Download fundamental analysis as a method of share valuation in comparison

INTERNATIONAL ECONOMICS & FINANCE JOURNAL
Vol. 6, No. 1, January-June (2011) : 27-37
FUNDAMENTAL ANALYSIS AS A METHOD OF
SHARE VALUATION IN COMPARISON WITH
TECHNICAL ANALYSIS
Venkatesh, C. K.* and Ganesh, L.**
Abstract: This article reports the results of a questionnaire survey in June/July 2010 on the use of
Fundamental and Technical analysis by brokers/fund managers in Indian stock market to form
their forecasts of share price movements. The findings of the research reveal that more than 85 per
cent of the respondents rely upon both Fundamental and Technical analysis for predicting future
price movements at different time horizons.
At shorter horizons there exists a skew towards reliance on Technical analysis as opposed to
Fundamental analysis. But the skew becomes steadily reversed as the length of horizon considered
to be extended. Technical analysis is considered slightly more useful in forecasting trends than
Fundamental analysis, but Fundamental analysis is significantly more useful while taking long
positions in the market.
Keywords: Stock market, Long Term, Short term
INTRODUCTION
In all financial markets, a central question in the market is how market participants
forecast their future market developments. Financial market participants are often
classified according to two different forecasting approaches, Fundamental and Technical.
Stock analysis is crucial when deciding to buy investments and when evaluating your
investment strategies. Regular stock market analysis can ensure to make the most of your
money and minimize your risks. While some investors use fundamental analysis while
others use stock market technical analysis or stock technical analysis to evaluate their
stocks.
Fundamental analysis is method of finding out the future price of a stock which an
investor wishes to buy. It relates to the examination of the intrinsic worth of a company to
find out whether the current market price is fair or not, whether it is overpriced or under
priced. It believes that analyzing the economy, strategy, management, product, financial
status and other related information will help to choose shares that will outperform the
market and provide consistent gains to the investor. It is the examination of the underlying
forces that affect the interest of the economy, industrial sectors, and companies. It tries to
*
Research Scholar, IGNOU, Assistant Professor, GFGC, Kadugudi, Bangalore-560 067, E-mail:
[email protected]
** Professor, Christ University Institute of Management, Hosur Road, Bangalore-560 029, E-mail:
[email protected]
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International Economics and Finance Journal
forecast the future movement of the capital market using signals from the economy,
industry and company. It requires an examination of the market from a broader
perspective. The presumption behind fundamental analysis is that a thriving economy
fosters industrial growth which leads to development of companies. Estimate of real worth
of a stock is made by considering the earning potential of the company which depends on
investment environment and factors relating to specific industry, competitiveness, quality
of management, operational efficiency, profitability, capital structure and dividend policy.
Technical analysis stands in contrast to Fundamental analysis. Fundamental analyses
study only the stock price movements themselves and believe that the history of previous
data provides indicators for future stock price movements.
Technical analysts have developed tools and techniques to study past patterns and
predict future price. It is basically the study of markets only. They study the technical
characteristics which may be expected at May or market turning points and their objective
assessment. The previous turning points are studied with a view to develop characteristics
that would help in identification of major market tops and bottoms. Human reactions are,
by and large consistent in similar though not identical reaction; with the help of various
tools, the technician attempts to correctly catch changes in trend and take advantage of
them.
Thus, “Technical analysis is directed towards predicting the price of a security. The
price at which a buyer and seller settle a deal is considered to be the one precise figure
which synthesizes, weighs and finally expresses all factors, rational and irrational
quantifiable and non-quantifiable and is the only figure that counts”. The purpose of doing
this complex analysis is to help them decide whether it is advisable to buy, sell or hold the
security of that company.
FUNDAMENTAL Vs TECHNICAL
Analyzing fundamentals such as earnings, cash flow, and assets, is useful in determining
buyout and liquidation value of a company. Growth models can be made to gauge potential
accumulation in the worth of the company. The difficulty is in trying to bridge this
information to the market price of the shares, whereas the technical analyst often interprets
the data by studying a chart. He may look for price patterns, trends, conflicting signals, or
slight changes in buying momentum.
Determining the success of technical analysis is very difficult due to the subjective
nature of this practice. Ten technical analysts can examine the same chart and have
differing opinions of how and when the price will move. Many famous technical analysts,
such as George C. Lane, have little written about their personal successes using such
techniques.
Technical analysis says nothing of a company’s finances; it attempts to get inside the
head of the investor. Fundamental analysts will try to figure out what a stock is really
Fundamental Analysis as a Method of Share Valuation in Comparison...
29
worth, versus what it is being traded at. Technical analysts will attempt to gauge the current
emotional state of the buyers to forecast if further buying or selling is likely. This article
discusses elaborately some of the investor’s opinion about fundamental and technical
analysis. The aim of this article is not to determine which art is better. Instead, should
endeavor to find out which method is commonly used on a particular stock.
REVIEW OF LITERATURE
The origin of Fundamental analysis for the share price valuation can be dated back to
Graham and Dodd (1934) in which the authors have argued the importance of the
fundamental factors in share price valuation. Theoretically, the value of a company, hence
its share price, is the sum of the present value of future cash flows discounted by the risk
adjusted discount rate. This conceptual valuation frame work is the spirit of the renowned
dividend discount model developed by Gordon (1962). However, the dividend discount
model valuation involves the forecast of future dividend payment which is difficult due to
the changes in firm’s dividend policy. Thus, the subsequent studies along this line of
literature searched for the cash flow that is unaffected by the dividend policy and can be
obtained from the financial statements.
A study by Yu-Hon Lui and David Mole (1998) reports on the use by foreign exchange
dealers in Hong Kong of fundamental and technical analyses to form their forecasts of
exchange rate movements. The findings of this study reveal that more than 90 per cent of
the respondents rely on both fundamental and technical analyses for predicting future rate
movements at different horizons.
Thomas Oberlechner (2001) presents the findings of a questionnaire and an interview
survey on the perceived importance of Technical and Fundamental analysis among foreign
exchange traders and financial journalists in Frankfurt, London, Vienna and Zurich.
Foreign Exchange traders confirm that, out of the both forecasting approaches, technical
analysis is more prominent than the other. But the Financial journalists put more emphasis
on fundamental analysis than foreign exchange traders.
STATEMENT OF THE PROBLEM
Most of research works concentrate on the foreign exchange market. Also the reviews
from the study do not throw light on the complementarities of the two tools. Another gap
exist that there may be difference of opinion with fundamental and technical analysis when
investing for long term and short term investment which is not examined in previous
studies. The current survey is done after critically reviewing the above mentioned research
works. The survey is done on the Stock markets. The major aspect of the current research
is to understand the attributes of the respondents when the market is bullish or bearish. The
current research work suggests suitability of the two tools to different investors (Long term
or Short term). It specifically analyses respondent’s preference towards the nature of the
companies while choosing stocks. The highlight of the current study is the identification of
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International Economics and Finance Journal
different industries /sectors and the applicability of Fundamental and Technical analysis
while taking positions in those industries or sectors which most of studies not covered in
the research work.
OBJECTIVE OF THE STUDY

To find out the commonly used method in forecasting trends and turning points in the
stock market.
SPECIFIC OBJECTIVES
The objective of the study can be concluded by
•
•
•
•
Understanding the demographic profile of respondents ( for the purpose of this
study respondents include, Brokers, Sub-brokers, Mutual fund companies,
Institutional investors).
Understanding the frequency of usage of analysis by various stock market
participants.
Analyzing the adoptability of Fundamental and Technical analysis to various
market conditions / situations.
Understanding the importance given by dealers to Fundamental and Technical
analysis over intervals of forecasting horizons.
DATA SOURCES AND METHODOLOGY
After analysis from licensed stock broking firms, Sub-brokers, Mutual fund companies,
licensed banks and Stock market analysts, a close- ended questionnaire was designed for
the analysis. The data was collected from four South Indian cities, namely, Bangalore,
Hubli, Hyderabad and Cochin. The closed ended questionnaire was admitted to a sample
of 100 respondents. Since the respondent’s choose are from experienced seniors, the
analysis made was more accurate. The usage of these tools by informed investors such as,
Brokers, Sub-brokers, Fund managers, Institutional investors is also critically reviewed in
this study. The questionnaire is statistically validated using various statistical tools such
as, Mean, Standard deviation. One way ANOVA test is conducted and it is tested at 1%, 5%
and more than 5% significance levels.
ANALYSIS AND INTERPRETATION
Descriptive Analysis
Analysis for the study can be done by
(a) Understanding the demographic profile: age of the respondents.
(b) Understanding the frequency of usage of analysis by various stock market
participants.
Fundamental Analysis as a Method of Share Valuation in Comparison...
31
(c) Analyzing the usage of Fundamental and Technical analysis while forecasting
trends and turning points.
Table 1
Age of the Respondent
Age
Frequency
Per cent
20 to 30 yrs
26
26.0
31 to 40yrs
62
62.0
Above 40 yrs
12
12.0
100
100.0
Total
Chart 1: Age of the Respondent
Table: 1 and chart: 1 indicates the age distribution of the respondents. It is evident that
substantial (88%) percentages of respondents are above 30 years of age. This shows that
the sample chosen for research has rich blend of experience and expertise.
Table 2
Designation of the Respondent
Position
Frequency
Per cent
Director
10
10.0
Fund Manager
4
4.0
Senior Dealer
60
60.0
Junior Dealer
Total
18
18.0
100
100.0
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International Economics and Finance Journal
Chart 2: Designation of the Respondent
Above table and chart indicates the designation of the respondents. A substantial
(60%) percentage of respondents assumed the office of senior dealers, 18% are Junior
dealers, 10% are Directors and 4% of the respondents were fund managers. As the sample
size has more number of senior dealers it makes the findings more concrete and reliable.
Table 3
Types of Firms
Type of Firm
Licensed Broking Firm
Licensed Banks
Others
Total
Frequency
Per cent
70
26
4
100
70.0
26.0
4.0
100.0
Chart 3: Type of Firm
Fundamental Analysis as a Method of Share Valuation in Comparison...
33
With respect to the firms chosen for survey, it is the blend of broking firms and
banks. Since As these two have maximum share in the trading activities. 70 per cent of
the respondents belong to licensed broking firms, 26 per cent belong to licensed banks
and 4 per cent belong to other categories which include Mutual funds and Institutional
investors.
Table 4
Tradeoff between Fundamental Analysis and Functional Analysis
Items
Level of
variable
N
Mean
Std.
Deviation
F Value
Sig
Value
Frequency of usage of Analysis
FA
TA
Total
47
50
97
28
71.91
51.49
23.718
23.867
32.876
88.25
.000**
Analysis helps in generating better
returns in the short term
FA
TA
Total
40
50
90
11
89.25
55.56
4.877
6.148
40.685
4576.28
.000**
Analysis helps in generating better
returns in the long term
FA
TA
Total
50
25
75
94
5.76
66.67
8.168
8.191
40.088
1706.20
.000**
When the market is bullish, the
results of analysis is highly reliable
FA
TA
Total
49
50
99
16
83.88
50.40
16.465
16.382
37.821
422.73
.000**
When the market is bearish, the
results of analysis is highly reliable
FA
TA
Total
50
49
99
61
39.40
50.51
30.299
30.069
31.731
11.30
.001**
Analysis is most useful tool while
strategizing the portfolios in stock
markets
FA
TA
Total
50
38
88
91
8.74
56.93
7.769
6.615
40.261
2564.11
.000**
Analysis is the most useful tool
while taking long positions in
the stock market
FA
TA
Total
50
28
78
92
8.48
64.10
14.544
16.710
39.904
444.45
.000**
Analysis is more useful while
forecasting trends
FA
TA
Total
37
50
87
13
86.73
57.24
12.948
12.395
40.064
780.05
.000**
Analysis is more useful while
forecasting turning points
FA
TA
Total
41
50
91
14
86.34
55.22
6.327
8.207
38.557
2340.31
.000**
Analysis is advisable to short
term investors
FA
TA
Total
23
50
73
9
90.57
68.49
4.165
5.509
40.653
4449.61
.000**
Analysis is advisable to Long
term investors
FA
TA
Total
50
14
64
97
3.24
78.13
6.435
7.229
36.096
1816.92
.000**
** 1% sig * 5% Sig.
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International Economics and Finance Journal
Chart 4
Table 4 and Chart 4 shows the perceived usefulness of both the analytical tools. More
than 72 per cent of the respondents use Technical analysis regularly to understand the
movements of the stock prices. About 90 per cent of the respondents believe that Technical
analysis generates huge amount of returns in the short run.
On the contrary, 94 per cent of the respondents endorse that Fundamental analysis is
highly reliable tool for generating returns in the longer run.
As the stock market is highly volatile and take the forms of bullish and bearish trends,
the survey shows that nearly 84 per cent of the respondents rely upon technical indicators
when the market is bullish. Close to 61 per cent of the respondents take positions based on
Fundamental anlysis when the market is bearish in nature.
Creating portfolios in the stock market is a matter of utmost importance to all the
investors, more than 91 per cent of the respondents reveal that Fundamental analysis is the
useful tool for creating portfolios in the market. In addition to this a large portion (92 per
cent) of the respondents agree that Fundamental analysis is the feasible tool for taking long
positions in the stock market.
For understanding the Stock market game one has to depend more upon trends and
turning points. Close to 87 per cent of the respondents have choosen Technical analysis for
idenfying trends and turning points.
Investors in the market can be broadly categorised as, short term and long term
investors. Accordingly, the analysis has revealed that about 91 per cent of the respondents
have advised Technical analysis for the short term investors and an overwhelming 97 per
cent of the respondents have advised Fundamental analysis for the long term investors.
Fundamental Analysis as a Method of Share Valuation in Comparison...
35
Table 5
Level of Forecasting Horizons for Fundamental and Technical Analysis
Items
Level of
variable
Intra day
1 week
1 month
3 months
6 months
1 year
Beyond 1 year
N
Mean
Std.
Deviation
F
Value
Sig
Value
FA
TA
Total
50
50
100
.10
9.98
5.04
.303
.141
4.970
43641
.000**
FA
TA
Total
50
50
100
.02
9.98
5.02
.314
.141
4.991
41568
.000**
FA
TA
Total
50
50
100
.04
9.96
5.41
1.178
.198
4.650
2901
.000**
FA
TA
Total
50
50
100
.52
9.48
6.35
1.298
1.035
3.356
711
.000**
FA
TA
Total
50
49
99
3.37
6.63
7.08
1.764
2.690
2.302
4
.055
FA
TA
Total
50
48
98
7.25
2.75
6.36
.560
1.537
3.731
930
.000**
FA
TA
Total
50
39
89
8.31
1.69
6.34
.198
1.127
4.194
2594
.000**
** 1% sig * 5% Sig.
Chart 5
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International Economics and Finance Journal
Table 5 compare the importance of Fundamental and Technical analysis over seven
different horizons. Both approaches exercise an influence, though to a different extent, at
all horizons. For Fundamental analysis, this influence increases with the length of the time
horizon. Out of a 10 point scale 8.31 is been scored by Fundamental analysis for a time
horizon of beyond one year. The reverse is true for Technical analysis which has highest
score at shorter time horizons and lower scores at longer horizons.
At the shorter time horizon it has a scoring of 9.98 on a scale of 10 and at the long time
horizon the scoring has reduced to 1.69.
Thus, at shorter horizon, there exists a skew towards reliance on technical, as opposed
to fundamental analysis, but this skew becomes steadily reversed as the length of the
horizon considered increases.
This finding is consistent with that of Taylor and Allen (1992) for United Kingdom
Stock exchange market and Yu-Hon Lui, David Mole (1998) for Hong - Kong Foreign
Exchange market.
Further, the analysis indicates dealers consensus on the shift of the skew towards both
Fundamental and Technical analysis. Statistical analysis shows that the skew towards
reliance on technical methods is significant at the Intraday, 1 week, 1 month and 3 months.
The skew towards Fundamental analysis is significant at 1 year and beyond one year, that
is, at longer time horizons.
This suggests that models that focus on fundamentals may perform badly over shorter
time horizons, over a longer time horizon models based on fundamental analysis may
perform better. The joint influence of Fundamental and Technical analysis is further
confirmed by dealer’s perception of their complementarity. A larger proportion of the
respondents indicate that the two analyses are complimentary than indicate that they are
mutually exclusive or substitutes.
Bottom Line
At the bottom line the survey concludes that, at all time horizons, a very high proportion
of respondents place some weight on both fundamental and technical analysis while
forming views. At shorter horizons, there exist a skew towards reliance on technical as
opposed to fundamental analysis, but the skew becomes steadily reversed as the length
of horizon considered is increased. Technical analysis can be a very valuable tool, but it
is important to realize the benefits as well as the limitations before diving in. There is no
definite answer about whether technical analysis should be used as a substitute to
fundamental analysis, but many agree that it has its merits when used as a compliment to
other investing strategies. More effort should be made into which stocks are
predominantly bought by fundamental investors and which ones attract technical
analysts.
Fundamental Analysis as a Method of Share Valuation in Comparison...
37
References
Yu-Hon Lui and David Mole (1998), The use of Fundamental and Technical Analysis by Foreign Exchange
Dealers: Hongkong Evidence, Journal of International Money and Finance, 17, 535-545.
Thomas Oberlechner (2001), Importance of Technical and Fundamental analysis in the European Foreign
Exchange Market, International Journal of Finance and Economics, January-2001; 6, 81-93.
DoronNissim, Stephen Penman, (2001), Ratio Analysis and Equity valuation; From research to Practice—
Review of Accounting Studies 6, 109-154.
Nobert M. Fiers, Ronald Macdonald, (2002), Towards the Fundamentals of Technical Analysis, Economic
Modelling, 19, (2002), 353-374.
Sanjay Sehgal and Meenakshi Gupta, (2005), Technical Analysis in the Indian Capital Market—A Survery,
Decision, Vol. 32, No. 1.
Jennit. L. Bettman, Stephen. J. Salut, Emmenn L. Schultz, (2009), Fundamental and Technical Analysis,
Substitutes of Compliments, Accounting and Finance 49, (2009), 21-36.
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