CHAPTER - IV

THEORITICAL FRAMEWORK ON
EQUITY SHARES
What is equity share?

A Joint ownership of a property by one or more owner-investors and one or more owner-
occupants. The owner-investors get the benefit of depreciation, and the owner-occupants can
treat a part of their monthly mortgage payments as rent, and benefit from tax write-offs for
interest and property taxes. When the property is sold, both types of owners share in the profit
or loss realized from the sale.

Equity is the stockholders' proportionate share (ownership interest) in the corporation's

capital stock and surplus. An owner's equity in business is equal to the business's assets
minus its liabilities.

Equity share also called as stock market can be defined as a medium for trading of company
stocks apart from securities. The range of participants in the stock market varies from small
individual stock investors to large hedge fund to traders. These is to facilitate the exchange
on a predetermined price. The purpose of a stock exchange is to facilitate the exchange of
securities between buyers and sellers, thus providing a market place.

Equity shares are another name for a share or stock that represents an ownership in a
company in one its most basic forms. They become available if a company needs capital or
money to operate as a business, it can generate the required funds by selling ownership in the
company.

This means that the company issues equity shares for a fair price and these shares represent
ownership in the company for anyone who purchases the shares. These shares are an
ownership in the company and give the owner the right to have a share in the profits of the
firm. When there is no difference in the class of the share, then all the shares of the company
considered as equity shares.

Equity is defined as 'the residual interest in the assets of the company after deducting all its
liabilities such as long term borrowing for rising loan capital in the form of debenture either
single debenture, debenture issued of series or debenture stock finance.'
An equity share is a document issued by a company which entitles the shareholder to be one
of the owners of the company. One of these shares can be purchased from a stock market and
by owning one you can earn a portion of its profits and even sell it to receive a capital gain.
However, you also run a risk of making a capital loss if you have sold the share at a price
below your buying price so be extremely careful when purchasing equity shares as there is a
risk in doing so.

The British English term for the word refers solely to the stock market and is so commonly
used that is almost replaces the word stock itself.

Indian Equity Market

The Indian Equity Market is also the other name for Indian share market or Indian stock
market. The forces of the market depend on monsoons, global findings flowing into equities
in the market and the performance of various companies. The Indian market of equities is
transacted on the basis of two major stock indices, National Stock Exchange of India Ltd.
(NSE) and The Bombay Stock Exchange (BSE), the trading being carried on in a
dematerialized form. The physical stocks are in liquid form and cannot be sold by the
investors in any market. Two types of funds are there in the Indian Equity Market; Venture
Capital Funds and Private Equity Funds.

The equity indexes are correlated beyond the boundaries of different countries with their
exposure to common calamities like monsoon which would affect both India and Bangladesh
or trade integration policies and close connection with the foreign investors. From 1995
onwards, both in terms of trade integration and FIIs India has made an advance. All these
have established a close relationship between the stock market indexes of India stock market
and those of other countries. The Stock derivative adds up all futures and options on all
individual stocks. This stock index derivative was found to have gone up from 12 % of NSE
derivatives turnover in 2002 to 35 % in 2004. The Indian Equity Market also comprise of the
Debt Market, dominated by primary dealers, banks and wholesale investors.

Indian Equity Market at present is a lucrative field for the investors and investing in Indian
stocks are profitable for not only the long and medium-term investors, but also the position
traders, short-term swing traders and also very short term intra-day traders. In terms of
market capitalization, there are over 2500 companies in the BSE chart list with the Reliance
Industries Limited at the top. The SENSEX today has rose from 1000 levels to 8000 levels
providing a profitable business to all those who had been investing in the Indian Equity
Market. There are about 22 stock exchanges in India which regulates the market trends of
different stocks. Generally the bigger companies are listed with the NSE and the BSE, but
there is the OTCEI or the Over the Counter Exchange of India, which lists the medium and
small sized companies. There is the SEBI or the Securities and Exchange Board of India
which supervises the functioning of the stock markets in India.

In the Indian market scenario, the large FMCG companies reached the top line with a double-
digit growth, with their shares being attractive for investing in the Indian stock market. Such
companies like the Tata Tea, Britannia, to name a few, have been providing a bustling
business for the Indian share market. Other leading houses offering equally beneficial stocks
for investing in Indian Equity Market, of the SENSEX chart are the two-wheeler and three-
wheeler maker Bajaj Auto and second largest software exporter Infosys Technologies.

Other than some restricted industries, foreign investment in general enjoys a majority share
in the Indian Equity Market. Foreign Institutional Investors (FII) need to register themselves
with the SEBI and the RBI for operating in Indian stock exchanges. In fact from the Indian
stock market analysis it is known that in some specific industries foreigners can have even
100% shares. In the last few years with the facility of the Online Stock Market Trading in
India, it has been very convenient for the FIIs to trade in the Indian stock market. From an
analysis on the Indian Equity Market it can be said that the increase in the foreign
investments over the years no doubt have accentuated the dynamism of the Indian market of
equities. Foreign investors are allowed to buy Indian equity for the purpose of converting the
equity into ADR or GDR.

Thus, the growing financial capital markets of India being encouraged by domestic and
foreign investments is becoming a profitable business more with each day. If all the
economic parameters are unchanged Indian Equity Market will be conducive for the growth
of private equities and this will lead to an overall improvement in the Indian economy.
Impact of recession on Indian market

The recession in the US market and the global meltdown termed as Global recession have
engulfed complete world economy with a varying degree of recessional impact. World over
the impact has diversified and its impact can be observed from the very fact of falling Stock
market, recession in jobs availability and companies following downsizing in the existing
available staff and cutting down of the perks and salary corrections. Globally the financial
sector sacking the existing base of employees in high numbers in US the major example
being CITI Group same still followed by others in hospitality industry Jet and Kingfisher
Airlines too. The cut in salary for the pilots being 90 % can anyone imagine such a huge cut
in salary.

In the globalized market scenario, the impact of recession at one place/ industry/ sector
peculate down to all the linked industry and this can be truly interpreted from the current
market situation which is faced by the world since approx 2 month and still the situation is
not in control in spite of various measures taken to fight back the recession in the market. The
badly hit sector is being the financial sector, and major issue being the "LIQUIDITY Crises"
in the market.

In-spite of the various measures to subsidies the impact of the recession and cut down the
inflation present nothing really sound have been done.

Various steps taken by RBI to curb the recession in the economy and counter act the
prevailing situation.

The sudden drying-up of capital inflows from the FDI which were invested in Indian stock
markets for greater returns visualizing the Potential Higher Returns flying back is continuing
to challenge liquidity management. At the heart of the current liquidity tightening is the
balance of payments deficit, and this NRI deposit move should help in some small way.

To curb the liquidity crises the RBI will continue to initiate liquidity measures as long as the
current unusually tight domestic liquidity environment prevails. The current step to curb
these being lowering of interest rates and reduction of PLR. However, the big-picture story
remains unchanged – all countries in the world with current account deficits and strong credit
cycles are finding it difficult to bring cost of capital down in the current environment. India is
no different. New measures do not change our view on the growth outlook. Indeed, we
remain concerned about the banking sector and financial sector. The BOP- Balance of
Payment deficit – at a time when domestic credit demand is very high – is resulting in a
vicious loop of reduced access to liquidity, slowing growth, and increased risk-aversion in the
financial system.

In total the recession have turned down the growth process and have set the minds of
economists and others for finding out the real solution to sustain the economic growth and
stability of the market which is desired for the smooth running of the economy.

Complete business/ industry is in dolled rum situation and this situation persist for a longer
duration will create the small business to vanish as they have lower stability and to run
smoothly require continuous flow of liquidity which is derived from the market.

In present situation down fall in one sector one day leads to a negative impact on the other
sector thus all together everyone feel the impact of the Financial crises with the result of the
current recession which started in US and slowly and gradually due to linked global world
have impacted everyone.

Solution for the problem still remain at the top of the mind of every one, still everyone facing
the impact of recession but how long is the major question which is of great importance.

Equity is the ownership interest of investors in a business firm. Investors can own equity shares in a
firm in the form of common stock or preferred stock. Equity ownership in the firm means that the
original business owner no longer owns 100% of the firm but shares ownership with others. On a
company's balance sheet, equity is represented by the following accounts: common stock, preferred
stock, paid-in capital, and retained earnings. Equity can be calculated by subtracting total liabilities
from total assets.

Stock analysis is a term that refers to the evaluation of a particular trading instrument, an investment
sector or the market as a whole. Stock analysts attempt to determine the future activity of an
instrument, sector or market. There are two basic types of stock analysis: fundamental analysis and
technical analysis. Fundamental analysis concentrates on data from sources including financial
records, economic reports, company assets and market share. Technical analysis focuses on the study
of past market action to predict future price movement
Each investment alternative has its own strengths and weaknesses. Some options seek to
achieve superior returns (like equity), but with corresponding higher risk. Other provide
safety (like PPF) but at the expense of liquidity and growth. Other options such as FDs offer
safety and liquidity, but at the cost of return. Mutual funds seek to combine the advantages of
investing in arch of these alternatives while dispensing with the shortcomings. Indian stock
market is semi-efficient by nature and, is considered as one of the most respected stock
markets, where information is quickly and widely disseminated, thereby allowing each
security’s price to adjust rapidly in an unbiased manner to new information so that, it reflects
the nearest investment value. And mainly after the introduction of electronic trading system,
the information flow has become much faster. But sometimes, in developing countries like
India, sentiments play major role in price movements, or say, fluctuations, where investors
find it difficult to predict the future with certainty.

Banks are the major part of any economic system. They provide a strong base to Indian
economy as well. Even in the share markets, the performance of banks shares is of great
importance.

Thus, the performance of the share market, the rise and the fall of market is greatly affected
by the performance of the banking sector shares and this report revolves around all factors,
their understanding and a theoretical and technical analysis

A lot of investors trading in the financial markets with securities and stocks are trying to
foresee the market movements with the help of accessible information of the press. This may
concern the question will securities with higher prospective benefits get greater revenues to
securities with lower prospective benefits? These ideas can be investigated using time
research and deeper analysis. If a security is determined precisely, the future return of the
security will come to the beta at the securities market line. Nevertheless, if it goes down that
line then that states the security is understated and it is overrated if it goes above the line. In
any situation, regulations have to be implemented.
Security market line is a line that shows the risks against revenue in the trading market at a
specified time and can expose all the securities that are in a good demand. It is also called
characteristic line or SML. Security market line really shows the outcomes of the financial
capital asset pricing model. It is also called CAPM formula. Risk on the market is represented
through the X-axis also called beta. Prospective revenue is represented through the Y-axis.
Securities risk premium is identified with the help of security market line.
Security market line turns out to be an effective instrument in identifying if a security
involved in your Security market gives sensible prospective revenue for specified risks. Your
securities are represented on the chart with security market line. So, if the securities risks
against the prospective profits are situated above the line it is undervalued security. It is so, as
the trader supposes to get higher revenue for specified risk. The asset that is situated below
the line is overvalued. This can happen when the trader can take less profit for the considered
risk. Take this effective knowledge for your consideration and use for earning profits.

Fundamental Analysis:
Fundamental analysis refers to the study of the core underlying elements that influence the
economy of a particular entity. It is a method of study that attempts to predict price action and
market trends by analyzing economic indicators, government policy and societal factors
within a business cycle framework. The fundamental analysis of a company involves the
following parameters:
1. Macroeconomic Analysis
2. Industry Analysis
3. Company analysis

How does an investor determine if a stock is undervalued, overvalued, or trading at fair

market value? With fundamental analysis, this may be done by applying the concept of
intrinsic value. If all the information regarding a corporation's future anticipated growth, sales
figures, cost of operations, and industry structure, among other things, are available and
examined, then the resulting analysis is said to provide the intrinsic value of the stock. To a
fundamentalist, the market price of a stock tends to move towards its intrinsic value. If the
intrinsic value of a stock is above the current market price, the investor would purchase the
stock. However, if the investor found through analysis that the intrinsic value if a stock was
below the market price for the stock, the investor would sell the stock from their portfolio or
take a short position in the stock.

1. Macroeconomic Analysis:

Change in rates by RBI:

Looking at the changing scenario, RBI keeps on changing rates such as Repo Rate,
Reverse Repo Rate and Cash Reserve Ratio. These rates have a direct relation with
Bank’s performance and in turn share prices are linked with bank’s performance. Thus, a
change in these rates or even a speculation of change in these rates affects share prices.

Global Analysis:
Any change in global economy or in other words, global changes also affects Indian
Economy. For example: The recession was first observed in USA and later on it caught its
lead in other countries too. When it entered India, the share market crashed literally. It
affected many banks as ICICI and others, resulting in loss of people’s confidence towards
banks.

Change in Governments Policy:

The government takes desired steps and keeps on reviewing its policies, rules, regulations
and procedures. A change in FDI and FII inflow restrictions, entry exit barriers for foreign
banks in India, EXIM regulations, change in Basel norms, etc. form a part of important
government policies. For example if government allows entry of foreign banks in India, then
competition would rise, and it may happen that those foreign banks may outperform and
leave our own banks far behind. Thus, some restriction would follow and this will definitely
affect share prices.
Effect of Inflation on banking operations:
Several economists have found that countries with high inflation rates have inefficiently
small banking sectors and equity markets. This effect suggests that inflation reduces bank
lending to the private sector, which is consistent with the view that a sufficiently high rate of
inflation induces banks to ration credit.

Effect of monetary policy on Banking Sector:

Monetary policy affects banking sector in many ways. One way is through credit Markets.
Because of imperfect information, incomplete contracts and imperfect bank Competition,
monetary policy may affect banks’ loan supply. In particular, expansive Monetary policy may
increase banks’ loan supply directly (bank lending channel), or indirectly by improving
borrowers’ net worth and, hence, by reducing the agency costs of lending.

Porter’s five forces analysis:

1. Threat of New Entrants. The average person can't come along and start up a bank, but
there are services, such as internet bill payment, on which entrepreneurs can capitalize. Banks
are fearful of being squeezed out of the payments business, because it is a good source of fee-
based revenue. Another trend that poses a threat is companies offering other financial
services. Also, the possibility of a mega bank entering into the market poses a real threat.

2. Power of Suppliers. The suppliers of capital might not pose a big threat, but the threat of
suppliers luring away human capital does. If a talented individual is working in a smaller
regional bank, there is the chance that person will be enticed away by bigger banks,
investment firms, etc.

3. Power of Buyers. The individual doesn't pose much of a threat to the banking industry, but
one major factor affecting the power of buyers is relatively high switching costs. If a person
has a mortgage, car loan, credit card, checking account and mutual funds with one particular
bank, it can be extremely tough for that person to switch to another bank. In an attempt to
lure in customers, banks try to lower the price of switching, but many people would still
rather stick with their current bank. On the other hand, large corporate clients have banks
wrapped around their little fingers. Financial institutions - by offering better exchange rates,
more services, and exposure to foreign capital markets - work extremely hard to get high-
margin corporate clients.

4. Availability of Substitutes. There are plenty of substitutes in the banking industry. Banks
offer a suite of services over and above taking deposits and lending money, but whether it is
insurance, mutual funds or fixed income securities, chances are there is a non-banking
financial services company that can offer similar services. On the lending side of the
business, banks are seeing competition rise from unconventional companies. Sony, General
Motors and Microsoft all offer preferred financing to customers who buy big ticket items

5. Competitive Rivalry. The banking industry is highly competitive. The financial services
industry has been around for hundreds of years and just about everyone who needs banking
services already has them. Because of this, banks must attempt to lure clients away from
competitor banks. They do this by offering lower financing, preferred rates and investment
services. The banking sector is in a race to see who can offer both the best and fastest
services, but this also causes banks to experience a lower ROA. They then have an incentive
to take on high-risk projects. In the long run, we're likely to see more consolidation in the
banking industry. Larger banks would prefer to take over or merge with another bank rather
than spend the money to market and advertise to people.

Market capitalization:

Generally we commit one mistake that we guess the company’s worth from the price of its
stock. It is the market capitalization of the company, rather than the stock price, that is more

Important when it comes to determining the worth of the company. We need to multiply the
stock price with the total number of outstanding stocks in the market to get the market
capitalization of a company and that is the worth of the company. Thus, a company or bank
with high Market Capitalization turns out to be more popular among investors. For example,
HDFC BANK, ICICI BANK and SBI are more popular among investors than other banks
because they have huge market share and market capitalization. As market capitalization
increases, the share price tends to increase and as market capitalization decreases, the share
price tends to decrease.

Price/earnings ratio:

Price/Earnings ratio or the P/E ratio gives us a fair idea of how a company's share price
compares to its earnings. If the price of the share is too much lower than the earning of the
company, the stock is undervalued and it has the potential to rise in the near future. On the
other hand, if the price is way too much higher than the actual earning of the company and
then the stock is said to overvalued and the price can fall at any point. The earnings also have
a direct relation with price which is already explained above.

Internal affairs of the company:

Any happening inside the company or any internal news does affect its share price. For
example any key person moving out of the company, acquisition or takeover or merger news,
share split, employee strike and any other thing internal to the affairs of the bank affects the
share price. A positive note from the internal affairs takes the price to new highs and a
negative does vice versa.

Interest rates:
Interest rates play a major role in determining stock market trends. Bull markets (those in an
upward market) are usually associated with low interest rates and high Capital Gains, and
bear markets (those in a downward trend) with high interest rates and low Capital gains.
Interest rates are determined by the demand for capital – pushes them up and normally
indicates that the economy is thriving and that shares probably expensive. Low interest
indicate low demand for capital, thus liquidity builds up on the economy, driving share price
down. Other interest rates like that of on Deposits and Borrowings also have impact on share
prices.

Other factors:

Other factors like Growth of the company, figures of deposits, advances, balance sheet, Profit
and Loss Account, etc. Also affect the share prices drastically. A discussion for the same is
done in later part of the report.

EXTERNAL FACTORS:

After studying the internal factors, let’s take a look at some External Factors which affect the
Share Prices.

Sentiments:

Investor sentiment is almost impossible to predict and can be infuriating if, for example, you
have bought shares in a company that you think is a good „buy‟ but the price remains flat.
Investor sentiment is influenced by a wide variety of factors. Share prices can, for example,
be flat during the summer simply because so many major investors are on holiday or
attending major sporting events such as Royal Ascot and Wimbledon, hence the adage „sell
in May and go away‟. Investor sentiment can lead to irrational buying or selling of shares and
result in bull and bear markets. A bull market is when share prices rise while a bear market is
when they fall. In the technology boom of the late 1990s, for example, investors paid
extremely high prices for shares and ignored traditional valuation measures, such as P/E
ratios. This carried on until 2000 when investors belatedly realized these shares has risen too
far and resulted in a three year bear market in shares. Thus, Sentiments of investors affect the
share prices a lot and this is something unpredictable and immeasurable factor, but still the
most important one.
Company news and other news:

The way investors interpret news coming out of companies is also a major influence on share
prices. If, for example, a company puts out a warning that business conditions are tough,
shares will often drop in value. If, however, a director buys shares in the firm, it may be a
signal that the company’s prospects are improving. Companies put out a great deal of news
and most of the major announcements are covered by the financial press. But some
announcements not regarded as so important and sometimes, particularly among smaller
firms that are monitored less by investors and financial journalists, indicators of the
company’s health can be missed. Takeovers or even rumours of takeovers also have a big
influence on prices. This is because investors expect the bidder to pay a premium to
shareholders. Also any other news or speculation about factors like change in Repo Rate,
Cash Reserve Ratio, Reverse Repo Rate, any change or likely change in the policies of
government or RBI or SEBI, any new guidelines issued by the concerned authority, etc.
affect the price of the share. A positive news in any of these respects leads to a rise in price
and a negative takes it to the other side.

Thus, news in any respect is undoubtedly a huge factor when it comes to stock price. Positive
news about a company can increase buying interest in the market while a negative press
release can ruin the prospect of a stock. Having said that, we must always remember that
often times, despite amazingly good news, a stock can show least movement. It is the overall
performance of the company that matters more than news. It is always wise to take a wait and
watch policy in a volatile market or when there is mixed reaction about a particular stock.

Demand and supply:

This fundamental rule of economics holds good for the equity market as well. The price is
directly affected by the trend of stock market trading. When more people are buying a certain
stock, the price of that stock increases and when more people are selling the stock, the price
of that particular stock falls. Now it is difficult to predict the trend. Thus, we should be very
careful while dealing in stocks as buying or selling pressure may lead to steep rise or fall in
price of the shares.
Analysts’ reports:

Reports produced by independent analysts also influence share prices. If an analyst changes
their recommendation from „sell‟ to „buy‟, for example, the shares will often rise in value.
Analysts‟ reports are produced primarily by investment banks for professional investors,
although some stockbrokers will make their research available to private investors. We may
find summaries of some reports published on financial news websites or in newspapers and
magazines. Some investment banks also publish their reports on their websites for free. We
should remember that the recommendation an analyst puts on a company will affect its share
price very quickly and can become irrelevant within hours. This is because the analyst will
usually say a stock is a „buy‟ within a particular price range. If the price moves above their
targets the improvements the analyst expects may be „priced in‟ and so the shares are not
worth buying. But analysts‟ reports are always worth reading, even if the recommendation is
out of date. The reports usually contain a great deal of useful information on the company
and how its business is developing. They also often look at how the company rates against its
competitors.

The economy:

The health of the global economy has a fundamental influence on share prices because it is
ultimately responsible for driving company profits. Broadly speaking, if the economy is
growing, company profits improve and shares will become more highly valued. If the
economy is weakening, company profits will fall and share prices will go down. Investors
look at a vast amount of data to try and work out what is going to happen to the economy and
shift their portfolios before the events occur. This is why we will often see markets move
well ahead of an actual event occurring. For example, we could get little reaction from the
stock market when interest rates rise. This is because investors have already anticipated the
shift months in advance and adjusted their portfolios beforehand. We can usually assume that
the stock market will anticipate moves in the economy by around six to nine months. So if we
want to stay ahead of the game we need to follow economic data as closely as the
professionals. The kind of information we need to play close attention to is: employment
data, the reports put out by the Monetary Policy Committee (to get an idea where interest
rates are headed), trade with other countries, retail sales and manufacturing. Sentiment
surveys produced by trade bodies such as the Confederation of British Industry are also
important indicators of where the economy is heading.

It is not only news about the US and UK economy that will impact on share prices. The
signals coming out of other major economies, particularly the US and UK‟s major trading
partners, such as the Europe and Asia will also affect US and UK shares as what happens in
these economies will have an impact on our own. When looking at economic data, we need to
think not only how the wider economy will be affected but whether certain areas will be more
affected than others. A rise in interest rates is, for example, often bad news for house builders
as people feel less confident about taking on debt. Retailers are often badly affected too as
people spend less. Pharmaceutical companies are, however, usually unaffected as people’s
demand for drugs is not influenced by the state of the economy. Companies whose profits are
closely tied to the health of the economy are known as “cyclical” stocks. Those businesses
that aren’t too affected by the economy are called “defensive” stocks. If economic conditions
deteriorate you will often see investors shift from cyclical stocks to defensives. Thus, the
economic health of an Economy affects the Share Prices.

Press and broking house recommendations:

The financial pages of most national newspapers and investment magazines usually contain
share tips. Like analysts‟ reports these tips can have a major influence on share prices. If a
journalist recommends a share, the price will usually rise and if they write a negative story
the price will fall. These moves usually happen very quickly so if we follow the
recommendation it often makes sense to do so as soon as possible. The Broking House also
recommends BUY or SELL for particular shares based on their own research analysis. They
display these recommendations in leading media such as Television and News Papers. Thus,
these recommendations affect the price of shares and lead the market in the direction these
recommendations take.

Technical influences:

Share prices can rise and fall for a variety of technical reasons that may have nothing to do
with the actual outlook for an individual company or the outlook for the market. It is, for
example, a common occurrence for share prices to drop back after a strong rally. This
happens because investors take profits on some of the shares that have risen in value,
protecting their gains just in case the shares start to slip back. Investors often refer to this as
market consolidation. Another technical reason for share prices to rise or fall is the quarterly
adjustment in the FTSE 100™ index. Shares that are expected to enter the FTSE 100™ may
experience a sharper rise than one would expect in the weeks beforehand while shares that
leave the index can fall more sharply. This happens because funds that simply track the index
have to match the composition of the index. Some professional fund managers who hold the
affected stocks also adjust their portfolios as they do not want their holding to be too far
above or below the company’s weighting in the index. Share prices can also be affected by
investors who use technical analysis to drive their investment techniques. Technical analysis,
also known as Chartism, is simply the study of past share price movements and stock market
index trends, which are then used to forecast how shares and stock markets will behave in
future. Market makers can also influence prices. If they, for example, do not own enough
shares to balance their books they will have to buy more. Market makers also influence prices
if the market is looking flat, reducing prices to attract buyers. Thus, technical reasons can also
be a cause for the rise or fall in the prices of shares.

3.