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CHAPTER 17

CHAPTER 17. Macroeconomic and Industry Analysis. Framework of Analysis. Fundamental Analysis Approach to Fundamental Analysis Domestic and global economic analysis Industry analysis Company analysis Why use the top-down approach. Global Economic Considerations.

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CHAPTER 17

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  1. CHAPTER 17 Macroeconomic and Industry Analysis

  2. Framework of Analysis • Fundamental Analysis • Approach to Fundamental Analysis • Domestic and global economic analysis • Industry analysis • Company analysis • Why use the top-down approach

  3. Global Economic Considerations • Performance in countries and regions is highly variable • Political risk • Exchange rate risk

  4. Table 17.1 Economic Performance in Selected Emerging Markets

  5. Performance in countries • Considerable variation in performance across countries • expanding economies: more chance to succeed • contracting economies: less chance to succeed • Based on these performance, form expectation for your investment • economies growing • economies slowing down

  6. Political riskConsider 2 investors: A, an American wishing to invest in Indonesian stocks and an Indonesian wishing to invest in U.S. stocksWhich one would face a more difficult task when doing macroeconomic analysis?

  7. Figure 17.1 Change in Real Exchange Rate: U.S. Dollar versus Major Currencies, 1999–2006 US investors: 2009: invest $1000 in Japan, exchange rate 1USD = 100 Yen, $1000 is worth 100,000 YenIn 2010: 1 USD = 110 Yen, 100,000 Yen = 909 USDLose $91

  8. Domestic Economy • Gross domestic product • Market value of goods and services produced over a period of time • Unemployment rates • The ratio of number of people classified as unemployed to the total labor force • Interest rates & inflation • inflation is the rate at which the general level of prices is rising. • High inflation is associated with overheated economy • Trade-off between inflation and unemployment • Budget Deficits • Government spending > government revenue • Consumer sentiment • consumers’ optimism and pessimism about the economy

  9. Interest rate4 Factors that can influence interest rates(1) Supply of fund (savers)(2) Demand of fund (borrowers)(3) Government net supply/fund(4) Expected inflation

  10. Demand and Supply Shocks • Demand shock - an event that affects demand for goods and services in the economy • Tax rate cut • Increases in government spending • Supply shock - an event that influences production capacity or production costs • Commodity price changes • Educational level of economic participants

  11. Federal Government Policy • Fiscal Policy - government spending and taxing actions • Increase spending: increase demand • tax increase: reduce demand • Net impact: • budget deficit • budget surplus

  12. Federal Government Policy (cont.) • Monetary Policy - manipulation of the money supply to influence economic activity • Tools of monetary policy • Open market operations • Discount rate • Reserve requirements • If government wants to tighten money supply, what should it do?

  13. Business Cycle

  14. Business Cycles • Business Cycle • Peak • Trough • Industry relationship to business cycles • Cyclical • above average sensitivity to states of economy • Defensive • below sensitivity to states of economy

  15. Business Cycles (examples) • At trough, right before recovery, one would expect cyclical industries to outperform others • (economy increases (decreases) by 1%, the industry increases (decreases) by > 1%) • Example: durable goods: auto, washing machine, financial industries • Cyclical firms: betas > 1 or < 1, high or low betas? • Economy enters recession: • cyclical or defensive • example: food, public utilities, pharmaceutical • Low or high betas? • performance is stable, unaffected by market conditions

  16. Figure 17.3 Cyclical Indicators

  17. Leading indicators tend to rise and fall in advance of the economy Examples: Avg. weekly hours of production workers Stock Prices Leading Indicators

  18. Table 17.2 Indexes of Economic Indicators

  19. Coincident Indicators - indicators that tend to change directly with the economy Examples: Industrial production Manufacturing and trade sales Coincident Indicators

  20. Lagging Indicators - indicators that tend to follow the lag economic performance Examples: Ratio of trade inventories to sales Ratio of consumer installment credit outstanding to personal income unemployment Lagging Indicators

  21. Figure 17.4 Indexes of Leading, Coincident, and Lagging Indicators

  22. Table 17.3 Economic Calendar

  23. Figure 17.5 Economic Calendar at Yahoo!

  24. Table 17.4 Useful Economic Indicators

  25. Figure 17.6 Return on Equity, 2007

  26. Defining an Industry • North American Industry Classification System, or NAICS codes • Codes assigned to group firms for statistical analysis

  27. Figure 17.7 Industry Stock Price Performance as Measured by Rate of Return on Dow Jones Sector iShares, January-October 2007

  28. Figure 17.8 ROE of Major Banks

  29. Table 17.5 Examples of NAICS Industry Codes

  30. Industry Analysis • Sensitivity to business cycles • Sector Rotation • Industry life cycles

  31. Sensitivity to Business Cycle • Factors affecting sensitivity of earnings to business cycles • Sensitivity of sales of the firm’s product to the business cycles • Operating leverage • Financial leverage

  32. Figure 17.9 Industry Cyclicality

  33. Operating leverage • Operating leverage = fixed cost / variable cost • If operating leverage is high • fixed cost dominates variable cost • When economy changes, cost do not move enough to offset change in sale • economy goes down, sale decreases, variable cost also decreases, but is dominated by fixed cost, total cost is quite stable, therefore, earning goes down more than the economy • Sale increases, variable cost increases, but still dominated by fixed cost, total cost is quite stable, earning goes up more than economy • Earning is very sensitive to economy • If operating leverage is low: variable cost >> fixed cost • sale goes down, total cost goes down • sale goes up, total cost goes up • earning is stable

  34. Table 17.6 Operating Leverage of Firms A and B Throughout the Business Cycle

  35. Financial leverage • Use of borrowing • Similar to fixed cost • High financial leverage, earning is more sensitive to economy • Low financial leverage, earning is more stable

  36. Figure 17.10 A Stylized Depiction of the Business Cycle

  37. Sector Rotation Portfolio is adjusted by selecting companies that should perform well for the stage of the business cycle Peaks – natural resource extraction firms Contraction – defensive industries such as pharmaceuticals and food Trough – capital goods industries Expansion – cyclical industries such as consumer durables

  38. Sector Rotation Gains

  39. Figure 17.11 Sector Rotation

  40. Industry Life Cycles StageSales Growth Start-up Rapid & Increasing Consolidation Stable Maturity Slowing Relative Decline Minimal or Negative

  41. Figure 11.11 The Industry Life Cycle

  42. Industry Life Cycle • Example: VCR • Start-up: new, so sale and earnings go up rapidly • Consolidation stage: • product is established, more firms enter, growth rate is stable, and higher than economy • Maturity stage • product reach full potential use by consumers • market is very competitive • pay more dividends • less on reinvestment • Relative decline • new better products come in, e.g., DVD • Substitute for old products

  43. CHAPTER 19 FINANCIAL STATEMENT ANALYSIS

  44. Financial Statement Analysis • Objectives: • Use a firm’s income statement, balance sheet, and statement of cash flows to calculate standard financial ratios. • Calculate the impact of taxes and leverage on a firm’s return on equity using ratio decomposition analysis. • Measure a firm’s operating efficiency • Identify likely sources of biases in accounting data.

  45. Balance Sheet Common Sized Trend or Indexed Income Statement Common Sized Trend or Indexed Statement of Cash Flows Financial Statements

  46. Income Statement • Firm’s revenues and expenses during a specific period • Typical format Sale - Operating expense COGS Depreciation Operating Income (EBIT) - Interest Earning before tax (EBT) - Tax Net Income (NI)

  47. Table 19.1 Consolidated Statement of Income for Hewlett-Packard, 2006

  48. Balance Sheet • A snapshot of firm’s assets and liability at a given point in time Asset Liabilities + Equity 1. Current Asset 1. Current liabilities Cash Short term debt Account receivable Account payable Inventory Note payable 2. Fixed asset 2. Long-term debt 3. Equity Common stock Retained earning Total assets Total liabilities + equity

  49. Table 19.2 Consolidated Balance Sheet for Hewlett-Packard, 2006

  50. Statement of cash flow • Net income: accounting profit • Cash flow: cash available on hand • Statement of cash flow: firm’s cash receipts and payments during a specific period

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