Technical vs. Fundamental Analysis

Analysis of financial markets is often divided into two broad disciplines, known as fundamental analysis and technical analysis. Both forms of analysis are different approaches to the decision making process in the context of trading or investing in financial markets.

It shouldn't really be versus one another, it should say instead complement each other. Technical analysis tools can be used to draw significance to various economic trends. Knowing economic trends can aid the technician in determining the potential significance of a various technical signals and patterns. An investor that marries the knowledge has a strong sense of the market. The common thread between technical and fundamental analysis is the study of trends.

Where technical analysis is the study of trends in price and volume, fundamental analysis concerns itself with economic and corporate growth trends and the projection of performance based on trends of relevant factors. In laymen language, fundamental analysis suggests which stock to buy, while technical analysis suggests when to buy it.

The basis of all long term trends in price and volume for any tradable is fundamentals. Technical analysis thrives on the study of changing supply and demand patterns. In the study of trends it is important to determine significance in changes in underlying perceptions of value that result from fundamentals and the forecasts of future performance. A balanced understanding of the two disciplines can provide an excellent basis for a successful trading experience.

As with technical analysis, there are many fundamental tools that are purposed toward early identification of trend reversals. Technical analysis will be used as part of the decision-making process in investing or trading in shares. It will be used primarily to assist with the timing element of the process, where an investor or trader seeks to:

• Identify the beginning of an up trend in a stock
• Buy a position in the stock
• Identify the end of the trend
• Sell the position

Analysis of financial markets is often divided into two broad disciplines, known as fundamental analysis and technical analysis. Both forms of analysis are different approaches to the decision making process in the context of trading or investing in financial markets.

It shouldn't really be versus one another, it should say instead complement each other. Technical analysis tools can be used to draw significance to various economic trends. Knowing economic trends can aid the technician in determining the potential significance of a various technical signals and patterns. An investor that marries the knowledge has a strong sense of the market. The common thread between technical and fundamental analysis is the study of trends.

Where technical analysis is the study of trends in price and volume, fundamental analysis concerns itself with economic and corporate growth trends and the projection of performance based on trends of relevant factors. In laymen language, fundamental analysis suggests which stock to buy, while technical analysis suggests when to buy it.

The basis of all long term trends in price and volume for any tradable is fundamentals. Technical analysis thrives on the study of changing supply and demand patterns. In the study of trends it is important to determine significance in changes in underlying perceptions of value that result from fundamentals and the forecasts of future performance. A balanced understanding of the two disciplines can provide an excellent basis for a successful trading experience.

As with technical analysis, there are many fundamental tools that are purposed toward early identification of trend reversals. Technical analysis will be used as part of the decision-making process in investing or trading in shares. It will be used primarily to assist with the timing element of the process, where an investor or trader seeks to:

• Identify the beginning of an up trend in a stock
• Buy a position in the stock
• Identify the end of the trend
• Sell the position

How about your Investment IQ?

I scored 16/20 in the Investment IQ test by MoneyControl !! I would have scored less than 10 some months ago before I started this blog. :)

Use this tool to evaluate whether you should manage your investments yourself or whether you should approach/ use a professional manager.

This evaluation will consider your temperament, aptitude and technical knowledge. It should take you between 5 and 8 minutes to answer the 20 questions.

Scores on temperament(5), aptitude(5) and technical knowledge(10) are taken. The qualifying score( 15) is a Moneycontrol recommended benchmark and it refers to the minimum you need to score if you want to manage your money independently.

As I said, I wouldn't have scored 16 if I was not doing this blog. In fact I was very miserable with all this personal finance. But I have learnt that finance is not rocket science and I owe it to my family that I manage our finances better.

Maybe you score less than 15. But does it mean you should start finding a professional manager? Or should you try and build your financial literacy levels. Choice is obviously yours!!

CAPITAL GAINS TAX

Capital gains
Incomes such as salary, rent and business income are regular and recurring incomes. These are earned in return for providing a particular service such as skills in case of the salaried, professional service or service in the form of permission to use property. However, these do not cover all sources of income. Incomes can arise out of the sale of capital assets such as your house, jewellery, land or even equity shares and mutual fund units. The profits that you make on such sale transactions will be charged to tax as capital gains.

Short term and long term asset

Asset	Short term	Long term
Equity shares, mutual fund unit,zero coupon bond	Held for 12 months or less	Held for more than 12 months
Other assets like jewellery, land, property	Held for 36 months or less	Held for 36 months or less

Tax treatment

The tax treatment is different for short term and long term as also for some instruments such as equity shares and equity mutual funds.

Short-term capital gains tax

Short-term capital gains are added to the total taxable income of the individual and therefore taxed at the relevant tax slabs. The gain in this case is simply the difference between the cost of purchase and the sale value of the asset.

Exception: In case of equity shares and equity mutual funds, short-term capital gains will be taxed at a flat rate of 15%. So instead of including this income to the total taxable income, the tax will be calculated and added directly to the total tax liability.

Long-term capital gains

Long-term capital gains are taxed at a flat rate of 20% irrespective of your income slab. However, there is an added benefit of indexation, which is available only on long-tem capital gains. Indexation is nothing but adjusting the cost of purchase of units to the cost inflation index as on the date of sale.

Indexed cost is calculated with the help of a table of cost inflation index that is provided by a notification in the official gazette each year. In the case of long-term holdings, the cost of purchase is adjusted to the present inflation index before deducting it from the sale value. So if you had bought debt mutual funds in April 2001 at Rs. 5,000 and sold them in August 2002 at Rs. 10,000, your cost of purchase will be adjusted to inflation. The inflation-adjusted cost would thus work out to Rs. 5,246. So your capital gain will be Rs. 4,753 on which you will be taxed at 20%.

Exception: Equity shares purchased after 1st March 2003 and equity mutual funds bought after 1st October 2004 are exempt from long-term capital gains tax. The intention is to encourage long-term savings in equities.

Another exception is in case of non-equity mutual funds, you will have an option to forego the benefit of indexation and pay long-term capital gain tax at 10% instead of 20%. Which option is more beneficial can be determined on a case-to-case basis.

Exemptions

Sale of residential house

If you have sold your residential house property for a profit, you will get some relief on the capital gains tax payable, if you fulfill certain conditions. Following are the conditions:

1. The house that you sell must have been owned by you for at least 3 years, which means it necessarily must be a long-term asset

2. Once you sell the house, you should buy a new house within two years from the date of sale. Alternately, if you have bought a house within one year before the sale of the existing house, you will be eligible for tax relief. If you are constructing a house, then you should do so within 3 years from the date of sale

3. The cost of the new house should be at least equal to the capital gain

Case study

Ashok Pai bought a house in November 1984 for Rs 5 lakh. He sold the house on 1st April 2003 for Rs 25 lakh. Thus, the long-term capital gains tax on this will be:

Sale value Rs 25 lakh

Indexed cost of
purchase

Rs 5 lakh X 463 / 125 Rs 18.52 lakh

Capital gains Rs 6.48 lakh

In order to save tax on this amount, Pai must buy a house within two years from 1st April 2003 or construct a house within 3 years from that date. He must buy a house of value at least of Rs 6.48 lakh. Had he already purchased a house before selling the existing one, he should have done so during the period from 1st April 2002 to 1st April 2003.

Sale of any long-term asset

Sections 54EC provides exemptions on fulfillment of certain conditions. If you sell long-term assets and within six months, invest the sale proceeds in bonds of NHAI or REC (bonds of NABARD, NHB and SIDBI were earlier allowed but have been disallowed with effect from Finance Bill 2006), then you will get an exemption of either the invested amount or the capital gain amount, whichever is lower.

So suppose you have sold the units for Rs. 20,000, and the capital gain amounts to Rs. 12,000. If you invest the entire Rs. 20,000 in bonds as specified, your entire gain of Rs. 12,000 will be exempt. If you invest Rs. 9,000, only that much will be exempt from tax and Rs. 3,000 will be taxable.

Provisions of section 54ED have been abolished with effect from Finance Bill 2006.

Why Share Price is Not Important

Market Cap is the True Measure of a Company's Value

Why is a stock that cost Rs.50 cheaper than another stock priced at Rs.10?
This question opens a point that often trips up beginning investors: The per-share price of a stock is thought to convey some sense of value relative to other stocks. Nothing could be farther from the truth.
In fact, except for its use in some calculations, the per-share price is virtually meaningless to investors doing fundamental analysis. If you follow the technical analysis route to stock selection, it’s a different story, but for now let’s stick with fundamental analysis.
The reason we aren’t concerned with per-share price is that it is always changing and, since each company has a different number of outstanding shares, it doesn’t give us a clue to the value of the company. For that number, we need the market capitalization or market cap number.
The market cap is found by multiplying the per-share price times the total number of outstanding shares. This number gives you the total value of the company or stated another way, what it would cost to buy the whole company on the open market.

Here’s an example:
Stock price: Rs. 50
Outstanding shares: 50 million
Market cap: Rs. 50 x 50,000,000 = Rs. 2.5 billion
To prove our opening sentence, look at this second example:
Stock price: Rs.10
Outstanding shares: 300 million
Market cap: Rs.10 x 300,000,000 = Rs.3 billion

This is how you should look at these two companies for evaluation purposes. Their per-share prices tell you nothing by themselves.

What does market cap tell you?
First, it gives you a starting place for evaluation. When looking a stock, it should always be in a context. How does the company compare to others of a similar size in the same industry?

The market generally classifies stocks into three categories:
Small Cap under $1 billion
Mid Cap $1 - $10 billion
Large Cap $10 billion plus

Some analysts use different numbers and others add micro caps and mega caps, however the important point is to understand the value of comparing companies of similar size during your evaluation.
You will also use market cap in your screens when looking for a certain size company to balance your portfolio.

Conclusion: Don’t get hung up on the per-share price of a stock when making your evaluation. It really doesn’t tell you much. Focus instead on the market cap to get a picture of the company’s value in the market place.