Chapter 4
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Saba AroraNISM SERIES – XV: RESEARCH ANALYST CERTIFICATION BY- CA NITIN GURU
Chapter 4: Fundamentals of Research
What is investing?
Investment, involves upfront commitment of a sum of money to earn returns on it over a period of
time. Investment is very distinct from trading or speculative activities. Investment activity focuses on
the potential of an asset’s value to increase over a period.
Active Investing
Active investment involves identifying the specific security or set of securities that should be purchased
or sold. It involves constant evaluation of every security in the investment portfolio so that investors
can sell securities that are priced above their fair value. The objective of an active investor is to earn a
rate of return that is above the return generated by the broader asset class.
Passive Investing
Investing in a broad set of securities that fairly represents the asset class the investor needs to invest.
The objective of a passive investor is to earn the rate of return that the select asset class provides. A
passive investor analysis is limited to the broader asset class.
The Role of Research in Investment activity
When analysis involves analyzing all the available information to arrive at a conclusion, research
involves obtaining all the necessary information. A fundamental research analyst will have to spend
significant amount of time researching on the economy, the industry and the company as well.
Research analysts may also have to conduct primary research that may involve visiting the company’s
facilities, speaking to customers, suppliers, employees and others.
Insider information vs Mosaic Analysis
An analyst may come across some information that is not known to public in general. It is not necessary
that all such information would fall under insider information. Insider information is a material non-
public information that when published would immediately affect an investor’s decision to buy or sell
the security. Depends on the source of the information its impact and its certainty. Often analysts
collate information from different sources, which individually may not be significant but when put
together with other public or non-public information may provide critical insight to the information.
These are called as mosaic analysis. Such Mosaic analysis is acceptable.
Technical Analysis
Technical Analysis is based on the assumption that all information that can affect the performance of
share are reflected in the stock prices. It is focused on forecasting the direction of prices through the
study of patterns in historical market data-price and volume. According to technical analysis, there are
three essential elements in understanding the price behavior:
1. The history of the past prices provides indications of the underlying trend and its direction.
2. The volume of trading provides information inputs on the underlying strength of the trend.
3. The time span over which price and volume are observed.
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NISM SERIES – XV: RESEARCH ANALYST CERTIFICATION BY- CA NITIN GURU
By observing price and volume patterns, technical analysts try to understand if there is adequate buying
interest that may take prices up, or vice-versa. An upward or downward trend should be accomplished
by strong volumes. If a trend is not supported by volumes or the volumes decrease, it may indicate a
weakness in the trend. Some of the charts used include line charts, bar charts, candlestick chart.
Chartists use moving average of the price of the stock to reduce the impact of day to day fluctuations in
price that may make it difficult to identify the trend.
Fundamental Analysis
Fundamental Analysis is focused on long term investing. An investor should first gauge the fair price of
the equity based on the expected performance of the business. If the market price is above the fair
value, the investor should sell the share or avoid investing. This thought process is in contradiction of
Efficient Market Hypothesis (EMH), which propagates that share prices incorporate and reflect all
relevant information. Comprehensive study on the company’s business as well as its governance style
to understand the expected returns.
How is macro-economic trend
How is the competition intensity within the industry
How is company positioned vis-à-vis its competitors
What is the cost structure of the company
How strong is the financial position of the company
What are the capabilities of the management
Whether the right governance structure is present that can ensure that the board of directors
and management act in the best interest of shareholders?
All the above questions can be typically put within three baskets:
1. Economic Analysis
2. Industry Analysis
3. Company Analysis
Quantitative Research
Some Analysts approach equity analysis purely forms a quantitative approach using econometric
analysis. Quantitative approach can be used for both technical analysis and fundamental analysis.
Analysts look for finance and operational metrics of the company. At the simplest level, time series
analysis and regression of historical data can help extrapolate future earnings. Applying pure
econometric approach in fundamental analysis suffers from some major limitations. Primary among
them is the availability of comparable information.
Behavioral Approach to Equity Investing
Very often the decisions are influenced by behavioral biases in the decision maker, which leads to less
than optimal choices being made.