os s due t o b e l o wexpec t a t i ons per formance of one o r a f ew o f t hem.

I nves t men t po r t f o l i o

P oo l o f d i f f e r en t i nves t men t s by which an i nves t o r be t s t o make a prof i t

(o r i ncome) w h i l e a i m i n g t o p r e s e r v e t h e i n v e s t e d ( p r i n c i p a l ) a m o u n t .

T h e s e i n v e s t m e n t s a r e c h o s e n g e n e r a l l y o n t h e b a s i s o f d i f f e r e n t r i s k -r ewar d combi na t i ons : f r o m ' l ow r i sk , l o w y i e l d ' ( g i l t e d g e d ) t o ' h i gh

r i s k , h i gh y i e l d ' (junk b onds ) ones ; o r d i f f e r en t t y pes of i ncome s t r eams :

s t eady bu t f i xed , o r va r i ab l e but wi th a potent i a l for g r owt h .

Economi c Def i n i t i on o f por t fo l io inves tment. Def i ned .

Ter m por t f o l i o i nves t men t Def i n i t i on : The acqu i s i t i on o f f i nanc i a l a s s e t s

( whi ch i nc l udes s t ock , bonds , depos i t s , and cu r r enc i es ) f r om one coun t r y

19
http://www.businessdictionary.com/definition/passive.htmlhttp://www.businessdictionary.com/definition/investment.htmlhttp://www.businessdictionary.com/definition/income.htmlhttp://www.businessdictionary.com/definition/management.htmlhttp://www.investorwords.com/1967/firm.htmlhttp://www.businessdictionary.com/definition/direct-investment.htmlhttp://www.businessdictionary.com/definition/range.htmlhttp://www.businessdictionary.com/definition/securities.htmlhttp://www.businessdictionary.com/definition/type.htmlhttp://www.businessdictionary.com/definition/spread.htmlhttp://www.businessdictionary.com/definition/risk.htmlhttp://www.businessdictionary.com/definition/capital-gain-loss-holding-period.htmlhttp://www.businessdictionary.com/definition/due.htmlhttp://www.businessdictionary.com/definition/expectation.htmlhttp://www.businessdictionary.com/definition/performance.htmlhttp://www.businessdictionary.com/definition/pool.htmlhttp://www.businessdictionary.com/definition/investment.htmlhttp://www.businessdictionary.com/definition/investor.htmlhttp://www.businessdictionary.com/definition/profit.htmlhttp://www.businessdictionary.com/definition/income.htmlhttp://www.businessdictionary.com/definition/combination.htmlhttp://www.investorwords.com/2900/low.htmlhttp://www.businessdictionary.com/definition/risk.htmlhttp://www.businessdictionary.com/definition/yield.htmlhttp://www.businessdictionary.com/definition/yield.htmlhttp://www.investorwords.com/2172/gilt_edged.htmlhttp://www.investorwords.com/2306/high.htmlhttp://www.investorwords.com/5901/high_yield.htmlhttp://www.businessdictionary.com/definition/junk-bond.htmlhttp://www.businessdictionary.com/definition/type.htmlhttp://www.investorwords.com/2410/income_stream.htmlhttp://www.businessdictionary.com/definition/variable.htmlhttp://www.investorwords.com/2258/growth.htmlhttp://glossary.econguru.com/economic-term/portfolio+investmenthttp://www.businessdictionary.com/definition/investment.htmlhttp://www.businessdictionary.com/definition/income.htmlhttp://www.businessdictionary.com/definition/management.htmlhttp://www.investorwords.com/1967/firm.htmlhttp://www.businessdictionary.com/definition/direct-investment.htmlhttp://www.businessdictionary.com/definition/range.htmlhttp://www.businessdictionary.com/definition/securities.htmlhttp://www.businessdictionary.com/definition/type.htmlhttp://www.businessdictionary.com/definition/spread.htmlhttp://www.businessdictionary.com/definition/risk.htmlhttp://www.businessdictionary.com/definition/capital-gain-loss-holding-period.htmlhttp://www.businessdictionary.com/definition/due.htmlhttp://www.businessdictionary.com/definition/expectation.htmlhttp://www.businessdictionary.com/definition/performance.htmlhttp://www.businessdictionary.com/definition/pool.htmlhttp://www.businessdictionary.com/definition/investment.htmlhttp://www.businessdictionary.com/definition/investor.htmlhttp://www.businessdictionary.com/definition/profit.htmlhttp://www.businessdictionary.com/definition/income.htmlhttp://www.businessdictionary.com/definition/combination.htmlhttp://www.investorwords.com/2900/low.htmlhttp://www.businessdictionary.com/definition/risk.htmlhttp://www.businessdictionary.com/definition/yield.htmlhttp://www.investorwords.com/2172/gilt_edged.htmlhttp://www.investorwords.com/2306/high.htmlhttp://www.investorwords.com/5901/high_yield.htmlhttp://www.businessdictionary.com/definition/junk-bond.htmlhttp://www.businessdictionary.com/definition/type.htmlhttp://www.investorwords.com/2410/income_stream.htmlhttp://www.businessdictionary.com/definition/variable.htmlhttp://www.investorwords.com/2258/growth.htmlhttp://glossary.econguru.com/economic-term/portfolio+investmenthttp://www.businessdictionary.com/definition/passive.html


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i n ano t he r coun t r y . I n con t r a s t t o f o r e i gn d i r ec t i nves t men t , wh i ch i s t he

a cq ui si ti on o f c on tr ol li ng i nt er es t i n f or ei gn f ir ms a n d b us in es se s, po r t f o l i o i nves t men t i s f o r e i gn i nves t men t i n t o t he s t ock mar ke t s . Mos t

economi s t s cons i de r f o r e i gn d i r ec t i nves t men t mor e us e f u l t han po r t f o l i oi nves t men t s i nce t h i s l a s t one i s gene r a l l y r ega r ded as t empor a l and canl eave t he f o r e i gn coun t r y a t t he f i r s t s i gn o f t r oub l e .

A ss et a ll oc at io n - t he w ay w e d iv id e o ur c ap it al a mo ng d if fe re nt

i nv es tm en t o pt io ns - a cc ou nt s f or m or e t ha n 9 0 p er c en t o f y ou r

po r t f o l i o ' s ove r a l l r e t u r n . Whi ch i s why i t ' s s o ve r y i mpor t an t t o ge t t heas s e t a l l oca t i on r i gh t i n y our i nves t men t po r t f o l i o .

The por t f o l i o ' s t he t h i ng

G e t u s e d t o t h e f a c t t h a t , a t a n y o n e t i m e , a f e w p a r t s o f o u r p o r t f o l i ow i l l b e d o i n g t e r r i b l y. O v e r a l o n g e n o u g h t i m e p e r i o d , e a c h a n d e v e r y

c o m p o n e n t w i l l h a v e h a d a b a d y e a r o r t w o . T h i s i s n o r m a l a s s e t - c l a s s b e h a v i o r a n d c a n n o t b e a v o i d e d . S o , f o c u s o n t h e p e r f o r m a n c e o f t h e

por t f o l i o a s a who l e , no t t he i nd i v i dua l pa r t s .

I n a s s e t a l l oca t i on , j ob one i s t o p i ck an appr opr i a t e s t ock / bond mi x

Thi s i s de t e r mi ned p r i mar i l y by our r i s k t o l e r ance . Do no t b i t e o f f mor er i s k t h a n w e c a n c h e w - a c l a s s i c b e g i n n e r' s m i s t a k e . C a l m ly a n d c o o l ly

p l a n n i n g f o r a m a r k e t d o w n t u r n i s q u i t e d i f f e r e n t f r o m a c t u a l l y l i v i n g

t h r ough one , i n t he s ame way t ha t c r a s h i ng a f l i gh t s i mul a t o r i s d i f f e r en tf r om c r as h in g a r e al a i rp l an e . T i me h o ri z on i s a l so i m po r ta n t. D o n o t

i n v e s t a n y m o n e y i n s t o c k s t h a t y o u w i l l n e e d i n l e s s t h a n f i v e y e a r s ,

and do no t i nves t mor e t han ha l f un l es s y ou wi l l no t need t he money f o r

a t l eas t a decade .

Al l oca t e ou r s t ocks wi de l y among many d i f f e r en t a s s e t c l a s s es

Our b i gges t expos ur e s hou l d be t o t he b r oad domes t i c s t ock mar ke t . Us e

s mal l s t ocks , f o r e i gn s t ocks , and r ea l e s t a t e i nves t men t t r us t s ( REI Ts ) i n

s mal l e r amoun t s .

I t makes a d i f f e r ence wher e we pu t t h i ngs

S om e a ss et c la ss es , s uc h a s l ar ge f or ei gn a n d d om es ti c s to ck s, a nd

d o m e s ti c s m a l l s t o c k s, a r e a v a i l a b l e i n t a x - ef f i c ie n t v e h i c l e s ; p u t t h e s e

i n y o u r t a x a b le a c c o u n ts . O t h e r a s s e t c l a s s es , p a r t i c u l a rl y v a l u e s t o c k s,REI Ts , and j unk bonds , a r e h i gh l y t ax - i ne f f i c i en t . P u t t hes e on l y i n y our

t ax - s he l t e r ed r e t i r emen t accoun t s .

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D o n ' t r eb a l a n c e p o rt f o l io t o o o f t e n . T h e b e n e f it o f r e b a l a nc i n g b a c k t o

po l i cy a l l oca t i on i s t ha t i t f o r ces t o s e l l h i gh and buy l ow. As s e t c l a s s est e n d t o t r e n d u p o r d o w n f o r u p t o a f e w y e a r s . G i v e t h i s p r o c e s s a

chance t o wor k ; We s hou l d no t r eba l ance mor e o f t en t han once p e r y ea r .

T he se r ul es a p pl y t o t ax -s he lt er ed a cc ou n ts . I n t ax a bl e a cc o un ts ,

r e ba l an c e o n ly w i th o u tf l ow s , i n fl o ws , a n d m a nd a to r y d i st r ib u ti o ns ;h ere , t he r e ba la nc in g b en ef i t i s u su al l y o utw ei gh ed b y th e t a x

cons equences .

H u m a n b e i n g s t e n d t o b e m o s t i m p r e ss e d w i t h w h a t h a s h a p p e n ed i n t h e

p a s t s e v e r a l y e a r s a n d w r o n g l y a s s u m e t h a t i t w i l l c o n t i n u e f o r e v e r . I tn e v e r d o e s . T h e f a c t t h a t l a r g e U . S . g r o w t h s t o c k s p e r f o r m ed e x t r e me l y

w el l i n t he l at e 1 99 0s d oe s n ot m ak e i t m or e l ik el y t ha t t hi s w il l

c o n t i n u e ; i n f a c t , i t m a k e s i t s l i g h t l y l e s s l i k e l y . T h e p e r f o r m a n c e o f d i f fe r e n t k i n d s o f s t o c k s a n d b o n d s i s b e s t e v a l u a t e d o n l y o v e r t h e l o n g

hau l .

I n v e st o r s l i k e t o h a v e f a s h i o n a b le p o r t fo l i o s, i n v e s te d i n t h e e r a ' s m o s t

e xc it in g t ec hn ol og ie s. R es is t t he t em pt at io n. T he re i s a n i nv er secor r e l a t i on be t ween an i nves t men t ' s en t e r t a i nmen t va l ue and i t s expec t ed

r e t u r n ; I P O s , o n a v e r a g e , h a v e l o w r e t u r n s , a n d b o r i n g s t o c k s t e n d t o

r ewar d t he mos t .

A n a ss et a ll oc at io n t ha t m ax im iz es c ha nc es o f g et ti ng r ic h a ls om ax im iz es y ou r c h an ce s o f b ec o mi ng p o or .B es t c ha n ce o f m ak in g

o ur se lf f ab u lo u sl y w ea lt hy t hr ou g h i nv es ti ng i s t o b u y a f ew s ma ll

s t o c k s w i t h g o o d g r o w t h p o s s i b i l i t i e s ; O f c o u r s e , i t i s f a r m o r e l i k e l yt ha t w e w il l l os e m os t o f o ur m on ey t hi s w ay . O n t he o th er h an d,

a l t h o u g h w e c a n n o t a c h i e v e e x t r e m e l y h i g h r e t u r n s w i t h a d i v e r s i f i e d

por t f o l i o , i t i s t he bes t way t o avo i d a r e t i r emen t d i e t o f ca t f ood .

K no wl ed ge o f f in an ci al h is to ry i s t he m os t p ot en t w ea po n i n t hei nv e st or 's a rm am en ta ri um . S in c e t he d aw n o f s to c k b ro k in g i n t he

s e v e n t e e n t h c e n t u r y , e v e r y g e n e r a t i o n h a s e x p e r i e n c e d i t s o w n v e r s i o n

o f t e c h b u s t . T h e r e c e n t d o t - c o m c a t a s t r o p h e w a s j u s t o n e m o r e a c t i nf i n a nc e ' s l o n g e s t r u n n i n g c o m e d y . B e a b l e t o s a y t o y o u r se l f , ' I ' v e s e e n

t h i s mov i e be f o r e , and I t h i nk I know how i t ends . ' The on l y t h i ng t ha t ' s

new i s t he h i s t o r y y ou haven ' t r ead .

A por t f o l i o o f 15 t o 30 s t ocks does no t p r ov i de adequa t e d i ve r s i f i ca t i on

T he m yt h t ha t i t d oe s r es ul ts f ro m a m is in te rp re ta ti on o f m od er nf i n a n c i a l t h e o r y . W h i l e i t i s t r u e t h a t a 3 0 - s t o c k p o r t f o l i o h a s n o m o r e

s h o r t- t e r m v o l a t il i t y t h a n t h e m a r k e t, t h e r e i s m o r e t o r i s k t h a n d a y - t o -

d a y f l u c t u a t i o n s . T h e r e a l r i s k i s n o t t h a t s h o r t - t e r m v o l a t i l i t y w i l l b e

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t o o h i g h , b u t t h a t l o n g - t e r m r e t u r n w i l l b e t o o l o w . T h e o n l y w a y o f

mi n i mi z i ng t h i s r i s k i s t o own t hous ands o f s t ocks i n many na t i ons . Or af ew i ndex f unds .

I nves t men t Management : The p r o f es s i ona l management o f a s s e t s , s uch as

r ea l e st at e, a nd s ec ur it ie s, s uc h a s e qu it ie s, b on d a nd o th er d eb t

i n s tr u m e n ts , i s c a l l ed i n v e st m e n t m a n a g e me n t . I n v e s tm e n t m a n a g e me n ts e rv i ce s a r e s o ug h t b y i n ve s to r s, w h ic h c o u ld b e c o mp a n ie s , b a nk s ,

i ns ur an ce f ir ms o r i nd iv id u al s, w it h t he p u rp o se o f m ee ti ng s ta te d

f i nanc i a l goa l s .

The need f o r i nves t men t management a r i s e s due t o :

The ex i s t ence o f a l a r ge number o f compl ex f i nanc i a l p r oduc t s

F i nanc i a l mar ke t vo l a t i l i t y

Changes i n r egu l a t o r y r equ i r emen t s

E v er y i n di v id u a l p r ac t ic e s i n ve s tm e nt m a na g em e nt t o s o me d e gr e e,

i nc lu di ng b u dg et in g, s av in g , i nv es ti ng a n d s pe nd in g . H ow ev er , a ni n v e st m e n t m a n a g e r i s o n e w h o s p e c i a l iz e s i n p l a c in g m o n e y i n d i v e r s e

i n st r um e nt s i n o r de r t o a c co m pl i sh p r ed e te r mi n ed g o a ls . I n ve s tm e nt

manager s a r e a l s o wi de l y known as f und manager s . I nves t men t manager s

m ay s pe ci al iz e i n a dv is or y o r d is cr et io n ar y m an ag e me n t. W he n a n

i nves t men t manager mer e l y o f f e r s s ugges t i ons r ega r d i ng wher e t o i nves tm o n e y a n d w h e n t o s e l l s e c u r i t i e s , t h e p r a c t i c e i s k n o w n a s a d v i s o r y

i nves t men t management . When an i nves t men t manager can t ake ac t i on i nm an a gi ng p o rt fo li os w it ho u t r eq u ir in g c l i en t a pp ro v al , i t i s c a ll ed

"d i s c r e t i ona r y " i nves t men t management .

In ve st me nt ma na ge me nt i s o ft e n u se d s yn on ymo us l y w it h f un d

man agement . Mor eove r, t e r ms l ike a s s e t ma nagement , wea lthm an ag em en t a nd p or tf ol io m an ag em en t a re u se d, w it h a t hi n l in e

d i f fe r en t i a t i ng them. Asse t manag emen t i s o f t en us ed f o r th e

m a n a g em e n t o f c o l l e ct i v e i n v e s t m e n ts , w h i c h r e f e r s t o i n v e s ti n g m o n e yo n b e h a l f o f a l a r g e g r o u p o f c l i e n t s i n a w i d e r a n g e o f i n v e s t m e n t

o p t i o n s . A n e x a m p l e o f t h i s i s m u t u a l f u n d s . I n v e s t m e n t m a n a g e m e n t

t h a t i n v o l v e s m a n a g i ng t h e i n v e s t m e nt s o f h i g h n e t w o r t h i n d i v i du a l s i so f t e n r e f e r r e d t o a s w e a l t h m a n a g e m e n t . A s s e t m a n a g e m e n t a n d w e a l t h

management a r e a l s o ca l l ed por t f o l i o management .

The p r oces s o f i nves t men t management i nvo l ves t he f o l l owi ng :

S et ti ng i nv es tm en t o b je c ti ve s: I nv es tm en t g o al s a re d if fe re n t f or

i n di v id u al s , f i na n ci a l i n st i tu t io n s, b a nk s , i n su r an c e c o mp a ni e s a n d

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pens i on and mut ua l f unds . F or i n s t ance , t he ob j ec t i ve o f a b ank cou l d be

t o a ch ie ve a m in im

Project- Portfolio Mgmt. & Investment Analysis-Working-08.02.11

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Transcript of Project- Portfolio Mgmt. & Investment Analysis-Working-08.02.11