Fundamental stock analysis
This presentation is the property of its rightful owner.
Sponsored Links
1 / 38

FUNDAMENTAL STOCK ANALYSIS PowerPoint PPT Presentation


  • 86 Views
  • Uploaded on
  • Presentation posted in: General

A. 3. 1. FUNDAMENTAL STOCK ANALYSIS. CHAPTER SEVEN. Practical Investment Management Robert A. Strong. Outline. Valuation Philosophies Investors’ Understanding of Risk Premiums The Time Value of Money The Importance of Cash Flows The Tax Factor EIC Analysis

Download Presentation

FUNDAMENTAL STOCK ANALYSIS

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


Fundamental stock analysis

A

3

1

FUNDAMENTAL STOCK ANALYSIS

CHAPTER SEVEN

Practical Investment Management

Robert A. Strong


Fundamental stock analysis

Outline

  • Valuation Philosophies

    • Investors’ Understanding of Risk Premiums

    • The Time Value of Money

    • The Importance of Cash Flows

    • The Tax Factor

    • EIC Analysis

  • Value vs. Growth Investing

    • The Value Approach to Investing

    • The Growth Approach to Investing

    • How Price Relates to Value

    • Value Stocks and Growth Stocks:

      How to Tell by Looking


Fundamental stock analysis

Outline

  • The Price-to-Book Ratio

    • The Price-Earnings Ratio

    • Differences between Industries


Fundamental stock analysis

Outline

  • Some Analytical Factors

    • Growth Rates

    • The Dividend Discount Model

    • The Importance of Hitting the Earnings Estimate

    • The Multistage DDM

    • Caveats about the DDM

    • False Growth

    • A Firm’s Cash Flows

    • Small-Cap, Mid-Cap, and Large-Cap Stocks

    • Ratio Analysis

    • Cooking the Books


Fundamental stock analysis

Valuation Philosophies

  • Fundamental analysts believe

    securities are priced according to fundamental economic data.

  • Technical analysts think investor behavior

    and supply and demand factors play the most important role.


Fundamental stock analysis

Valuation Philosophies

  • Investors’ understanding of risk premiums:

    Investors are almost always risk-averse.

  • The time value of money:

    Everyone agrees on this basic principle.

  • The importance of cash flows:

    Most investment research deals with predicting future corporate earnings.

  • The tax factor:

    The tax code is complicated and not all investments are taxed equally.


Fundamental stock analysis

Valuation Philosophies

  • Economy, Industry and Company (EIC)

    analysis:

  • The analyst first considers conditions in

    the overall economy(market risk),

  • then determines which industries are the

    most attractive in light of the economic conditions (using Porter’s competitive strategy analysis framework, for example),

  • and finally identifies the most attractive

    companies within the attractive

    industries.


Fundamental stock analysis

Valuation Philosophies

Insert Figure 7-1 here.


Fundamental stock analysis

Value vs. Growth Investing

The Value Approach to Investing

  • A value investor believes that securities

    should be purchased only when the underlying fundamentals (macroeconomic information, industry news, and a firm’s financial statements) justify the purchase.

  • Value investors believe in a regression

    to the mean.


Fundamental stock analysis

+

Most of the time a security’s long-term return is consistent with its risk.

Overvalued stock: Sell

x

x

x

x

x

x

x

x

x

x

x

x

Undervalued stock: Buy

x

x

x

Cumulative Return

0

Over the long run, a security cannot survive with a cumulative return that is negative.

-

Time in the Long Term

Regression to the Mean


Fundamental stock analysis

Value vs. Growth Investing

The Growth Approach to Investing

  • Growth investors seek steadily growing

    companies. There are two factions:

  • Information traders are in a hurry; they

    believe information differentials in the marketplace can be profitably exploited.

  • True growth investors are more willing to

    wait, but they share the belief that good investment managers can earn above-average returns for their clients.


Fundamental stock analysis

  • The modern perspective is that

    value isinextricably intertwined with price.

$ 8

Value vs. Growth Investing

How Price Relates to Value

  • In the early days of the market, before the

    Great Crash of 1929, price played a minor role: “A stock with good long-term prospects is always a good investment.”


Fundamental stock analysis

relative

price-to-book

ratio

relative

price-earnings

ratio

+

Value vs. Growth Investing

Value Stocks and Growth Stocks:

How to Tell by Looking

  • No precise definition exists.

  • Classification by Morningstar Mutual Funds:


Fundamental stock analysis

The Price-to-Book Ratio

  • Book value per share is an accounting concept synonymous with equity per share or net asset value.

  • Share price is not normally equal to book value because of

    • depreciation, uncollectible debts, goodwill, etc.

    • economic obsolescence

    • intangible assets


Fundamental stock analysis

The Price-to-Book Ratio

  • The price-earnings ratio (PE) is computed

    by dividing the current stock price by the firm’s earnings per share.

  • Because of differences among industries,

    relative ratios are commonly computed.


Fundamental stock analysis

The Price-to-Book Ratio

Insert Figure 7-3 here.


Fundamental stock analysis

The Price-to-Book Ratio

Insert Figure 7-4 here.


Fundamental stock analysis

Some Analytical Factors: Growth Rates

  • Growth rates from historical data:

  • Growth rates from earnings retention:


Fundamental stock analysis

Some Analytical Factors: Growth Rates

Insert Table 7-4 here.


Fundamental stock analysis

Some Analytical Factors: Growth Rates

Choosing a Growth Rate

  • Financial analysts typically calculate a

    number of growth rates using different ways to determine a likely range for the statistic.

  • Recent data may be more reliable than data

    from the more distant past.

  • Company statements regarding company

    targets may be considered too.


Fundamental stock analysis

Some Analytical Factors: Growth Rates

Insert Table 7-5 here.


Fundamental stock analysis

Some Analytical Factors: Growth Rates

Growth Rate Estimates from Other Analysts

  • Another important source of growth rate estimates is from other security analysts.

  • Three popular services that monitor and report these estimates are Zacks, First Call, and the Institutional Brokers Estimate System (I/B/E/S).

  • The term whisper number refers to what people really think the earnings will be, and not what the published estimate is.


Fundamental stock analysis

The Dividend Discount Model (DDM)

  • Also called Gordon’s growth model.

  • The model assumes that the dividend

    stream is perpetual and that the long-

    term growth rate is constant.


Fundamental stock analysis

The Dividend Discount Model (DDM)

  • The variable k is sometimes called the

    shareholders’ required rate of return.

  • Note that the shareholder’s required rate of

    return is the sum of the expected dividend yield and the expected stock price appreciation.


Fundamental stock analysis

The Importance of Hitting the Earnings Estimate

  • The market often penalizes a company’s stock substantially when the earnings report is disappointing.

  • This is especially true when the required rate of return and the estimated growth rate are high.


Fundamental stock analysis

The Multistage DDM

  • Often, initial high growth levels cannot be

    sustained.

  • Suppose the growth rate g is expected to

    persist from the third year:


Fundamental stock analysis

Some Analytical Factors

  • Caveats about the DDM:

    The DDM is at most a useful tool in security analysis - it requires certain assumptions and it has shortcomings.

  • False growth:

    False growth occurs when a firm acquires another firm with a lower price-earnings ratio - historical data should always be scrutinized carefully when used to determine a growth rate.


Fundamental stock analysis

False Growth

Insert Table 7-7 here.


Fundamental stock analysis

Some Analytical Factors

  • A firm’s cash flow:

    The statement of cash flows is a useful analytical tool - the cash flow from operations figures are widely used as a check on a firm’s earnings quality.


Fundamental stock analysis

Some Analytical Factors

  • Small-cap, mid-cap, and large-cap stocks:

    Another consideration in fundamental stock analysis relates to the size of the firm - for example, the small firm effect.


Fundamental stock analysis

Some Analytical Factors: Ratio Analysis

  • The fundamental analyst is necessarily

    interested in the firm’s accounting statements and in the prevailing general economic conditions.

  • To assist in the analysis, several

    organizations publish comparative statistics for industry groups.

    e.g. Dun and Bradstreet’s Industry Norms

    & Key Business Ratios, which

    includes solvency, efficiency and

    profitability ratios.


Fundamental stock analysis

Some Analytical Factors: Ratio Analysis

Dun & Bradstreet’s 14 Key Business Ratios

  • Solvency Ratios

  • Quick Ratio = (Cash + Accounts Receivable)/Current Liabilities Measures ability to raise cash quickly, ignores inventory

  • Current Ratio = Current Assets/Current Liabilities

  • General measure of liquidity

  • Current Liabilities to Net Worth = Current Liabilities/Net Worth

  • Compares short-term liabilities to permanent invested capital

  • Current Liabilities to Inventory = Current Liabilities/Inventory

  • Measures extent to which payment of current debts relies on sale of inventory

  • Total Liabilities to Net Worth = Total Liabilities/Net Worth

  • Measures firm’s reliance on debt financing

  • Fixed Assets to Net Worth = Fixed Assets/Net Worth

  • Measures proportion of firm’s equity tied up in long-term assets


Fundamental stock analysis

Some Analytical Factors: Ratio Analysis

Dun & Bradstreet’s 14 Key Business Ratios

  • Efficiency Ratios

  • Collection Period = Accounts Receivable/Credit Sales per Day

  • Measures firm’s efficiency in turning credit sales into cash

  • Sales to Inventory = Annual Net Sales/Inventory

  • Measures speed that inventory moves from shelf to customer

  • Assets to Sales = Total Assets/Net Sales

  • Measures efficiency with which assets are used to produce sales

  • Sales to Net Working Capital = Sales/Net Working Capital

  • Measures aggressiveness or conservatism in financing sales

  • Accounts Payable to Sales = Accounts Payable/Annual Net Sales

  • Measures how rapidly company pays its suppliers


Fundamental stock analysis

Some Analytical Factors: Ratio Analysis

Dun & Bradstreet’s 14 Key Business Ratios

  • Profitability Ratios

  • Return on Sales (Profit Margin) = Net Profit after Taxes/Annual Net Sales

  • Measures profit per dollar of net sales

  • Return on Assets = Net Profit after Taxes/Total Assets

  • Measures company’s efficiency in using assets to produce operating profit

  • Return on New Worth (Return on Equity) = Net Profit after Taxes/Net Worth

  • Measures return to the suppliers of equity capital


Fundamental stock analysis

Some Analytical Factors: Cooking the Books

  • All publicly traded firms in the United States

    must have their financial statements audited to ensure they fairly present the company’s financial position.

  • Still, every year, there is at least one story of

    accounting fraud at a major firm. Unfortunately, there is not much the analyst can do about fraud.


Fundamental stock analysis

Review

  • Valuation Philosophies

    • Investors’ Understanding of Risk Premiums

    • The Time Value of Money

    • The Importance of Cash Flows

    • The Tax Factor

    • EIC Analysis

  • Value vs. Growth Investing

    • The Value Approach to Investing

    • The Growth Approach to Investing

    • How Price Relates to Value

    • Value Stocks and Growth Stocks:

      How to Tell by Looking


Fundamental stock analysis

Review

  • The Price-to-Book Ratio

    • The Price-Earnings Ratio

    • Differences between Industries


Fundamental stock analysis

Review

  • Some Analytical Factors

    • Growth Rates

    • The Dividend Discount Model

    • The Importance of Hitting the Earnings Estimate

    • The Multistage DDM

    • Caveats about the DDM

    • False Growth

    • A Firm’s Cash Flows

    • Small-Cap, Mid-Cap, and Large-Cap Stocks

    • Ratio Analysis

    • Cooking the Books


  • Login