📘 8.1 Equity as an Investment
Equity is a financial instrument that provides ownership in a company. Equity shareholders have a residual claim on the business — i.e., they receive what is left after all other liabilities are paid【251:5†NISM Series X-A-Investment Adviser Level 1 2025-2.pdf】.
📈 Capital Appreciation
Equity investors earn returns primarily through increase in share prices over time. There is no fixed return, but growth potential is higher than debt.
💰 Dividend Income
Dividends are profit distributions. They are not guaranteed and depend on the company’s performance and board decisions.
🗳️ Voting Rights
Equity holders get to vote on key company decisions including mergers, acquisitions, and board appointments.
📉 No Fixed Obligation
Unlike lenders, equity investors are not entitled to fixed interest. Companies are not obligated to repay equity capital or dividends.
🧠 Higher Risk, Higher Return
Equity offers potentially higher returns but involves higher volatility and no capital guarantee. Suitable for long-term, risk-tolerant investors.
- Debt: Fixed return, priority in payment, low risk, no ownership
- Equity: Variable return, residual claim, higher risk, ownership + control
Equity investments are ideal for wealth creation over long periods, while debt is preferred for income stability and capital protection.
📘 8.2 Diversification of Risk through Equity Instruments
Equity carries higher risk than bonds, but diversification helps reduce exposure to individual company or sector failures. Risk reduction is achieved by combining stocks that don’t move together — either across industries (cross-sectional) or over time (time series):contentReference[oaicite:1]{index=1}.
🌐 Cross-Sectional Diversification
Holding stocks from different sectors, industries, and geographies at a given time. Reduces sector-specific or idiosyncratic risks.
Example: Tech + Pharma + FMCG + Banking + Global ETFs
⏳ Time Series Diversification
Investing across time periods helps smooth returns. Market cycles tend to cancel out short-term volatility over long-term holding.
Motto: “Time in the market beats timing the market.”
🔁 Business Cycle & Sector Timing
Different sectors perform differently during the business cycle:
- Counter-cyclical: Do well in recession (e.g. FMCG, Pharma)
- Leading sectors: Recover early (e.g. Auto, Infra)
- Lagging sectors: Recover later (e.g. Banking, Metals)
This pattern enables rotation strategies and hedging risks across economic phases.
📘 8.3 Risks of Equity Investments
Equities are considered a high-return but high-risk asset class. Various types of risks impact equity performance. Some can be managed or diversified, while others are market-wide and unavoidable【257:1†NISM Series X-A-Investment Adviser Level 1 2025-2.pdf】.
📉 8.3.1 Market Risk
Systematic risk arising from macro factors like global cues, interest rates, policy changes, inflation. Affects all listed stocks. Measured by Beta. Cannot be diversified but can be hedged.
🏭 8.3.2 Sector-Specific Risk
Risks unique to a business sector (e.g., travel bans affecting airlines). Also known as idiosyncratic risk. Can be managed through sectoral diversification.
🏢 8.3.3 Company-Specific Risk
Risk related to a specific company’s performance, management, or strategy. Can be reduced by holding a diversified portfolio across companies.
🔁 8.3.4 Transactional Risk
Arises when the counterparty fails to deliver shares or funds. Mitigated by trading through regulated stock exchanges with settlement guarantees.
💧 8.3.5 Liquidity Risk
Occurs when an investor cannot exit due to lack of buyers. Measured by impact cost. Higher in small-cap or thinly traded stocks.
💱 8.3.6 Currency Risk
Foreign investors face returns volatility due to exchange rate movements. FPIs react to currency swings, impacting markets significantly.
Macroeconomic conditions like inflation, GDP growth, interest rates, oil prices, and global geopolitics also affect equity markets. These form the broader economic risk backdrop for all investors.
📘 8.3 Risks of Equity Investments
Equities are considered a high-return but high-risk asset class. Various types of risks impact equity performance. Some can be managed or diversified, while others are market-wide and unavoidable【257:1†NISM Series X-A-Investment Adviser Level 1 2025-2.pdf】.
📉 8.3.1 Market Risk
Systematic risk arising from macro factors like global cues, interest rates, policy changes, inflation. Affects all listed stocks. Measured by Beta. Cannot be diversified but can be hedged.
🏭 8.3.2 Sector-Specific Risk
Risks unique to a business sector (e.g., travel bans affecting airlines). Also known as idiosyncratic risk. Can be managed through sectoral diversification.
🏢 8.3.3 Company-Specific Risk
Risk related to a specific company’s performance, management, or strategy. Can be reduced by holding a diversified portfolio across companies.
🔁 8.3.4 Transactional Risk
Arises when the counterparty fails to deliver shares or funds. Mitigated by trading through regulated stock exchanges with settlement guarantees.
💧 8.3.5 Liquidity Risk
Occurs when an investor cannot exit due to lack of buyers. Measured by impact cost. Higher in small-cap or thinly traded stocks.
💱 8.3.6 Currency Risk
Foreign investors face returns volatility due to exchange rate movements. FPIs react to currency swings, impacting markets significantly.
Macroeconomic conditions like inflation, GDP growth, interest rates, oil prices, and global geopolitics also affect equity markets. These form the broader economic risk backdrop for all investors.
📘 8.4 Overview of Equity Market
Equity securities represent ownership claims on a company’s net assets. The equity market allows investors to buy/sell these ownership shares through regulated exchanges or private offerings. Equity markets are central to long-term wealth creation.
🏛️ Listed Equity
Traded on stock exchanges. Offers high liquidity, transparency, and regulatory protection. Companies must disclose financials regularly and meet listing obligations.
📃 Unlisted Equity
Shares of privately held companies. Less liquid and riskier due to limited disclosure. Valuation is complex and returns depend on long-term business growth or IPOs.
⚖️ Investment Scope
Equity market offers varied instruments and segments — small-cap to large-cap, growth to value stocks — aligning with different investor goals and risk profiles.
🔍 Need for Understanding
Investors must analyze fundamentals, sectors, valuation, and risk before making allocations. Equity investing requires patience, discipline, and time horizon alignment.
📘 8.5 Equity Research and Stock Selection
Equity research helps investors choose the right stocks for their portfolio by assessing the business fundamentals, market conditions, and intrinsic value. The goal is to identify undervalued stocks and avoid overpriced ones using structured methodologies and research tools.
🔍 8.5.1 Buy-Side vs Sell-Side Research
Sell-Side: Analysts working with brokerages or investment banks. They publish public research reports with recommendations (Buy, Hold, Sell) and price targets. Their focus is on wide coverage across sectors to support trading and advisory services.
Buy-Side: Analysts at mutual funds, pension funds, hedge funds, or PMS. Their research is private, supports internal investment decisions, and needs to be highly accurate to generate superior portfolio returns.
📚 8.5.2 Fundamental Analysis
Evaluates a company’s intrinsic value based on financial and economic data. Uses the EIC Framework (Economy → Industry → Company). The analysis helps investors assess if a stock is underpriced or overpriced versus its true worth.
- Top-Down: Start with macroeconomics → industries → companies
- Bottom-Up: Start with company → industry → macro view
📈 8.5.3 Stock Analysis Process
Steps include:
- Review macroeconomic indicators (GDP, inflation, rates, policy)
- Understand business cycle and sector rotation
- Perform industry life cycle and SWOT analysis
- Use financial ratios and company reports to assess performance
This builds the foundation for company selection before valuation.
💡 8.5.4 Estimating Intrinsic Value
Valuation is the process of calculating the true worth of a stock compared to its market price. Common methods include:
- Discounted Cash Flow (DCF): Based on expected future cash flows
- Asset-Based: Used when assets drive value (real estate, gold, NBFCs)
- Relative Valuation: Compare financial ratios with industry/peers
📊 8.5.5 Key Valuation Multiples
- P/E Ratio: Price to earnings — how much investors pay for ₹1 of earnings
- P/B Ratio: Price to book — often used in financial sector
- PEG Ratio: P/E adjusted for growth rate — ideal value is around 1
- EV/EBITDA: Enterprise value to operating cash flow — used for capital-heavy firms
- Dividend Yield: Dividend income as % of share price
- Earnings Yield: Inverse of P/E — shows return on investment
Different sectors prefer different metrics — P/E for consumer, P/B for banks, EV/EBITDA for capital intensive businesses.
📘 8.6 Combining DCF and Relative Valuation
Investors often combine Discounted Cash Flow (DCF) and Relative Valuation methods to get a more accurate estimate of a stock’s fair value. Each technique has strengths, and when used together, they provide cross-verification and confidence in investment decisions.
📉 Discounted Cash Flow (DCF)
- Calculates intrinsic value using forecasted cash flows
- Heavily dependent on growth rate and discount rate
- Useful for long-term, predictable businesses
📊 Relative Valuation
- Compares a company’s price to similar firms using ratios
- Key ratios:
P/E,P/B,EV/EBITDA,PEG - Best used when good peer data is available
🔁 Connection Between Both
Multiples are simplified versions of the DCF model. For example, P/E = Price / Earnings is linked to expected future profits and required return.
- Use DCF to calculate long-term intrinsic value
- Use Relative Valuation for comparing similar companies
- Use together to cross-check results and spot over/under valuation
📉 8.7 Technical Analysis
Technical analysis involves forecasting stock price movements based on historical data — primarily price and volume — without analyzing company fundamentals. It assumes all known information is already reflected in the current market price.
🔍 8.7.1 Key Assumptions
- Prices are driven by supply and demand.
- Markets move in identifiable trends.
- Trends tend to persist and change only with shifts in supply/demand.
- Past price and volume patterns can help predict future movements.
📊 8.7.2 Technical vs Fundamental Analysis
Fundamental Analysis: Focuses on intrinsic value using earnings, assets, and business performance. Used for long-term investing.
Technical Analysis: Focuses on short-term price action and trends. Used for entry/exit timing. Does not consider intrinsic value.
Tip: Many investors combine both — use fundamental analysis to select stocks and technical analysis to decide when to buy or sell.
📈 8.7.3 Popular Technical Tools
- Trendlines: Connect highs and lows to identify direction (uptrend/downtrend/sideways).
- Moving Averages: Smooth out price data. Common types: 50-day, 200-day.
- Bollinger Bands: Use standard deviation around moving average to detect overbought or oversold levels.
📘 8.7.4 Technical Analysis in Fixed Income
Though more common in equities, technical tools can also be applied to bonds and fixed income instruments when price and volume data is available.
Trend analysis, moving averages, and oscillators can be used to track price momentum in bond markets, especially for active traders or institutional participants.
