Portfolio Management

MODULE V:
What is meant by Stock Selection?
Stock selection is the selection of one or more stock (or shares) based on
certain set of criteria in order to maximise the probability of meeting the
trading or investment objective.

There are more than 5000 stocks available for trading or investment.
None can trade or invest in all at the same time.

Hence, one needs to select a manageable number of stocks.

Fundamental and Technical Analysis are the two most preferred

tools for stock selection.
 Types of Analysis

Economic Fundamental Technical

Quantitative

Qualitative
 Fundamental Analysis
Fundamental analysis is a method used to identify the true value of a stock.
1. The current price of a stock may not reflect the actual value
of the stock. The stock may be overvalued or undervalued
in the market.
2. Fundamental analysis helps investors to study the health of
the company, and thus leading to the actual value of the
stock.
3. This is done by using various qualitative and quantitative
factors.
4. The main purpose of this method is to identify companies
that that are fundamentally strong in order to invest in
them for the long term.
Economic Analysis
1. It involves assessing or examining topics or issues from an economist’s perspective.
2. This allows investors to analyse the market from the big picture to all the way down to
individual stocks.
3. By examining the economic numbers one can determine the current market strength
and have a better idea of what the future holds.
4. Key Economic indicators investors must incorporate while selecting stocks:

i. Indices (e.g. Nifty, Sensex)

ii. Gross Domestic Product (GDP)
iii. Unemployment rate
iv. Inflation rate
v. Consumer Confidence
vi. Purchase Managers' Index
 Types of Fundamental Analysis
Qualitative Analysis

It takes into account information that can’t be expressed in numbers.

i. It relates to the company itself.

ii. Factors – examples –

a) Management experience and performance

b) Corporate governance
c) Industry and competition etc.
Types of Fundamental Analysis
Quantitative Analysis

i. It is related to information that is shown in company’s financial statements. It involves

measuring simple statistical data to complex calculations.
ii. This analysis helps you to evaluate investment opportunities such as when to buy and
sell securities.
iii. Factors – examples -
a) Company’s revenues
b) Profit margins
c) Return on equity
d) Future growth potential
e) Financial ratios
Using Financial Ratios for Fundamental Analysis
1. Price To Earnings Ratio

i. It is one of the most widely used financial ratio analysis.

ii. Computation - Price Per Share / Earnings Per Share.
iii. As a thumb rule, a low P/E ratio is preferred while buying a stock.

2. Price To Book Value

i. Computation - Current price of the stock / Book value per share.

ii. A lower P/BV ratio could mean that the stock is undervalued.
iii. However, the definition of lower varies from sector to sector.
Financial Ratios
5. Current Ratio

i. It is a key financial ratio for evaluating a company's liquidity.

ii. Computation - Current Assets / Current Liabilities.
iii. As a thumb rule, a company with a current ratio greater than 1 is better.
Technical Analysis
It focuses on the stock market, rather the company.

It seeks to predict price movements by examining historical

data, mainly price and volume.

The underlying idea is that the market price already reflects the
fundamentals of any given stock, which therefore can be ignored.

It is a good idea for investors to leverage both technical and

fundamental analysis to fill the gaps.
 Price Charts
Technical analysts use a variety of charts based on the information they seek. However, there
are three types of charts that are most commonly used. They are: Line, Bar and Candlestick

Line Chart

1. It plots the closing price of a share for each

trading day over a period.

2. The line formed by joining the dots plotted

on the graph shows the movements in stock
price during the period.
 Price Charts
Bar Chart

1. It plots the intra-day high and low prices of a

stock using a bar for each trading day for a
specified time period.
2. The top of the bar corresponds to the day’s high
and the bottom, day’s low.
3. Two additional horizontal lines indicate the
opening and closing price. The length of the bar
is proportional to the volatility in a stock.
4. Colored coded - If the share price closes above
the open price it is colored green, and if the
close is below the open the bar is colored red.
 Price Charts
Candlestick chart

1. It displays the relationship between the high &

low and opening & closing prices of a stock.
2. The body of the candle represents the opening
and closing prices during the period.
3. Above and below the body are vertical lines called
wicks or shadows that show the lows and highs of
the traded prices.
4. While an individual candle provides sufficient
information, patterns can be determined only by
comparing one candle with its preceding and next
candles.
 5 Steps Approach For Great Stock Picking
1. Approach stock purchases as buying a business rather than just a stock purchase in the
portfolio.
2. Evaluate the true worth of the business considering the future earning potential.
3. The margin of safety is the real risk containment measure, and not stop loss.
4. Do not depend on turnaround as it seldom occurs.
5. Invest for the long term to generate inflation-adjusted superior returns.

So when one asks how to choose stock to invest in, the real question, is how to
identify a great business and what all parameters should be used to identify it?
1.
Remember
Always remember your financial goals and
investment timeframe.
2. Review your financial goals periodically, at-least
once in 5 years.
3. Risk and Return profile of various assets are not
constant.
4. Consider taking help from a registered and qualified
Investment Advisor.
5. No stock remain the best all the time. Market is
dynamic and you need to review your portfolio
periodically.
What is Portfolio Revision ?

The art of changing the mix of securities in a portfolio is called as portfolio

revision. The process of addition of more assets in an existing portfolio or
changing the ratio of funds invested is called as portfolio revision. The sale and
purchase of assets in an existing portfolio over a certain period of time to
maximize returns and minimize risk is called as Portfolio revision
Need for Portfolio Revision
1. An individual at certain point of time might feel the need to invest more. The need for
portfolio revision arises when an individual has some additional money to invest.

2. Change in investment goal also gives rise to revision in portfolio. Depending on the cash
flow, an individual can modify his financial goal, eventually giving rise to changes in the
portfolio i.e. portfolio revision.

3. Financial market is subject to risks and uncertainty. An individual might sell off some of
his assets owing to fluctuations in the financial market.
 Portfolio Revision Strategies

There are two types of Portfolio Revision Strategies.

Active Revision Strategy- Active Revision Strategy involves frequent changes in an existing portfolio
over a certain period of time for maximum returns and minimum risks. Active Revision Strategy
helps a portfolio manager to sell and purchase securities on a regular basis for portfolio revision.

Passive Revision Strategy -Passive Revision Strategy involves rare changes in portfolio only under
certain predetermined rules. These predefined rules are known as formula plans. According to
passive revision strategy a portfolio manager can bring changes in the portfolio as per the formula
plans only
Portfolio performance evaluation
The portfolio performance evaluation involves the determination of how a managed portfolio has performed
relative to some comparison benchmark. Performance evaluation methods generally fall into two categories,
namely conventional and risk-adjusted methods. The most widely used conventional methods include benchmark
comparison and style comparison. The risk-adjusted methods adjust returns in order to take account of differences
in risk levels between the managed portfolio and the benchmark portfolio. The major methods are the Sharpe
ratio, Treynor ratio, Jensen’s alpha, Modigliani and Modigliani, and Treynor Squared. The risk-adjusted methods are
preferred to the conventional methods.

The portfolio performance evaluation primarily refers to the determination of how a particular investment portfolio
has performed relative to some comparison benchmark. The evaluation can indicate the extent to which the
portfolio has outperformed or under-performed, or whether it has performed at par with the benchmark
 Objectives
The evaluation of portfolio performance is important for several reasons. First, the investor,
whose funds have been invested in the portfolio, needs to know the relative performance of
the portfolio. The performance review must generate and provide information that will help
the investor to assess any need for rebalancing of his investments. Second, the management
of the portfolio needs this information to evaluate the performance of the manager of the
portfolio and to determine the manager’s compensation, if that is tied to the portfolio
performance. The performance evaluation methods generally fall into two categories, namely
conventional and risk-adjusted methods.
 Investment Objectives
a. Return Objectives
•Capital Preservation: The primary goal is to avoid loss and maintain the
original investment value.
•Current Income: Focuses on generating regular income through dividends,
interest, or rent.
•Capital Appreciation: Seeks to grow the investment's value over time by
focusing on assets with high growth potential.
•Total Return: Combines income and capital appreciation to maximize overall
returns.
b. Risk Tolerance
•Risk-Averse: Minimizing risk is the priority, even at the cost of lower returns.
•Risk-Neutral: Balances risk and return expectations.
•Risk-Seeking: Willing to take higher risks for potentially higher returns.
 Investment Constraints
a. Liquidity Needs
•How quickly and easily assets can be converted into cash without significant
loss of value.
•Example: An investor nearing retirement may prefer more liquid assets.
b. Time Horizon
•The duration over which the investment objectives are to be achieved.
•Short-Term: Less than 3 years (e.g., saving for a car).
•Medium-Term: 3-10 years (e.g., saving for a house).
•Long-Term: More than 10 years (e.g., retirement planning).
c. Legal and Regulatory Considerations
•Investors may face restrictions due to laws, regulations, or ethical guidelines.
•Example: Pension funds are often limited to lower-risk investments by law.
d. Tax Considerations
•The impact of taxation on returns, such as capital gains tax, dividend tax, or estate tax.
•Example: Investors in high tax brackets might favor tax-efficient investment vehicles like
municipal bonds.
e. Unique Circumstances and Preferences
•Personal values, ethical considerations (e.g., avoiding tobacco or fossil fuels), or specific
financial needs.
•Example: A socially responsible investor may prioritize ESG-compliant portfolios.