Behavioral Finance Investors Corporation and Markets

Question: Discuss about the Behavioral Finance Investors Corporation and Markets. Answer: Introduction The selection of stocks for investment is a crucial task requiring skills and knowledge to analyze the risk and return of the different alternatives. The analysts generally employ two methods such as technical and fundamental to analyze and select the stocks for investment. The technical analysis is concerned with analyzing trend in prices and predicting the future movements based on the analysis of historical trend (Schlichting, 2013). The fundamental analysis is about evaluation of the financial performance of the company and analysis of the macro economic data to predict the future movements in the prices. There are various techniques used in technical and fundamental analyzes, however the most prominent being used in this report are line chart and moving average (technical) and dividend discount model and PE Multiple (fundamental). In this report, two portfolios have been formed comprising 15 stocks each. One portfolio is based on technical analysis and another is based on fundam ental analysis. Literature Review The analysis of stocks for investment begins with evaluation of the financial performance and position of company and it further goes on analyzing the trends in the historical prices of the stock. Thus, the two aspects such as fundamental and technical are the most crucial in analyzing and selecting the stocks for investment (Schlichting, 2013). However, there are various challenges being paused by theories of efficient market and behavioral finance in analysis and selection of the stocks. The theories of efficient market hypothesis and behavioral finance provide a view that no one can beat the market. Even the selection of stocks by carrying out comprehensive analysis of technical and fundamental aspects can not avoid the possibility of loss when behavioral influences persist (Schlichting, 2013). The fundamental concepts and theories of finance such as modern portfolio theory of Harry Markowitz and capital asset pricing model of Sharpe have provided strong basis to analyze the performance and selection of the stocks (Elton, et al., 2009). These fundamental theories of finance are based on the belief that the investor act rationally. Further, these theories also assume that the capital markets are efficient and remain so at all times because the required information is available to all the market participants at all times (Elton, et al., 2009). However, the theories of behavioral finance oppose the view that all the investors are rational. Further, the view that capital markets are efficient is opposed by the theory of efficient market hypothesis. It should be kept in mind that the techniques and models used in fundamental and technical analyzes are based on the assumptions that the investors are rational and capital markets are efficient (Schlichting, 2013). Thus, there exist conflicts between the results of fundamental and technical analysis and the results of behavioral finance and efficient market theories. The investors strive to beat the market by analyzing the stocks comprehensively covering the technical and fundamental aspects, but the efficient market hypothesis states that no one can beat the market (Ackert and Deaves, 2009). Further, the concepts of behavioral finance state that investors can not always be rationale which means that their decisions for purchase and sale the stocks can not always be based on the fundamental and technical analysis. The decisions of investor to purchase and sale the stocks are affected by the behavioral influences sometimes. For example, the global financial crisis of USA occurred in the year 2008 had shaken not only the economy of the USA but of the other countries such as the United Kingdom, China, and Australia as well (Ackert and Deaves, 2009). According to the fundamental concepts of finance, the financial crisis of 2008 should have affected the United States only, but it surprised the entire world (Baker and Nofsinger, 2010). The capital markets all around the world went into depression when the financial crisis was encountered in the United States. The reason for this depression in all the markets was the behavioral influences. When the stocks in the United States fell down, the investors in other countries such as the UK, China, and Australia also started losing faith and they started selling their holdings. The selling pressure created on the stock markets laid the prices of the securities to go down which ultimately culminated into financial crisis (Baker and Nofsinger, 2010). The way behavioral finance affects the understanding of the capital markets, the efficient market hypothesis also provides glimpse of one other side of capital market. The principles of behavioral finance state that investor can not be rationale and the efficient market hypothesis states that market can not be inefficient. The efficient market hypothesis is based on the belief that the prices of securities incorporate all the required information, thus, it is impossible for the investors to take advantage of the information gap and make excessive gains (Kurth, 2013). In other sense, the efficient market hypothesis states that the investors can not find undervalued or overvalued securities to make opportunities to earn profits. However, the fundamental concepts of finance established in the capital asset pricing model and growth rate model of Gordon provides that the securities may be under or overvalued in the market. According to the fundamental principles of finance, the securities trading in the market do not always trade at their true worth (Kurth, 2013). Rational and Methodology The methodology comprises overall framework that help in selection of data and analytical tools to draw inferences from the selected data. Adoption of suitable methodology is crucial to complete the research work in an effective and efficient manner (Phillips and Stawarski, 2016). The present report is directed to research, analyze the stocks, and find out that whether they beat the market or not. The methodology selected for this purpose comprises of two primary methods of stock selection such as fundamental and technical. The fundamental and the technical analysis provide different approaches based on different parameters for selection of the stocks. Since, both the methods are based on different principles and concepts and thus, none of these can be said be superior then the other (Palicka, 2011). In fact both the methods such as fundamental and technical can be said to be complementary to each other. The fundamental analysis results in selection of the stocks which are strong in terms of financial performance whereas the technical analysis provides for selection of the stocks which are showing growth in the prices though, financial performance may not has been good (Palicka, 2011). For the purpose of this report, the stock of CapitaLand Limited is financial strong as depicted from the profit margin ratio of 22.66% (Yahoo finance, 2017). Further, there is another stock comprised in the portfolio formed based on fundamental analysis namely Courts Asia Limited with the return on equity of 8.83% (Yahoo finance, 2017). Thus, the stocks selected based on the fundamental analysis will be good in terms of their financial performance. On the other hand, the stocks selected based on the technical analysis tend to be good in terms of price growth (Palicka, 2011). It is considered better to opt for both the methods of stock selection because it will result in rational choices and the results of the analysis would be meaningful. Thus, for current research, two portfolios have been formed where one comprises 15 stocks selected based on the fundamental analysis and the other comprises 15 stock selected based on the technical analysis Analysis of one Stock from Fundamental Portfolio The fundamental analysis with the dividend discount method and PE Multiple method is considered to be appropriate. In regards to the current report, the stock namely Global Logistic Properties Limited has been analyzed by using these two methods as below: Dividend Discount Model This model is used to compute the intrinsic value of the stock by using the expected dividend (Madura, 2014). The intrinsic value of Global Logistic Properties Limited is computed as below: Dividend Discount Model Dividend expected 0.06 Growth rate 3% Discount rate 5.26% Intrinsic Value 2.57 It could be observed that the intrinsic value of Global Logistic Properties Limited is SGD2.57 arrived at applying dividend discount model. However, the current market price of the stock is SGD2.68 (Yahoo finance, 2017). This implies that the stock is overvalued. PE Multiple Model The intrinsic value of Global Logistic Properties Limited applying PE Multiple Model is given as under (Madura, 2014): PE Multiple Model Industry PE ratio 28.30 EPS of CapitaLand Limited 0.14 Intrinsic Value 3.96 The intrinsic value of the stock as shown in the above table is SGD 3.96 which is higher than the current market price of the stock of SGD2.68 (Yahoo finance, 2017). Thus, as per PE Multiple model, the stock is undervalued. Analysis of one Stock from Technical Portfolio The most commonly used technical methods for analysis of the stocks are line chart and moving average (Kinsky, 2011). The stock of Chip Eng Seng Corporation Ltd has been analyzed by applying these two methods as below: Line Chart: Figure 1: Analysis of Chip Eng Seng Corporation Ltd It could be observed from the trend line shown in the chart that the stocks price has raised higher and higher over the period. Thus, relying upon this trend, it could be said that the stock will be worth investing. Moving Average: The moving average of Chip Eng Seng Corporation Ltd has been found to be SGD0.6307 (refer excel). The moving average can be taken as the cut off level which means that is the price of the stock goes beyond this level, the chances of price going further high increase and conversely if the price of the stock goes below this level, it is more likely that the price of the stock will fall further. Support and Resistance Levels: It has been observed that Chip Eng Seng Corporation Ltd trades in the range of S$0.61 to S$0.75. This means that the stock has a support level of S$0.61 and resistance level of S$0.75. The analysis of support and resistance levels is crucial in deciding the point in time when the sale or purchase of the stock will take place. In case of Chip Eng Seng Corporation Ltd, the investor can sale, if the stock falls below S$0.61 and on other hand, when the stock goes above S$0.75, the investor may consider buying. Figure 2: Support and Resistance Levels Activities in Fundamental Portfolio There are two activities in the fundamental portfolio. Under the activities-1, 700 shares of Global logistic Properties Limited have been sold at the rate of S$2.78 per share on February 09, 2017. The decision to sale 700 shares of Global logistic Properties Limited was taken to book the profits as the stock was on its peak. Further, under the activity-2, 1,044 shares of Wing Tai Holdings Limited were purchased on February 10, 2017 at the rate of S$1.855 (Appendix-2). The amount received on sale of 700 shares of Global logistic Properties Limited was used in buying shares of Wing Tai Holdings Limited. Looking at the fundamentals of Wing Tai Holdings Limited, it was estimated that the stock will grow in future therefore the decision to further increase the holding in the company was taken. Activities in Technical Portfolio There were two activities in the technical portfolio also. Under the activity-1, 800 shares of Tiong Seng Holdings Limited were sold on January 19, 2017 at the rate of S$0.2400 (Appendix-2). It was observed that the price of stock was increasing slowly; therefore, the decision to clear out the position was taken so that the funds could be utilized more profitably. Under the activity-2, the funds released from Tiong Seng Holdings Limited were deployed in Chip Eng Seng Corporation Ltd by purchasing another lot of 278 shares on January 20, 2017. The initial analysis of Chip Eng Seng Corporation Ltd showed potential in the stock, thus, it was considered the best option to deploy the released funds. Evaluation of Performance of both the Portfolios Evaluating the performance of both the portfolios, it could be articulated that the portfolio-2 (technical analysis) performed better than the portfolio-1 (fundamental analysis). The overall return of portfolio-2 has been found to be 6.02% which is greater than the return of portfolio-1 of 4.74% (Appendix-2). Further, it could be observed that both the portfolio-1 also could not beat the market as its holding period return remained lower than the market expected return of 5% (Appendix-3). However, the portfolio-2 beat the market by earning return higher than the expected market rate of return. Conclusion This report covers the aspects of selection of stocks to formulate the portfolios. This report provides learning on various methods of stock evaluation falling under two broad categories such as technical and fundamental. Further, the report also covers the aspects of portfolio analysis in a great detail. Different techniques such as dividend discount model, PE Multiple model, line chart, and moving average have been explored in this report. Further, the discussion in this report covers extensively the aspects of efficient market hypothesis and behavioral finance. The report provides learning on the efficiencies and inefficiencies of the market. Further, the concepts of behavioral finance have been elaborated with the practical application these concepts in the live events such as global financial crisis of 2008. The analysis of two portfolios depicts that portfolio-1 could not beat the market with 4.74% holding period return (HPR); however, the portfolio-2 was able to beat the marke t with holding period return of 6.02% References Ackert, L. and Deaves, R. 2009. Behavioral Finance: Psychology, Decision-Making, and Markets. Cengage Learning. Baker, H.K. and Nofsinger, J.R. 2010. Behavioral Finance: Investors, Corporations, and Markets. John Wiley Sons. Elton, E.J., Gruber, M.J., Brown, S.J., and Goetzmann, W.N. 2009. Modern Portfolio Theory and Investment Analysis. John Wiley Sons. Kinsky, R. 2011. Charting Made Simple: A Beginner's Guide to Technical Analysis. John Wiley Sons. Krantz, M. 2016. Fundamental Analysis for Dummies. John Wiley Sons. Kurth, S. 2013. Critical Review about Implications of the Efficient Market Hypothesis. GRIN Verlag. Madura, J. 2014. Financial Markets and Institutions. Cengage Learning. Palicka, V.J. 2011. 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