Security Analysis

What is Security Analysis?

Security analysis refers to the method of analyzing the value of securities like shares and other instruments to assess the total value of business which will be useful for investors to make decisions. There are three methods to analyze the value of securities – fundamental, technical, and quantitative analysis.

Features

  • To value financial instruments like equity, debt, and warrants of a company.
  • To use publicly available information. The use of insider information is unethical and illegal.
  • Security analysts must act with integrity, competence, and diligence while conducting the investment profession.
  • To use various analytical tools, this includes fundamental, technical, and quantitative approaches.
  • Security analysts should place the interest of clients above their personal interests.

Examples

#1 – Box IPO Analysis

Box IPO Relative Valuation

For Box IPO valuation, I have used the following approaches  –

  1. Relative Valuation – SAAS Comparable Comps
  2. Comparable Acquisition Analysis
  3. Valuation using Stock-Based Rewards
  4. Valuation cues from Box Private Equity Funding
  5. Valuation cues from DropBox Private Equity Funding Valuation
  6. Box DCF Valuations

You can learn more about Box Valuation Analysis from here.

#2 – Alibaba IPO Analysis

In analyzing the Alibaba IPO, I primarily used the discount Cash Flow technique

Alibaba IPO Analysis

You can learn more about how I went about doing a security analysis of Alibaba from this article – Alibaba Valuation Analysis

Types of Security Analysis

Below are the Top 3 Types of Security Analysis.

Security Analysis

The securities can broadly be classified into equity instruments (stocks), debt instruments (bonds), derivatives (options), or some hybrid (convertible bond). Considering the nature of securities, security analysis can broadly be performed using the following three methods:-

#1 – Fundamental Analysis

This type of security analysis is an evaluation procedure of securities where the major goal is to calculate the intrinsic value of a stock. It studies the fundamental factors that effects stock’s intrinsic value like profitability statement & position statements of a company, managerial performance and future outlook, present industrial conditions, and the overall economy.

#2 – Technical Analysis

This type of security analysis is a price forecasting technique that considers only historical prices, trading volumes, and industry trends to predict the future performance of the security. It studies stock charts by applying various indicators (like MACD, Bollinger Bands, etc.), assuming every fundamental input has been factored into the price.

#3 – Quantitative Analysis

This type of security analysis is a supporting methodology for both fundamental and technical analysis, which evaluates the historical performance of the stock through calculations of basic financial ratios, e.g., Earnings Per Share (EPS), Return on Investments (ROI), or complex valuations like discounted cash flows (DCF).

Why Analyze Securities?

The basic target of every individual is to increase its Net Worth by investing its earnings into various financial instruments, i.e., the creation of money using the money. Security analysis helps people achieve their ultimate goal, as discussed below:

#1 – Returns

The primary objective of the investment is to earn returns in the form of capital appreciation as well as yield.

#2 – Capital Gain

Capital Gain or appreciation is the difference between the sale price and purchase price.

#3 – Yield

It is the return received in the form of interest or dividend.

Return = Capital Gain + Yield

#4 – Risk

It is the probability of losing the principal capital invested. Security analysis avoids risks and ensures the safety of capital, also creates opportunities to outperform the market.

#5 – Safety of Capital

The capital invested with proper analysis; avoids chances to lose both interest and capital. Invest in less risky debt instruments like bonds.

#6 – Inflation

Inflation kills one’s purchasing power. Inflation over time causes you to buy a smaller percentage of good for every dollar you own. Proper investments provide you hedge against inflation. Prefer common stocks or commodities over bonds.

#7 – Risk-Return relationship

The higher the potential return of an investment, the higher will be the risk. But the higher risk doesn’t guarantee higher returns.

#8 – Diversification

“just don’t put all your eggs in one basket,” i.e., do not invest your whole capital in a single asset or asset class but allocate your capital in a variety of financial instruments and create a pool of assets called a portfolio. The goal is to reduce the risk of volatility in a particular asset.

Note: Analyzing securities doesn’t guarantee profits every time because research is made with the information publicly available. However, contrary to the Efficient Market Hypothesis (EMH), markets do not reflect all the information available, and thus security analysts can beat the market using technical and fundamental approaches.

Recommended Articles

This article has been a guide to Security Analysis. Here we discuss the top 3 types of security analysis, including fundamental, technical, and quantitative analysis with examples. You can learn more about financing from the following articles –