The exam gives you numbers and asks for a ratio, a valuation or a technical reading. There are two schools — fundamental analysis (intrinsic value from financial data) and technical analysis (price and volume) — plus bond analysis (yields and duration) to round out the set.

5.1 Fundamental analysis and its goal

Fundamental analysis estimates a security's intrinsic value from the economy, the industry and the company's financial statements, then compares that value with the market price to judge whether the security is cheap or dear. A top-down approach starts with the macro economy and narrows to sectors and then stocks; a bottom-up approach starts with the individual company.

The output feeds two families of tools: valuation multiples (price relative to a fundamental such as earnings, book value or dividends) and quality metrics (profitability, liquidity and leverage). The exam mostly tests the mechanics, so the priority is knowing exactly what each ratio divides by what, and what a high or low reading implies.

5.2 Valuation multiples

Price-to-earnings (P/E) = share price ÷ earnings per share (EPS). A HK40 share with HK2.50 EPS has a P/E of 16. A high P/E generally reflects high expected growth (or an expensive market).
Earnings per share (EPS) = attributable profit ÷ shares in issue. HK200m over 50m shares = HK4.00.
Earnings yield = 1 ÷ P/E — the inverse. A P/E of 16 gives an earnings yield of 1/16 = 6.25%. Useful for comparing shares against bond yields.
Price-to-book (P/B) = price ÷ net asset (book) value per share. HK24 over HK8 book value = 3.0. Book value per share = shareholders' equity ÷ shares (HK1,000m over 200m shares = HK5).
Dividend yield = annual dividend ÷ price. If the price falls while the dividend is held constant, the yield rises.
PEG ratio = P/E ÷ expected earnings growth rate (in %). A P/E of 20 with 10% growth gives 2.0; a PEG well below 1 is often read as cheap relative to growth.
Enterprise value (EV) = market capitalisation + debt − cash. HK800m + HK200m − HK50m = HK950m.

Worked example — P/E from scratch. A company earns HK200m attributable to 50m shares; the share trades at HK40. EPS = 200/50 = HK4.00; P/E = 40/4 = 10. Change the share price to HK64 and the P/E becomes 64/4 = 16 — same earnings, higher price, higher multiple.

5.3 Profitability, liquidity and leverage ratios

Profitability:

Return on equity (ROE) = net income ÷ shareholders' equity. HK120m / HK800m = 15%.
Return on assets (ROA) = net income ÷ total assets. HK90m / HK1,500m = 6%.
Gross margin = gross profit ÷ revenue. HK300m / HK1,000m = 30%.
Net margin = net profit ÷ revenue. HK80m / HK1,000m = 8%.
DuPont analysis decomposes ROE into net profit margin × asset turnover × financial leverage (the equity multiplier), revealing which lever drives the return.

Liquidity:

Current ratio = current assets ÷ current liabilities. HK600m / HK300m = 2.0.
Quick (acid-test) ratio = (current assets − inventory) ÷ current liabilities. (600 − 200)/250 = 1.6.
Working capital = current assets − current liabilities.

Leverage and cover:

Debt-to-equity = total debt ÷ equity. HK600m / HK400m = 1.5.
Interest cover = EBIT ÷ interest expense. HK500m / HK100m = 5 times.
Dividend payout ratio = dividend per share ÷ EPS. HK1.20 / HK3.00 = 40%.
Dividend cover = its inverse (EPS ÷ DPS) = 2.5 times.

Common trap. The quick ratio removes inventory; the current ratio does not. And do not confuse ROE (÷ equity) with ROA (÷ total assets) — the denominators are different, and so are the answers. Read which denominator the question wants.

5.4 Intrinsic-value models

Two discounting models appear.

Dividend discount (Gordon growth) model — values a share as next year's dividend divided by (required return − growth rate):

P = D₁ ÷ (r − g)

Worked examples. A HK2 dividend, 10% required return, 5% growth: P = 2 / (0.10 − 0.05) = 2 / 0.05 = HK40. A HK3 dividend, 12% required return, 6% growth: P = 3 / (0.12 − 0.06) = 3 / 0.06 = HK50.

Discounted cash flow (DCF) — estimates value as the present value of all expected future cash flows; in a multi-stage DCF the terminal value captures cash flows beyond the explicit forecast period.

Two sensitivities the exam tests:

Raising the discount rate lowers the valuation (future cash flows are worth less today).
The required rate of return rises with a higher risk-free rate, higher risk, or higher inflation.

These models make the time-value ideas from Chapter 3 concrete.

5.5 Technical analysis

Technical analysis studies past price and volume, not financial statements, on the assumption that prices move in trends and history tends to repeat, so patterns can anticipate movements.

A simple moving average (SMA) smooths noise. The 5-day SMA of closes 20, 22, 24, 26, 28 = 120/5 = HK24; the 3-day SMA of 16, 18, 20 = 54/3 = HK18. A moving average is a lagging indicator (built from past prices).
A golden cross (a shorter average crossing above a longer one) is bullish; a death cross (shorter crossing below longer) is bearish.
Support is a price where buying tends to halt a fall; resistance is a price where selling tends to cap a rise; a decisive move above resistance on strong volume is a breakout.
An uptrend is a series of higher highs and higher lows.
The Relative Strength Index (RSI) above 70 signals overbought; below 30, oversold.
A head-and-shoulders top is a classic reversal (bearish) pattern. Volume is used to confirm the strength of a move.

5.6 Bond yield and duration analysis

Bond analysis extends the yield ideas from Chapter 1 into measured risk.

Current yield = annual coupon ÷ price. A HK5 coupon at HK80 yields 6.25%; at HK120, ≈4.17%; a HK4 coupon at HK$50 yields 8%.
Yield to maturity (YTM) is the discount rate equating price to all future cash flows: a discount bond has YTM above coupon, a premium bond below, and a par bond has coupon = current yield = YTM. Price and yield move inversely.
Duration measures a bond's price sensitivity to interest-rate changes (and, in the Macaulay sense, the weighted-average time to receive cash flows). Longer maturity and lower coupon both raise duration, so a long-dated, low-coupon bond is the most rate-sensitive — the duration of a 10-year zero-coupon bond is approximately 10 years.
Modified duration turns this into an estimated price move: a bond with modified duration of 6 falls about 6% if yields rise by 1% (100 basis points).

Worked example — modified duration. A bond has a modified duration of 7. Yields rise by 50 basis points (0.50%). Estimated price change ≈ −7 × 0.50% = −3.5%. Interest-rate risk is greatest for long-duration bonds — exactly what the exam wants you to spot.

What Paper 8 tests here. Clean-number ratio calculations (P/E, EPS, ROE, current ratio, D/E, payout); the Gordon-growth valuation; an SMA; RSI thresholds (70/30); "which bond is most rate-sensitive?" (the long-dated, low-coupon one); and a modified-duration price move. The marks are for method — set out the formula, then substitute.

Securities Analysis