Investment Management From the Investor’s Perspective

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Introduction

Before starting on the proposal, I would like to mention a brief definition of investment management. In simple words, investment management is the method of managing funds that include investments, financial plans, banking and taxes. It is about achieving the goals of investments under specific restrictions e.g. getting the maximum possible returns under a known risk. In order to meet such goals, the investor trades inequities in stocks like funds or real estate. Effective management of such investments can give the investor high returns for a certain level of risk. According to Economywatch, “Investment management services are sought by investors, which could be companies, banks, insurance firms or individuals, with the purpose of the meeting stated financial goals.” (Economywatch, 2010)

Purpose of the Research

The objective of this paper is to formulate a research plan for investment management from the investor’s perspective. Now let us understand what investors normally do to attain their objectives. According to S. R. Vishwanath and Chandrasekhar Krishnamurti, “Investing behavior of an individual investor is directly related to the thinking, feeling, and acting of all investors. The aggregate of all investors is, of course, the market and acting of all investors. The aggregate of all investors is, of course, the market itself. Thus, the best guide to how markets function is man himself.” (Vishwanath et al, 628). Normally, the investor will try to assess the value of an asset, based on the information that he has about that particular asset. Different investors will have different values in their minds because the source of their information is different. The price depends on the demand and supply also. Such information is either private or public. By private information, I mean the one that comes from within the company. The people who might give such information may be managers, company directors or even the stockholders in the company. But prior to taking the information to be genuine, the investor should see whether it is authentic or not. A way to check this might be to check whether the person who is giving that information is himself benefitting from that asset or not.

Research project and aims

The aims of my research are to visualize the factors responsible for the success or failure of any stock and to what extent are analysts responsible for such results. In order to understand the various aspects of investment management, research was conducted and during the research, various people from the stock market were consulted. Several journals and magazines were also taken into consideration. The feedback from the stock traders was very helpful because it was an input based on practical experience and not theory. Based on the feedback, I was able to consolidate the following information with regard to the precautions that an investor should take before investing in any stock.

The investor should go through the financial reports of the company that have been made public since the last earnings. The income statement is the first document that he should study thoroughly. Then he should also study the various financial ratios like the liquidity ratios, financial leverage ratios, activity ratios, and profitability ratios and market value ratios. By way of the income statement and the ratios, he should be able to predict the future growth of the company.
The investor should be able to further update his projections by getting information about the macro-economic that affect future growth. Thanks to modern technology, information about the amendments in financial policies are easily available.
The investor can also benefit from getting future prospects and growth information from the competitors of the company.
Companies normally don’t disclose certain information that might be a hindrance in attaining a good response from the stock market. So the investor should find someone from inside the company who can give him that critical information. Such information is very important to assess the future growth of the company
One of the most important factors that divulge the company’s future prospects is the graph of earnings per share (EPS) and cash flow (CF). If both the lines are on the upward slide and are rising together, then it is safe to invest in the company. On the contrary, if there is any deviation, it depicts danger. Investors should avoid investing in such companies.
Once a stock is in the market, considerable information keeps on coming about that stock. The information that comes from the companies includes per-share earnings, dividends, company take over, etc. some information is received from the competitors also. All such information generally has an effect on the price of the stock. The companies, who have their stocks in the market, generally report about their present and future prospects, on a quarterly basis. The positive or negative reaction to this information depends on how much the earnings report has lived up to the expectations of the investors. In a competitive market, the reaction is spontaneous if there is something new in the reports revealed by the company. The reaction is positive if there is some improvement in the reports and negative if the report shows a decrease in the progress of the company.
One of the major drawbacks is that the earning thrust tactics depend on two of the most fragile links. One is the earnings report and another forecast from analysts. The earnings report such as the income statement is issued by the company and as such, can be manipulated. The forecast reports from the analysts are normally biased. These analysts influence the investors by such reports and forecast and gain business. But such gains by any company are short-lived (a few weeks or months). According to an online article in RankUHigh, “The most recognizable of all risks is the continual adjustment of a stock’s price to new information entering the market. We recognize that there exists a strong relationship between new information and the price movement in a stock.” (RankUHigh, 2011) A huge amount of money is involved in acquisitions and as such, there is a great impact on the prices of the stock. A long-term tactic by investors may be to invest in such stocks if they believe that the company will deliver what it has promised in the report. If the acquisition is hostile, the target company might have the following distinctiveness:

The company stocks haven’t been profitable in the years prior to the takeover.
The company stocks haven’t performed well in comparison to others in the same industry, prior to the takeover.
The insiders of the company don’t hold much of the stocks.

It’s easy to identify prospective target companies. Look for companies that have low holdings by the insiders, low ‘price to book’ ratio and low ROI. Investors who believe that after the acquisition, the company will deliver what it promised (greater earnings and growth) that the time of announcement. The possibility of success in acquisition stocks is more in situations where:

The management changes because the new management will try to build up the company image and work efficiently.
The target company is of the same business.
The motive of the merger is cost-saving and not growth.
The target company is smaller than the company that is going for the acquisition and not where both are equal.

The aims of my research are to visualize the factors responsible for the success or failure of any stock and to what extent are analysts responsible for such results.

Questions for Research

Some research questions may be:

How can you benefit from the forecasts by analysts? How will you know whether an analyst is good or not?
What according to you are the deciding factors of a stock’s success?
If you come to know that a new IPO is coming, what is the procedure that you’ll follow in order to invest in it?
What are the precautions that an investor should take while investing in stocks?
What are the risks involved in stock trading?
How do acquisitions affect the stock market?

Methodology

The first and foremost thing that the investor should do before investing in any stock is to do the SWOT analysis. Instead of taking into consideration the forecasts made by all the analysts on an average, I identified such analysts who played an important role and concentrated my attention on the revisions made by them in the forecasts of any particular company. This is because if one of the analysts makes recommendations for a particular weak stock, others follow and thus a strong buy opinion of the stock is created. I also kept an eye on companies that showed greater positive growth. I learned that the drift could be made good use of, by buying the stocks of that company. In stocks where acquisition of any company is being done, the most lucrative offer should be to invest in the target company before it announces the acquisition. The investor can also benefit from “risk arbitrage”. Risk arbitrage is the price drift from the day the announcement of acquisition is made and to the takeover day. Investments during this period can fetch good returns. As an ambitious and smart investor, I wanted to have such an information system that delivered information to you instantaneously. Normally, the information from the companies reaches the trading floor 15 to 20 minutes later. These 15 to 20 minutes are very critical. If the information has some positive remarks then once the information reaches the trading floor, the prices will shoot up. So if the investor gets the information before it reaches the trading floor, he can always have an upper hand. It is very critical to know when to buy a particular stock but at the same time, it is of great importance to know when to sell the stocks. One should act immediately as soon as he/she has any new information because in the stock market, information keeps on fading with the passage of time and the effect will not be the same. Technically speaking, the following are the methods of research to follow while trading in stocks.

Data Mining

We can always learn from the experiences of people. Very critical information can be had from the previously available data. Such data can help us in responding effectively to the ever-changing market. To have such kind of information, it is a must to have access to the hardware and software of investment management. If we have better and more accurate data, our analysis will also be accurate.

Statistical Validation

Statistical validation can be had by employing the Monte Carlo analysis. In the Monte Carlo analysis, random sampling of data is repeated in order to obtain the required results. For the calculations, it is advisable to use a computer because it can be relied upon for repetitive calculations and due to its use of random figures. Usually, Monte Carlo analysis is used when the desired results cannot be achieved by simple calculations. The Monte Carlo analysis is able to provide us with hundreds and thousands of possible results, those simple calculations cannot give us. Such analysis proves to be handy in situations where there is a lot of uncertainty. This includes the calculation of risk factors in investment management. There are two instances where Monte Carlo analysis should be done. Firstly, where the solution to a problem is very complicated and secondly, where there are a lot of uncertainties. Similarly, there are two instances where Monte Carlo analysis should not be done. Firstly, where the calculations are expected to take too long and secondly, where the calculations are very simple and can be done without the analysis.

Benchmark

Benchmark is the standard against which we are able to compare the performance of the stocks. It is usually an index of the performance of similar stocks in the past. The Standard & Poor’s 500 Index is one of the most widely accepted benchmarks. Individual investors and professionals can gauge the market and review the performance of their investments by comparing them to the suitable benchmark.

Attribution and Performance Analysis

The investor can do the attribution and performance analysis in the following three different ways.

Multi-Factor Analysis

The investor needs to gather information about the company in which he wants to invest. Such information includes the different financial ratios such as P/E ratio, cash ratio, quick ratio, etc. A great deal of information about the performance of the company can be had by such analysis.

Style Analysis

This style was developed by noble laureate William Sharpe. Going by his name, this ratio is also called the Sharpe ratio. But this is not a commonly used method. Information about the related benchmark and the portfolio returns is required to calculate this analysis. It is also very easy to explain.

Return Decomposition Analysis

In the return decomposition analysis, the benchmarks are compared to the attribute performance. It is the most widely accepted system of analysis. It has the ability to focus on the allocation or selection of the stocks.

Transaction Cost Analysis

All investors have certain priorities to finish the trades in hand. This leaves them with little time to make all the analyses that we talked about. Although there are some stocks that are supposed to be good in terms of returns, at times, it may be very dangerous to rely on assumptions. On such occasions, the transaction cost analysis that is provided by the service provider proves to be very helpful. Such analysis contains details about the usual pattern of trading and performance.

Portfolio Construction and Optimization

A portfolio of the company in which the investor is planning to invest should be made. The portfolio should contain information about the company’s various factors such as the kind of industry, its turnover, its safety standards, its risks, its style of working, its responsibility towards society, etc. Points should be given to each factor according to our understanding. The total points should be the deciding factor.

Leverage Analysis

The leverage analysis is related to the percentage of change in the profits and sales of a company. This analysis shows us the risks that the company is facing. Risks may be of three kinds – business risk, financial risk and force of sale risk. A frequent change in the EBIT of a company shows that the company is having some internal problems for e.g. labor problems. A frequent change in the company’s earnings before taxation or earnings per share shows that the company is having more debts and equity. The investor can take heed from such analysis and abstain from investing in such a company.

Risk Management

Risk is a huge topic or in other words, the scope of risk is vast. Most of the stocks are not known as far as their performance in the stock market is concerned. One should invest with great care in such stocks. Another risk is that the returns on stocks keep fluctuating. One should be up to date with all the information that we have discussed earlier in this paper. It is quite possible that the fluctuation in the stock rates of a company is due to some risk. Sometimes the investor buys stocks that have a lower price, but usually are priced higher, in the assumption that he will sell them when the price rises again. This is a big mistake that people do. One cannot predict the future prices in the stock market.

Rough Time Plan

Once you understand the basics of Investment Management, it will not be difficult at all to answer any question based on this topic. I have tried to explain in detail based on practical experience and also according to the technicalities. You should try and remember the technical terms used in this paper. Always remember to safeguard your interest as an investor. Take maximum possible precautions. In order to answer each of the questions mentioned in this paper, you should not take more than 3-4 minutes.

Feasibility as a PhD topic

Investment Management is a vast topic, suitable for doing research in PhD. It further enhances the knowledge that you have gained during your graduation. If you want to take investment management as a career in life, this will quite helpful. By doing this dissertation, you will be able to develop the required skills that will prove to be handy when you actually start investment management as your career. And as you proceed, you’ll gain practical experience as well.

References

Economywatch. (2010) Investment Management, Web.

RankUHigh. (2011) Stock Market Investing Guide, Web.

Vishwanath, S. R. and Krishnamurti, C. (2009) Investment Management: A Modern Guide to Security Analysis and Stock Selection, Germany: Springer.

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