Part 4: Fundamentals of Research NISM Series XV Research Analyst Short Notes

Fundamentals of Research – NISM Series XV Short Notes (Part 4)

This is Part 4 of the NISM Research Analyst Short Notes series on PassNISM.in. This chapter explains the foundational concepts of financial research — why research matters for investing, the difference between active and passive investing, the role of technical analysis versus fundamental analysis, and how behavioural biases affect investment decisions.

This chapter links directly to the regulatory purpose of the NISM Series XV certification and is tested consistently in the exam.

What is Investing?

Investing in the context of securities markets means committing capital today to earn returns over a future period. A sound investment decision requires thorough analysis of:

• Safety / Risk — How likely is it that you might lose money?
• Income — What returns (dividends, interest) will the investment generate?
• Growth Potential — Will the value of the investment increase over time?

Research and analysis are the tools that help investors evaluate these three dimensions before committing capital.

Active Investing vs Passive Investing Active Investing

Active investing involves identifying specific securities to buy or sell based on analysis. An active investor constantly evaluates every holding in the portfolio and makes changes when securities become overvalued or undervalued relative to their fair value. Active investing aims to beat the market by making better stock-picking decisions.

Research analysts play a central role in active investing — their job is to find mispriced securities and provide recommendations that generate alpha (returns above the benchmark).

Passive Investing

Passive investing involves buying a broad basket of securities that mirrors an index — such as buying all 50 stocks in the Nifty 50. The goal is simply to earn the returns that the selected asset class provides, not to outperform it. Index funds and ETFs are common passive investing vehicles.

Passive investors do not need research analysts to pick stocks. However, even passive strategies require analysts to study which indices and asset classes to track.

Role of Research in Investment Activity

The fundamental research analyst's work has two inseparable parts:

1. Research — Collecting all relevant information about a company, industry, and economy
2. Analysis — Processing that information to reach a well-reasoned investment conclusion

Information sources include annual reports, quarterly results, management conference calls, industry reports, government data, and interactions with company management. A company's annual report is a treasure trove of information, but thorough analysis requires going beyond it to develop genuine insight.

Insider Information vs Mosaic Analysis

This distinction is important for the NISM Series XV exam and for professional conduct as a research analyst.

Insider Information (UPSI)

Insider information is material, non-public information about a company that, if made public, would immediately and significantly affect an investor's decision to buy or sell that security. Under SEBI's Prohibition of Insider Trading Regulations 2015, trading based on insider information is illegal.

Whether information qualifies as insider depends on:

• The reliability and credibility of the source
• The significance of its impact on security prices
• The certainty or probability of the event occurring

Mosaic Analysis (Permitted)

Mosaic analysis is a research methodology where an analyst gathers many small, individual pieces of information from public or non-material non-public sources. No single piece is significant on its own, but when combined intelligently, they can paint a comprehensive picture of the company.

Mosaic analysis is legal and acceptable under SEBI regulations. It is the standard methodology used by skilled research analysts to develop unique insights without crossing into insider trading territory.

Exam Alert: Mosaic analysis is acceptable; using unpublished price-sensitive information (UPSI) is not. Know the difference clearly.

Technical Analysis

Technical analysis is based on the assumption that all available information — company fundamentals, economic conditions, and market sentiment — is already reflected in the current stock price. Therefore, studying price and volume patterns from historical data is sufficient to forecast future price movements.

Core Beliefs of Technical Analysis

• Markets discount all available information in the current price
• Price moves in trends — upward, downward, or sideways
• History tends to repeat itself, and patterns recur over time

Three Essential Elements in Understanding Price Behaviour

1. Historical price data — Past price movements provide indications of underlying trends and their direction
2. Trading volume — The volume of trading accompanying price movements indicates the strength of a trend
3. Time span — The duration over which price and volume are observed helps factor in long-term influences

Key Technical Analysis Concepts

• Support Level — A price level where buying interest is strong enough to prevent further price decline
• Resistance Level — A price level where selling pressure prevents further price rise
• Trend — The general direction of price movement (uptrend, downtrend, sideways)
• Breakout — When price moves decisively beyond a support or resistance level, signalling a potential new trend

Technical analysts (also called chartists) believe that by studying these patterns, they can predict future price movements with reasonable accuracy. Technical analysis is more suited to short-term trading.

Fundamental Analysis

Fundamental analysis takes a completely different approach. It is based on the idea that the long-term value of a stock is determined by the underlying business — its earnings power, growth prospects, management quality, and competitive advantages.

Core Premise

Since equity shares represent part ownership of a company, in the long run, a stock's price should reflect the company's ability to generate returns on its capital. Short-term price deviations from intrinsic value create opportunities to buy undervalued stocks or sell overvalued ones.

Scope of Fundamental Analysis

Fundamental analysis involves a comprehensive study at three levels:

1. Economic Analysis — Macro factors, GDP growth, inflation, interest rates, fiscal policy
2. Industry Analysis — Industry growth, competitive intensity, cyclicality, regulatory environment
3. Company Analysis — Business model, financials, management quality, competitive advantages

This approach is commonly known as the EIC framework (Economy → Industry → Company).

Technical vs Fundamental Analysis — Key Differences

Quantitative Research

Quantitative research applies mathematical and statistical models to analyse investments. Some analysts approach equity analysis purely from a quantitative perspective using econometric models.

The quantitative approach can be used for both technical and fundamental analysis:

• In technical analysis, quantitative analysts focus on underlying price and volume data rather than reading charts visually
• In fundamental analysis, the quantitative approach has limitations — frequent changes in accounting standards and business models make historical data less comparable over time

Pure quantitative approaches in fundamental analysis also struggle with qualitative factors such as management quality and brand strength that cannot be easily modelled.

Behavioural Approach to Equity Investing

Investment decisions should ideally be based purely on analysis. However, in practice, behavioural biases often cause investors to make suboptimal decisions. Understanding these biases is important both for the NISM exam and for real-world investment practice.

Common behavioural biases covered in the NISM Series XV syllabus include:

• Loss Aversion — The pain of losing money feels stronger than the pleasure of gaining an equivalent amount. This leads investors to hold losing positions too long and sell winners too early.
• Confirmation Bias — The tendency to seek out information that confirms your existing beliefs and ignore contrary evidence. Also called "my side bias."
• Ownership Bias (Endowment Effect) — We value things we own more highly than we would if we did not own them. This causes investors to hold positions longer than warranted.
• Gambler's Fallacy — The mistaken belief that past random events influence future random events. Example: Assuming a stock will rise because it has fallen for five consecutive days.
• Winner's Curse — The tendency to overpay in competitive bidding situations just to win. A financial win that turns into an economic loss.
• Herd Mentality — Following what everyone else is doing in the market, even without independent analysis. Driven by uncertainty and the assumption that others know more.
• Anchoring — Over-relying on the first piece of information encountered when making a decision (e.g., assuming a stock's 52-week high is its "fair" target price).

Quick Revision — Exam-Focused Points

• Investing requires evaluating safety, income, and growth potential
• Active investing = stock picking to beat the market; Passive investing = mirroring an index
• Mosaic analysis = combining non-material public information = legal and acceptable
• Insider trading = using UPSI = illegal under SEBI Insider Trading Regulations 2015
• Technical analysis = price + volume patterns = short-term focus
• Fundamental analysis = business value = long-term focus
• Three elements of technical analysis: past prices, volume, time span
• EIC framework: Economy → Industry → Company
• Behavioural biases: Loss aversion, confirmation bias, anchoring, herd mentality, gambler's fallacy
• Quantitative analysis has limitations in fundamental analysis due to changing accounting standards

Next in This Series

Part 5 of our NISM Research Analyst Short Notes covers Economic Analysis — GDP measurement methods, inflation, fiscal policy, monetary policy, FDI vs FPI, and economic trends.

Practice with free NISM Research Analyst mock questions at Research Analyst Free Mock Test.