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.
- To value financial instruments like equity, debt, and warrants of a company.
- To use publicly available information. The use of insider informationUse Of Insider InformationInsider Information is a piece of fact, information or an understanding (M&A, New Contracts, R&D breakthrough, new product launch etc.) which could impact the prices of a listed entity or publicly-traded organizations once disclosed in the public domain. Trading based on such information is considered to be illegal. 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.
#1 – Box IPO Analysis
For Box IPO valuation, I have used the following approaches –
- Relative Valuation – SAAS Comparable Comps
- Comparable Acquisition Analysis
- Valuation using Stock-Based Rewards
- Valuation cues from Box Private Equity Funding
- Valuation cues from DropBox Private Equity Funding Valuation
- Box DCF ValuationsDCF ValuationsDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company's future performance.
You can learn more about Box Valuation AnalysisBox Valuation AnalysisThe analysis of the Box IPO valuation can be done using various methodologies which are Relative Valuation – SaaS Comparable Comps, Comparable Acquisition Analysis, Using Stock-Based Rewards, Valuation cues from Private Equity Funding, Valuation cues from Dropbox Private Equity Funding, and Discounted Cash Flow Approach for Box IPO Valuation. from here.
#2 – Alibaba IPO Analysis
In analyzing the Alibaba IPO, I primarily used the discount Cash Flow technique
You can learn more about how I went about doing a security analysis of Alibaba from this article – Alibaba Valuation AnalysisAlibaba Valuation AnalysisAlibaba is the most profitable Chinese e-commerce company and its IPO is a big deal due to its size. With its huge size and network, Alibaba IPO may look at international expansion beyond China and may lead to price wars and intensive competition in the US.
Types of Security Analysis
Below are the Top 3 Types of Security Analysis.
The securities can broadly be classified into equity instruments (stocks), debt instrumentsDebt InstrumentsDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans. (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 chartsStock ChartsThe stock chart in Excel, commonly known as the high low close chart, is used to represent market conditions such as changes in stock prices. 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 ratiosBasic Financial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on., e.g., Earnings Per Share (EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.), 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 WorthNet WorthThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus. 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 appreciationCapital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets. 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 stocksCommon StocksCommon stocks are the number of shares of a company and are found in the balance sheet. It is calculated by subtracting retained earnings from total equity. 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.
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 –