Investing in stocks

Most PMS money in India goes into listed equity, so a distributor must be able to read a stock the way a portfolio manager does. You will not pick the stocks, but you will explain why the manager holds a company at 40 times earnings, and the exam will ask you to compute the ratios behind that conversation.

What a share actually gives you

An equity share is part ownership of a company. The holder gets a vote, a share of profits paid as dividends, and a claim on whatever is left after all creditors are paid. That residual claim is why equity returns are both higher and more uncertain than bond returns: the shareholder is last in line but keeps all the upside. Liability is limited to the amount invested.

Returns come in two forms. Dividend income is cash paid out of profits. Capital gain is the rise in price, which over long periods tracks growth in earnings. Preference shares sit between debt and equity: fixed dividend, priority over equity, usually no vote.

Fundamental analysis

Fundamental analysis estimates what a business is worth and compares that with the price. The top-down approach starts with the economy (growth, inflation, interest rates), moves to the industry (demand, competition, regulation) and finally the company. The bottom-up approach starts with the company and worries about the economy later. Most PMS managers describe their process as one or the other in the disclosure document.

The company study uses three statements: the profit and loss account (revenue, margins, profit), the balance sheet (assets, debt, net worth) and the cash flow statement (whether profits turn into cash). The exam's favourite ratios:

• Earnings per share (EPS) = Net profit ÷ Number of shares.
• Price to earnings (P/E) = Price ÷ EPS. How many years of current earnings the market pays for. Trailing P/E uses the last four quarters; forward P/E uses estimated earnings.
• Price to book (P/B) = Price ÷ Book value per share, where book value is net worth ÷ shares. Common for banks and asset-heavy companies.
• Return on equity (ROE) = Net profit ÷ Net worth. How efficiently shareholder money earns profit. ROCE does the same for total capital including debt.
• Dividend yield = Dividend per share ÷ Price; payout ratio = Dividend ÷ EPS.
• PEG ratio = P/E ÷ Expected earnings growth (in %). Adjusts P/E for growth; near 1 is often considered fair.
• Debt to equity and interest coverage (EBIT ÷ Interest) measure balance-sheet risk. EV/EBITDA compares enterprise value with operating cash profit and is used when companies carry different debt levels.

From ratios to value

Ratios compare a stock with its peers or its own history (relative valuation). Intrinsic valuation instead discounts the cash the business will produce. The simplest form is the dividend discount model with constant growth:

For the company above, if next year's dividend is ₹4.32 (₹4 growing at 8%) and investors require 12%, the model gives 4.32 ÷ (0.12 − 0.08) = ₹108. The market price is ₹300 because investors are paying for growth that is reinvested rather than paid out. A discounted cash flow (DCF) model captures that by projecting free cash flows and discounting them at the cost of capital. No single model is the answer; a manager triangulates.

Two styles use these tools differently. Value investors buy companies trading below their estimate of intrinsic value, often at low P/E or P/B. Growth investors pay higher multiples for businesses whose earnings are expected to compound fast. Quality, momentum and dividend strategies are further labels you will see in PMS investment approaches.

Technical analysis and market efficiency

Technical analysis ignores value and studies price and volume patterns: trends, support and resistance levels, moving averages, relative strength. It is used mainly for timing entries and exits. The efficient market hypothesis argues that prices already reflect available information, so consistently beating the market is hard; this is the intellectual case for index funds and the reason a PMS must justify its fees with a repeatable process rather than tips.

Equity risks a PMS client must accept

Beyond market swings, a concentrated PMS faces concentration risk (a few holdings drive results), liquidity risk in mid and small caps where a large sale moves the price, and governance risk where promoters act against minority holders. Unlike a mutual fund, a PMS has no SEBI cap of 10% per stock, so the manager's own limits and the client's tolerance are the only guardrails. Read the investment approach for stated limits on stock and sector weights.

When a client asks whether a PMS holding is expensive, walk through EPS, P/E, growth and ROE in that order. The habit of computing before opining is what separates a distributor from a salesperson.