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Sunday, March 16, 2008

stock market technical & fundamental analysis

What is Technical Analysis?
Technical Analysis is a method where one studies the market statistics to evaluate the worth of a company. Instead of assessing the health of the company by relying on its financial statements, it relies upon market trends to predict how a security will perform.

It is a method of evaluating stocks by analyzing stock market related activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts to identify patterns that can suggest future activity. They believe in the momentum that the scrips/markets gather over a period of time and cashing in on the same. Technical analysts believe that the historical performance of stocks and markets are indications of future performance.

This method enables 'short-term' investors to gauge companies who have very good potential to gather increased earnings in the near future.

What is a Fundamental Analysis?
A method of evaluating a stock by attempting to measure its intrinsic value. Fundamental analysts study everything from the overall economy and industry conditions, to the financial condition and management of companies. A fundamental analyst would most definitely look into the details regarding the balance sheets, profit loss statements, ratios and other data that could be used to predict the future of a company.

In other words, fundamental analysis is about using real data to evaluate a stock's value. The method uses revenues, earnings, future growth, return on equity, profit margins and other data to determine a company's underlying value and potential for future growth.

What is an Overvalued Stock or an Undervalued Stock?
An overvalued stock can be understood as an inflated hope that a company will do well. Thus, a stock is overvalued if its current price exceeds the intrinsic value of the stock. The market may temporarily price stocks too high or too low and that's how investors determine whether stocks are being overvalued or undervalued. If a stock is overvalued, the current price of the stock exceeds its earnings ratio (PE ratio*) and hence investors expect the price of the stock to drop. A high PE in relation to the past PE ratio of the same stock may indicate an overvalued condition, or a high PE in relation to peer stocks may also indicate an overvalued stock.

Thus the PE ratio is one of the many ways to determine whether a stock is overvalued. *A company's P/E ratio is computed by dividing the current market price of one share of a company's stock by that company's per-share earnings.

For example, a P/E ratio of 10 means that the company has Rs1 of annual, per-share earnings for every Rs10 in share price.

A stock is undervalued when,if is selling at a much lower price than what it is actually worth.This can be determined based on fundamentals like earnings and growth prospects. One of the best-known measures for finding an undervalued stock is the price earnings ratio (P/E).

Consider Colgate and Pepsodent, which are in the same industry and have similar fundamentals. If Colgate has a P/E of 15 and Pepsodent's is 20, Colgate could be an undervalued stock.

What does Value Investing mean?
Value investing is an investment style, which favors good stocks at great prices over great stocks at good prices. Hence it is often referred to as "price driven investing". A value investor will buy stocks he believes the market is undervaluing, and avoid stocks that he believes the market is overvaluing. Warren Buffet, one of the world's best-known investment experts believes in Value investing.

Value investors see the potential in the stocks of companies with sound financial statements that they believe the market has undervalued; as they believe the market always overreacts to good and bad news, causing stock price movements that do not correspond with their long-term fundamentals. Value investors profit by taking a position on an undervalued stock (at a deflated price) and then profit by selling the stock when the market corrects its price later.

Value investors don't try to predict which way interest rates are heading or the direction of the market and the economy in the short term, but only look at a stock's current valuation ratios and compare them to their historical range. In other words they pick up the stocks as fledglings and cash in on them when they are valued right in the markets.

For example, say a particular stock's P/E ratio has ranged between a low of 20 and a high of 60 over the past five years, value investors would consider buying the stock if it's current P/E is around 30 or less. Once purchased, they would hold the stock until its P/E rose to the 50-60 ranges before they consider selling it or even higher if they see further potential for growth in the future.

What is Contrarian Philosophy?
Investing with a value philosophy can be considered as one form of contrarian investing. Buying stocks that are out of favor in the marketplace, and avoiding stocks that are the latest market fad is a contrarian investing strategy. Thus it is an investment style that goes against prevailing market trends, where investors buy scrips that are performing poorly now and sell them in future when they perform well. Contrarians believe in taking advantages that arise out of temporary set backs or other such reasons that have caused a stocks price to decline at the moment.

A simple example of Contrarian Philosophy would be buying umbrellas in winter season at a cheap rate and selling them during rainy days.

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