INDIAN INSTITUTE OF FOREIGN TRADE

FINANCE COMPENDIUM
Part A

Prepared by:

Shivani Kumar | Kritin Kapoor

Senior Club Coordinators
Capital: The Finance and Investments Club
at IIFT
Table of Contents
Methods of Corporate Valuation .................................................................................................................. 3
Asset-Based Methods ............................................................................................................................... 3
The Balance Sheet: Cash & Working Capital ......................................................................................... 3
Shareholder's Equity & Book Value ...................................................................................................... 3
Intangibles ............................................................................................................................................. 4
Using Comparables ................................................................................................................................... 4
Earnings Per Share ................................................................................................................................ 4
The Price-to-Earnings Ratio................................................................................................................... 4
The Price-to-Sales Ratio ........................................................................................................................ 5
Free Cash Flows Methods ......................................................................................................................... 6
Discounted Cash Flow Method ................................................................................................................. 7
Enterprise Value ........................................................................................................................................ 7
TECHNICAL ANALYSIS .................................................................................................................................... 9
CHARTS AND TRENDS: .............................................................................................................................. 9
Chart Types: .......................................................................................................................................... 9
Candlestick Patterns: .......................................................................................................................... 11
Trends: ................................................................................................................................................ 13
VOLUMES: ........................................................................................................................................... 15
INDICATORS AND OSCILLATORS: ........................................................................................................ 16
How are indicators used? ................................................................................................................... 17

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 Methods of Corporate Valuation
Outline

❖ Asset-Based Methods
❖ Using Comparables
❖ Free Cash Flow Methods

Asset-Based Methods

Asset-based methods start with the "book value" of a company's equity: the value of all the company's
assets, less its debt.

The Balance Sheet: Cash & Working Capital

Ben Graham developed one of the premier screens for finding out companies with more cash on hand than
their current market value.

First, look at a company's cash and equivalents and short-term investments. Dividing this number by the
number of shares outstanding gives a quick measure that tells you how much of the current share price
consists of just the cash that the company has on hand. Buying a company with a lot of cash can yield a lot
of benefits -- cash can fund product development and strategic acquisitions and can pay high-calibre
executives.
Another measure of value is a company's current working capital relative to its market capitalization.
Working capital is what is left after you subtract a company's current liabilities from its current assets.
Working capital represents the funds that a company has ready access to for use in conducting its everyday
business.

Shareholder's Equity & Book Value

Shareholder's equity is an accounting convention that includes a company's liquid assets like cash, hard
assets like real estate, as well as retained earnings. This is an overall measure of how much liquidation
value a company has if all of its assets were sold off -- whether those assets are office buildings, desks, old
T-shirts in inventory or replacement vacuum tubes for ENIAC systems.

Shareholder equity helps you value a company when you use it to figure out book value. Book value is
literally the value of a company that can be found on the accounting ledger. To calculate book value per
share, take a company's shareholder's equity and divide it by the current number of shares outstanding.

If you then take the stock's current price and divide by the current book value, you have the price-to-
book ratio.

Another use of shareholder's equity is to determine return on equity, or ROE. Return on equity is a
measure of how much in earnings a company generates in four quarters compared to its shareholder's
equity. It is measured as a percentage.

For instance, if XYZ Corp. made a million dollars in the past year and has a shareholder's equity of ten
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million, then the ROE is 10%.

Intangibles

Brand is the most intangible element to a company, but quite possibly the one most important to a
company's ability as an ongoing concern. If the company has a well-known brand, it adds tremendous
economic value despite the fact that it cannot be quantified.

Some investors are preoccupied by brands, particularly brands emerging in industries that have
traditionally been without them.

Intangibles can also sometimes mean that a company's shares can trade at a premium to its growth rate.
Thus, a company with fat profit margins, a dominant market share, consistent estimate-beating
performance or a debt-free balance sheet can trade at a slightly higher multiple than its growth rate would
otherwise suggest.

Although intangibles are difficult to quantify, it does not mean that they do not have a tremendous power
over a company's share price. The only problem with a company that has a lot of intangible assets is that
one danger sign can make the premium completely disappear

Using Comparables

Earnings Per Share

The most common way to value a company is to use its earnings. Earnings, also called net income or net
profit, is the money that is left over after a company pays all of its bills. To allow for apples-to-apples
comparisons, most people who look at earnings measure them according to earnings per share (EPS).

You arrive at the earnings per share by simply dividing the dollar amount of the earnings a company
reports by the number of shares it currently has outstanding.

Thus, if XYZ Corp. has one million shares outstanding and has earned one million dollars in the past 12
months, it has a trailing EPS of $1.00. (The reason it is called a trailing EPS is because it looks at the last
four quarters reported -- the quarters that trail behind the most recent quarter reported.

$1,000,000 = $1.00 in earnings per share (EPS)

1,000,000 shares

The Price-to-Earnings Ratio

The earnings per share alone means absolutely nothing. To look at a company's earnings relative to its
price, most investors employ the price/earnings (P/E) ratio. The P/E ratio takes the stock price and
divides it by the last four quarters' worth of earnings. For instance, if, in our example above, XYZ Corp.
was currently trading at $15 a share, it would have a P/E of 15.

$15 share price = 15 P/E

$1.00 in trailing EPS

There is a large population of individual investors who stop their entire analysis of a company after
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they figure out the trailing P/E ratio. Popularized by Ben Graham, the P/E has been oversimplified by
those who only look at this number. Such investors look for "low P/E" stocks. These are companies that
have a very low price relative to their trailing earnings.

Also called a "multiple", the P/E is most often used in comparison with the current rate of growth in
earnings per share. The Foolish assumption is that for a growth company, in a fairly valued situation
the price/earnings ratio is about equal to the rate of EPS growth.

In our example of XYZ Corp., for instance, we find out that XYZ Corp. grew its earnings per share at a 13%
over the past year, suggesting that at a P/E of 15 the company is pretty fairly valued. Fools believe that
P/E only makes sense for growth companies relative to the earnings growth. In the end, P/E has to be
viewed in the context of growth and cannot be simply isolated without taking on some significant potential
for error.

The Price-to-Sales Ratio

Revenues are the sales generated by a company for providing goods or services. Revenue-based
valuations are achieved using the price/sales ratio, often simply abbreviated PSR.

The price/sales ratio takes the current market capitalization of a company and divides it by the last 12
months trailing revenues. The market capitalization is the current market value of a company, arrived at
by multiplying the current share price times the shares outstanding. This is the current price at which
the market is valuing the company.

For instance, if our example company XYZ Corp. has ten million shares outstanding, priced at $10 a
share, then the market capitalization is $100 million.

Some investors are even more conservative and add the current long-term debt of the company to the
total current market value of its stock to get the market capitalization. The logic here is that if you were to
acquire the company, you would acquire its debt as well, effectively paying that much more.

Market Capitalization = (Shares Outstanding * Current Share Price) + Current Long-term Debt

The next step in calculating the PSR is to add up the revenues from the last four quarters and divide this
number into the market capitalization. Say XYZ Corp. had $200 million in sales over the last four quarters
and currently has no long-term debt. The PSR would be:

PSR = (10,000,000 shares * $10/share) + $0 debt = = 0.5

$200 million revenues

The PSR is a measurement that companies often consider when making an acquisition. If you have ever
heard of a deal being done based on a certain "multiple of sales," you have seen the PSR in use.

What Level of the Multiple is Right?

Multiples may be helpful for comparing two companies, but which multiples is right? Many look at
estimated earnings and estimate what "fair" multiple someone might pay for the stock.
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For example, if XYZ Corp. has historically traded at about 10 times earnings and is currently down to 7
times earnings because it missed estimates one quarter, it would be reasonable to buy the stock with
the expectation that it will return to its historic 10 times multiple if the missed quarter was only a short-
term anomaly.

A modification to the multiple approach is to determine the relationship between the company's P/E
and the average P/E of the S&P 500. If XYZ Corp. has historically traded at 150% of the S&P 500 and the
S&P is currently at 10, many investors believe that XYZ Corp. should eventually hit a fair P/E of 15,
assuming that nothing changes.

Free Cash Flows Methods

Cash flow is probably the most common measurement for valuing public and private companies used by
investment bankers. Cash flow is the cash that flows through a company during the course of a quarter or
the year after taking out all fixed expense and is normally defined as earnings before interest, taxes,
depreciation and amortization (EBITDA).

Interest income and expense, as well as taxes, are all put aside because cash flow is designed to focus on
the operating business and not secondary costs or profits. Thus, a canny analyst would use the growth rate
of earnings before interest and taxes (EBIT) instead of net income in order to evaluate the company's
growth. EBIT is also adjusted for any one-time charges or benefits.

As for depreciation and amortization, these are called non-cash charges, as the company is not actually
spending any money on them. When looking at a company's operating cash flow, it makes sense to toss
aside accounting conventions that might mask cash strength.

Free Cash Flow goes one step further. It represents the cash a company generates after cash outflows to
support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a
measure of profitability that excludes the non-cash expenses of the income statement and includes
spending on equipment and assets as well as changes in working capital.

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Discounted Cash Flow Method
The premise of the discounted free cash flow method is that company value can be estimated by
forecasting future performance of the business and measuring the surplus cash flow generated by the
company. The surplus cash flows and cash flow shortfalls are discounted back to a present value and added
together to arrive at a valuation. The discount factor used is adjusted for the financial risk of investing in
the company. The mechanics of the method focus investors on the internal operations of the company and
its future

Enterprise Value
(also known as EV) is a metric that attempts to reflect the market value of a firm. It can be used as an
alternative to market capitalization.

Essentially, Enterprise Value attempts to provide a more accurate valuation aimed at a buyer. Whilst a
firm's market capitalization will indicate share price x share quantity, the firm may have a lot of debt
which the acquirer would need to pay off (thereby adding the price of the transaction).

The calculation for Enterprise Value is:

Market Capitalization + Debt + Minority Interest + Preferred Shares - Cash & Cash Equivalent

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 INDIAN INSTITUTE OF FOREIGN TRADE

FINANCE COMPENDIUM
Part B

Prepared by:

Anish Menachery | Mayur Kumar

Senior Cell Coordinators
Equity Research Cell
TECHNICAL ANALYSIS
Technical analysis of stocks and trends is the study of historical market data, including price and volume. It
really just studies the supply and demand in a market. It uses both behavioural economics and quantitative
analysis to use past performance to determine what direction, or trend, will continue in the future.

Technical analysis evaluates securities by analyzing the statistics generated by market activity. In other words,
it attempts to understand the emotions in the market. Hence, it provides with a new set of tools that enables
one to become a better trader.

Technical analysis can be used on any security with historical trading data including stocks, futures, commodities,
fixed income, currencies and other securities.

It is based on three assumptions:

1. The market discounts everything: This assumption states that at any given time, stock’s price reflects
everything that has or could affect the company – including fundamental factors, broader economic
factors and market psychology.
2. Prices move in trends: Most technical trading is based on the assumption that after a trend has been
established, the future price movement is more likely to be in the same direction as the trend than to
be against it.
3. History tends to repeat itself: Technical analysis assumes that history – in terms of price movement –
tends to repeat itself. It is believed to be so because, market participants tend to provide a consistent
reaction to similar market stimuli over time.

CHARTS AND TRENDS:

Chart Types: Charts are on of the most fundamental aspects of technical analysis. It is important to
understand what is being shown on a chart and the information it provides. There are three main chart types
that depict the price movement:

1. Line chart: it is the most basic chart type and uses only one data point (the closing price of the stock
or index) to form the chart.
2. Bar chart: It is more versatile than the line chart and displays all the four price variables namely open,
high, low, and close. A bar has 3 components:
i) The central line – Top of the bar indicates the highest price of the security while the bottom
indicates the lowest level.
ii) The left mark/tick – It indicates the open price
iii) The right mark/tick – It indicates the close price
3. Japanese candlestick: Unlike the bar charts, the open and close prices are shown by a rectangular body
in case of candlestick charts. The candlestick anatomy has 3 main components:
i) Central real body – The real body, rectangular in shape connects the opening and closing
price.
ii) Upper shadow – Connects the high point to the close(bullish)/open(bearish)
iii) Lower shadow – Connects the low point to the open(bullish)/close(bearish)

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 Fig 1. Line Chart

Fig 2. Bar Chart

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 Fig 3. Candlestick Chart

The Japanese candlesticks are the widely used charts among the three discussed above.

Candlestick volume charts: In addition to the four price variables that a candlestick displays, the candlestick
volume charts display an additional important information; i.e ‘the volume traded’. In such charts, the
thickness of the central real body of the candle depicts the volume of the security traded.

Candlestick Patterns:
Candlesticks are widely used to identify trading patterns. For the purpose of technical analysis, single as well
as multiple candlestick patterns may be used.

Important single candlestick patterns:

1. Marubozu
2. Doji
3. Spinning Tops
4. Paper Umbrella
5. Shooting Star

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 Fig 4. Marubozu Fig 5. Spinning Top Top Fig 6. Doji

Fig 7. Paper Umbrella Fig 8. Shooting Star

Important multiple candlestick patterns:

1. Engulfing pattern
2. Harami
3. Piercing pattern
4. Dark cloud cover
5. Morning Star
6. Evening Star

Fig 9. Engulfing Pattern Fig 10. The Harami Pattern

Fig 11. Piercing Pattern Fig 12. Dark Cloud Cover

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 Fig 13. Morning Star Fig 14. Evening Star

Trends: It is important to be able to understand and identify trends so that one can trade with rather than
against them. An important saying goes, “the trend is your friend”.

Trend directions: There are mainly, three types of trend directions:

1. Uptrend: When each successive peak and trough is higher than the previous, the security is said
to be in an uptrend.
2. Downtrend: When each successive peak and trough is lower than the previous, the security is said
to be in a downtrend.
3. Horizontal trend: When there is little movement up or down in the peaks and troughs, it is a
horizontal trend. It is rather, the lack of a well-defined trend in either direction and hence the lack
of a clear bullish or bearish dominance. Such trends are also called ‘trading range(s)’ and the
security/market under such a trend is called ‘range-bound’.

Fig 15. Uptrend Fig 16. Downtrend

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 Fig 17. Horizontal Trend

Trend lengths: Along with the three above mentioned trend directions, trend lengths also play a pivotal role
in decision making. Three major types of trend lengths are discussed below:

i) Long-term trend: Usually long-term trends are considered to be trends that last for more than a
year.
ii) Intermediate trend: It is considered to last between one and three months and often, move
against the long-term/major trend.
iii) Near-term/Short-term trend: They are considered to last for less than a month and are
components of both major as well as intermediate trends.

Trend lines: It is a simple charting technique that adds a line to a chart to represent the trend in the market or
a stock.

i) Upward trendline: It is drawn at the lows of an upward trend. It represents the support that the
stock has everytime it moves from a high to a low.
ii) Downward trendline: It is drawn at the highs of a downward trend. It represents the resistance
level that a stock faces everytime the price moves from a low to a high.

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 Fig 18. Trendlines

Trend Channels: It is the addition of two parallel trendlines that act as strong areas of support and resistance.
Traders expect a given security to trade between the two levels of support and resistance until it breaks
beyond one of the levels. Regardless of the direction of the channel, the above interpretation remains the
same.

Fig 19. Trend Channels

VOLUMES:
Volumes represent how many shares (in case of a stock) are ‘bought and sold’ over a given period of time.
High volumes represent the share is actively traded in the market. For example, if you decide to buy 100 shares
of Reliance Industries Limited (NSE: RELIANCE) and I decide to sell 100 shares of Reliance Industries Limited
(NSE: RELIANCE) then you and me together, have created a volume of 100 shares (and not, 200 shares).

Volume Trend Tables:

Volume information when read in isolation carries no useful meaning for execution of trade. For example, if
we know that volumes on MRF Limited (NSE: MRF) is 4,226 shares, how useful is this information if read in
isolation? Thus, volume information should always be read combined with preceding price and volume
information to have useful meaning.

The following table summarises how to use volume information:

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INDICATORS AND OSCILLATORS:
Indicators that are used in technical analysis provide an extremely useful source of additional information.
These indicators help identify momentum, trends, volatility and various other aspects in a security to aid the
analysis of trends.

There are two major types of indicators:

i) Leading indicators: Such indicators precede the price movements and hence, are of predictive
nature.
ii) Lagging indicators: Such indicators follow a price movement and hence, is used as a confirmation
tool.

Oscillators: Oscillators are special kind of indicators that fall within a bounded range. For example, the Relative
Strength Index (RSI) is an oscillator that oscillates within the range of 0 to 100.

Four major types of indicators are:

1. Trend
2. Momentum
3. Volume
4. Volatility

Trend: Trend indicators tell the direction of movement of market e.g Moving average convergence divergence
(MACD), Parabolic SAR, etc.

Momentum: Momentum indicators tell the strength of a trend and whether a reversal is going to occur. They
are useful in picking price tops and bottoms. E.g Relative Strength Index (RSI), Stochastic Oscillator, Average
Directional Index (ADX), etc.

Volume: These indicators tell the change of volume over time. This is useful because when the price changes,
the volume gives an indication of how strong the move is. E.g On-Balance Volume, Chaikin Money Flow, Klinger
Volume Oscillator, etc.

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Volatility: These indicators tell the extent of price change over a given period. Volatility is important and
traders make money during volatility. The higher the volatility, the faster a price is changing. However, it tells
us nothing about the direction of but only about the range of price changes. E.g Bollinger bands, Volatility
Index (VIX), Average True Range (ATR), etc.

How are indicators used?

There are two main ways indicators are used to form buy and sell signals viz. ‘crossovers’ and ‘divergence’.
Crossovers are most popular and are reflected when either the price moves through the moving average, or
when two different moving averages cross over each other. Divergence happens when direction of price trend
and direction of the indicator trend move in opposite direction. This signals to indicator users that the
direction of the price trend is weakening.

Sources:

1. Zerodha.com/varsity
2. Investopedia
3. Sebi.gov.in
4. Kotaksecurities.com
5. Corporatefinanceinstitute.com

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