INDIAN INSTITUTE OF PLANNING AND MANAGEMENT NEW DELHI

PORTFOLIO MANAGEMENT

UNDER THE GUIDANCE OF: PROF. SREY AGGARWAL

SUBMITTED BY: SAURABH KHARBANDA BATCH: PGP/FW/2009-11

PORTFOLIO MANAGEMENT
Portfolio means A combination of two or more securities. Capital market in India currently offers unprecedented opportunity to multiply our investment. As a result of such unprecedented growth investors are consistently looking for safer, yet profitable investment opportunities. Here the need for proper Stock-Picking & Portfolio Management comes into picture. Portfolio management is all about strengths, weaknesses, opportunities & threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and numerous other trade-offs encountered in the attempt to maximize return at a given appetite for risk. A portfolio refers to a collection of investment tools such as stocks, shares, mutual funds, bonds, cash and so on depending on the investors income, budget and convenient time frame. Following are the two types of Portfolio: 1. Market Portfolio 2. Zero Investment Portfolio Portfolio management refers to managing money of an individual under the expert guidance of portfolio managers. In a laymans language, the art of managing an individuals investment is called as portfolio management. Need for Portfolio Management Portfolio management presents the best investment plan to the individuals as per their income, budget, age and ability to undertake risks. Portfolio management minimizes the risks involved in investing and also increases the chance of making profits. Portfolio managers understand the clients financial needs and suggest the best and unique investment policy for them with minimum risks involved. Portfolio management enables the portfolio managers to provide customized investment solutions to clients as per their needs and requirements.

Types of Portfolio Management Portfolio Management is further of the following types:

Active Portfolio Management: As the name suggests, in an active portfolio management service, the portfolio managers are actively involved in buying and selling of securities to ensure maximum profits to individuals.

Passive Portfolio Management: In a passive portfolio management, the portfolio manager deals with a fixed portfolio designed to match the current market scenario.

Discretionary Portfolio management services: In Discretionary portfolio management services, an individual authorizes a portfolio manager to take care of his financial needs on his behalf. The individual issues money to the portfolio manager who in turn takes care of all his investment needs, paper work, documentation, filing and so on. In discretionary portfolio management, the portfolio manager has full rights to take decisions on his clients behalf.

Non-Discretionary Portfolio management services: In non discretionary portfolio management services, the portfolio manager can merely advise the client what is good and bad for him but the client reserves full right to take his own decisions.

Portfolio Manager An individual who understands the clients financial needs and designs a suitable investment plan as per his income and risk taking abilities is called a portfolio manager. A portfolio manager is one who invests on behalf of the client. A portfolio manager counsels the clients and advises him the best possible investment plan which would guarantee maximum returns to the individual. A portfolio manager must understand the clients financial goals and objectives and offer a tailor made investment solution to him. No two clients can have the same financial needs.

Terms used in Portfolio Management P/E Ratio

The price-earnings (PE) ratio, also known as the PE multiple, is computed by dividing the current market price of one share of a company by its earnings per share (EPS) during the most recent accounting period. The EPS is a company's profit after tax divided by the number of shares it has issued to its shareholders. What it is supposed to do is give you some idea of the value (essentially the potential for appreciation) in the investment you seek. Unfortunately, its looseness of definition (both high and low PEs can be good investments) and its susceptibility to creative accounting by companies (the bottom line is routinely manipulated by dodgy companies) make it more of a trap than a useful tool. There's little argument about the need to estimate value. Buy a company's shares, and you are effectively taking a stake in its business. If you expect this investment to appreciate, you need to believe that the intrinsic value of this business is not fully reflected in the price you pay for the stock. Successful investing is all about getting a fix on this intrinsic value, and acting on it whenever a gap exists between it and the market price. In general, if the market expects a company to grow and have higher future earnings, it will have a higher PE than a company in decline. Investors in Indian Shaving Products or Hindustan Lever pay a large multiple of these companies' current earnings for their shares because they expect their sales and profits to grow quickly, compared to other companies. If the PE is too high, however, it means that the share price has already anticipated the future growth. That's why investors often look out for low PE stocks with the potential for growth. The low PE should, in theory, imply that the price has not yet risen to reflect the stock's potential. But don't rush out and pick stocks purely on PEs. It is simple and useful, but it also has limitations that can really mislead investors. For instance, most low-PE stocks are poor performers. Even when they 4

are undervalued, they will never give you the long-term return you would get from a great stock that is undervalued, because these are in businesses that will grow faster than the market for years -- the classic case for stocks like Lever. However high a stock's PE is, if it does not fully reflect the earnings growth potential, it is still worth considering for investment. PE-growth (PEG) ratio: A ratio used to determine a stock's value while taking into account earnings growth. The calculation is as follows:

The PEG (price/earnings to growth) ratio is a tool that can help investors find undervalued stocks. It's not as well known as its cousins, the P/E and P/B ratios, but it is just as valuable. When used in conjunction with other ratios, it gives investors a perspective of how the market views a stock's growth potential in relation to EPS growth. The PEG ratio compares a stock's price/earnings ("P/E") ratio to its expected EPS growth rate. If the PEG ratio is equal to one, it means that the market is pricing the stock to fully reflect the stock's EPS growth. This is "normal" in theory because, in a rational and efficient market, the P/E is supposed to reflect a stock's future earnings growth. If the PEG ratio is greater than one, it indicates that the stock is possibly overvalued or that the market expects future EPS growth to be greater than what is currently in the Street consensus number. Growth stocks typically have a PEG ratio greater than one because investors are willing to pay more for a stock that is expected to grow rapidly (otherwise known as "growth at any price"). It could also be that the earnings forecasts have been lowered while the stock price remains relatively stable for other reasons. If the PEG ratio is less than one, it is a sign of a possibly undervalued stock or that the market does not expect the company to achieve the earnings growth that is reflected in the Street estimates. Value stocks usually have a PEG ratio less than 5

one because the stock's earnings expectations have risen and the market has not yet recognized the growth potential. On the other hand, it could also indicate that earnings expectations have fallen faster than the Street could issue new forecasts. It is important to note that the PEG ratio cannot be used in isolation. As with all financial ratios, investors using PEG ratios must also use additional information to get a clear perspective of the investment potential of a company. Investors must understand the companys operating trends, fundamentals and what the expected EPS growth rate reflects. Additionally, to determine if the stock is overvalued or undervalued, investors must analyze the companys P/E and PEG ratios in relation to its peer group and the overall market. Market price-to-book-value ratio: The price-to-book-value ratio is arrived at by dividing the market price by the book value of the stock. If the market price of the stock is higher than its book value, it indicates that the market expects the company to grow its earnings at a higher rate than the market average. If the price-to-book-value ratio is high and the return on net worth low, it could be an anomaly that needs investigating further. Investors need to find out if the expected earnings growth would materialize because of improvement in profit margin or sales growth. If investors believe that such growth cannot happen, they should probably consider selling the stock. Return on Capital Employed ROCE: A ratio that indicates the efficiency and profitability of a company's capital investments. Calculated as:

ROCE should always be higher than the rate that the company borrows at; otherwise any increase in borrowings will reduce shareholders' earnings.

Compound Annual Growth Rate CAGR: Interest rate at which a given present value would "grow" to a given future value in a given amount of time. The formula is CAGR = (FV/PV) 1/n - 1 Where FV is the future value, PV is the present value, and n is the number of years. The CAGR is a mathematical formula that provides a "smoothed" rate of return. It is really a pro forma number that tells you what an investment yields on an annually compounded basis; it indicates to investors what they really have at the end of the investment period. The Good CAGR is the best formula for evaluating how different investments have performed over time. Investors can compare the CAGR in order to evaluate how well one stock performed against other stocks in a peer group or against a market index. The CAGR can also be used to compare the historical returns of stocks to bonds or a savings account. The Bad When using the CAGR, it is important to remember two things: the CAGR does not reflect investment risk, and you must use the same time periods. Conclusion The CAGR is a good and valuable tool to evaluate investment options, but it does not tell the whole story. Investors can analyze investment alternatives by comparing their CAGRs from identical time periods. Investors, however, also need to evaluate the relative investment risk. This requires the use of another measure such as standard deviation. Technical Analysis: A method of evaluating securities by analyzing statistics generated by market 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. 7

Technical analysts believe that the historical performance of stocks and markets are indications of future performance. In a shopping mall, a fundamental analyst would go to each store, study the product that was being sold, and then decide whether to buy it or not. By contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores. Disregarding the intrinsic value of the products in the store, his or her decision would be based on the patterns or activity of people going into each store. Moving Average One of the easiest indicators to understand, the moving average shows the average value of a security's price over a period of time. To find the 50-day moving average, you would add up the closing prices (but not always, we'll explain later) from the past 50 days and divide them by 50. Because prices are constantly changing, the moving average will move as well. It should also be noted that moving averages are most often used when compared or used in conjunction with other indicators such as MACD and EMA. The most commonly used moving averages are of 20, 30, 50, 100, and 200 days. Each moving average provides a different interpretation on what the stock will do; there is not one right time frame. The longer the times span the less sensitive the moving average will be to daily price changes. Moving averages are used to emphasize the direction of a trend and smooth out price and volume fluctuations (or "noise") that can confuse interpretation.