1. Introduction to Research Analyst Profession
2. Terminology in Equity & Debt Markets
Notes: INTRODUCTION TO RESEARCH ANALYST PROFESSION
Research - collection of information from various sources and then Analysis - processing of data to take decisions.
Research Analysts are defined by the nature of analysis they do, the coverage, and use of the recommendations they provide. Let us understand some of them:
Primary Responsibilities of a Research Analyst
Research Analysts’ primary role is to understand and evaluate the growth of industries and companies.
Understanding economy:
• Changes in various macro-economic factors like - National income, Inflation, Interest rate and Unemployment rate
• Fiscal and Monetary Policies and their impact on the economy
• Flows from Foreign Direct Investment (FDI) and Foreign Portfolio Investors (FPIs)
• Savings and investment patterns
• Global factors that impact the GDP growth based on export and import transactions
Understanding industry:
Different industries face different challenges and opportunities. Their growth drivers could be significantly different. Accordingly, Research Analysts need to understand thoroughly the regulatory environment prevalent in the industry, business models, competition, operating factors, sensitivity of demand to price changes, consumers’ behaviour etc.
Understanding Companies:
Companies in the same industry may vary significantly in their approach towards business. Based on their styles, product configuration, business model, customers segment, their financials could also vary dramatically. Accordingly, companies are also studied by analysts in two dimensions - Qualitatively and Quantitatively.
Important Qualities of a Research Analyst
• Good with numbers
• Good Excel/spreadsheet and other data analytical tools
• Clarity in financial concepts
• Ability to read and comprehend financial statements and reports
• Ability to ask pertinent questions
• Attention to details
• Communication Skills – Written and Verbal
TERMINOLOGY IN EQUITY AND DEBT MARKETS
Following are some of the terminologies in Equity Market
1. Face Value (FV)
The nominal price of a share is known as its face value. The equity capital of the company is calculated by multiplying the number of shares issued by its face value.
2. Book Value
Book Value of a company is the net-worth of the company. To compute book value per share, net-worth of the company is divided by the number of outstanding shares.
3. Market Value
This is the market price of a share. The market value of the entire equity of a company is termed as market capitalization and is computed as market price per share multiplied by total number of outstanding shares.
4. Replacement Value
This refers to the market value of all the assets of a company at any point of time.
5. Intrinsic Value
Intrinsic Value of an asset is the present value of expected free cash flows from the asset.
6. Market Value v/s Intrinsic Value
In equity investing, therefore, there are two distinct notions of value and price. Intrinsic value is the estimated value per equity share, based on the future earning potential of a company. Market price is the price at which the share trades in the stock market, taking into account several factors including various estimates of intrinsic value.
7. Market Capitalization (Market Cap)
Market Capitalization (Market Cap), is the amount of money required to buy out an entire company at its current market price.
8. Enterprise Value
Enterprise Value (EV) is the theoretical takeover price of a firm. Along with Equity, it considers the debt as well as cash reserves of the company in determining its value.
Enterprise value = Market value of equity (Market capitalization) + Market value of debt – cash and cash equivalents
9. Earnings – Historical, Trailing and Forward
Earnings are profits in a business. Earnings can be defined at various levels. For example, net profits are the profits available to the equity owners. Earnings before Interest and Taxes (EBIT) are available to serve both equity and debt holders. Earnings before Interest Tax Depreciation and Amortization (EBITDA) is the earning available to a business to replace its assets over a period of time and to serve both equity and debt holders. Earnings of previous years are called historical earnings.
Trailing, earnings refer to the earnings of the latest four quarters, calculated on a rolling basis. Earnings computed based on future projections are called forward earnings.
10. Earnings Per Share (EPS)
Net profits of the company belong to the shareholders. Earnings per share is the net profit divided by the number of shares.
11. Dividend Per Share (DPS)
Dividend is generally declared as a percentage of the face value of the shares. It is the portion of profit which the company distributes amongst its shareholders.
12. Price to Earnings Ratio (PE Ratio)
Price to Earnings Ratio or the PE Ratio measures the price that the market is willing to pay for the earnings of a company. It is computed as:
Market price per share/Earnings per share
13. Price-to-Sales Ratio (P/S)
Price to Sales ratio is a valuation ratio that measures the price investors are willing to pay for each rupee of sales. It is calculated as:
P/S Ratio = Current Market Price (CMP) / Annual Net Sales per Share Or
P/S Ratio = Market capitalization / Annual Net Sales
14. Price-to-Book Value Ratio (P/BV)
Price to Book Value Ratio is one of the most widely used ratio to find price relative to the value. The P/BV measures a company's current market price (CMP) vis a vis its book value. Book value is calculated by dividing net-worth by the number of outstanding shares.
15. Differential Voting Rights (DVR)
A DVR is just like a normal share of a company, except that it carries less than 1 voting right per share unlike a common share. Such an instrument is useful for issuers who wish to raise capital without diluting voting rights.
Following are some of the terminologies in Debt Market
1. Face Value
Any debt instrument cannot be completely explained without answering how much borrowing it represents, for how long has the money been lent and what is the interest rate on the same.
2. Coupon Rate
Interest paid on the bond/debt security is known as Coupon rate, expressed as a percentage of its face value.
3. Maturity
Every loan will have a tenure. This is known as ‘tenor’ or ‘maturity’ or ‘term to maturity’ in bond markets.
4. Principal
This is the amount of borrowing of the issuer represented by the security. This is the initial investment which an investor makes when the bond is issued and is represented by face value. On redemption, this entire principal is returned to the investor.
5. Redemption of a Bond
When a bond matures, the investor ‘redeems’ the bond, which essentially means that the contract between the issuer and the investor is over.
6. Holding Period Returns (HPR)
Holding Period Return (HPR) is the return earned on an investment during a specific period when it was bought and held by the investor.
7. Current Yield
This is a simple method of calculating return on a debt security in which the coupon is divided with the current market price of the bond and the result is expressed as percentage.
8. Yield to Maturity (YTM):
Yield to Maturity or YTM is a more comprehensive and widely used measure of return calculation of a debt security than current yield. This method takes into consideration all future cash flows coming from the bond (coupons plus the principal repayment) and equates the present values of these cash flows to the prevailing market price of the bond.
9. Duration
Duration measures the sensitivity of the price of a bond to changes in interest rates. Bonds with high duration experience greater increases in value when interest rates decline and greater losses in value when rates increase, compared to bonds with lower duration.
10. Modified Duration (M Duration)
Modified Duration measures the impact of changes in interest rates on the price of the bond. While Duration gives us sensitivity of bond prices to change in interest rates, Modified Duration gives us the magnitude of this change.
11. Convexity
The impact of change in interest rates on bond prices is inverse but not linear. This means when rates go up, bond prices go down; but they don’t fall as much as they would rise when rates go down by the same magnitude.
Types of Bonds
We are now going to explain some of the commonly found types of bonds.
1. Zero-Coupon Bond
Bonds which do not pay coupon in their entire term are known as Zero Coupon Bonds or simply ‘Zeroes’. Such bonds are issued at a discount to their face values and are redeemed at par.
2. Floating – Rate Bonds
These are bonds whose coupon is not fixed, as in the case of vanilla bonds, but is reset periodically with reference to a defined benchmark.
3. Convertible Bonds
A convertible bond or debenture is generally issued as a debt instrument with the option to investors to convert the amount invested into equity of the issuer company later. This security has features of both debt and equity.
4. Amortization Bonds
Bonds usually pay interest during the tenor and the principal is repaid as a bullet payment upon maturity. However, there is a type of bond, known as ‘Amortization Bond’, in which each payment carries interest and some portion of the principal as well. Housing loans, auto loans and consumer loans are an example of this type of bond
5. Callable Bonds
Callable bonds allow the issuer to redeem the bonds prior to their original maturity date. In other words, bonds which have embedded call option in them are known as Callable Bonds.
6. Puttable Bonds
A Puttable bond gives the investor the right to seek redemption from the issuer before the original maturity date.
7. Payment in Kind (PIK) Bonds
These are bonds in which the coupon is not paid in cash but by way of more bonds. Companies which have cash flow problems issue such kind of securities and hence by nature these instruments are risky.
8. Principal – Protected Note (PPN)
PPN is a relatively complex debt product which aims at providing protection of the principle amount invested by investors, if the investment is held to maturity.
9. Inflation – Protected Securities
Debt instruments, being fixed income products run the risk of delivering negative real returns during high inflation periods. At times, the investors of debt papers are retired old persons, who do not have other source of income.