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Fundamental Analysis. Macroeconomics Analysis Industry Analysis Equity Valuation Model (Dividend Discount Model- DDM) Financial Statement Analysis. Macroeconomics Analysis. Global Economy Analysis affects export, price competition and profits exchange rate: purchasing power and earnings

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fundamental analysis
Fundamental Analysis
  • Macroeconomics Analysis
  • Industry Analysis
  • Equity Valuation Model(Dividend Discount Model- DDM)
  • Financial Statement Analysis
macroeconomics analysis
Macroeconomics Analysis
  • Global Economy Analysis
  • affects export, price competition and profits
  • exchange rate: purchasing power and earnings
  • Domestic Economy
  • The ability to forecast the macroeconomy can translate into great investment performance
  • outperform other analysts to earn extra profitsMany variables can affect economy

Gross Domestic Product (GDP): measures the economy’s total output of goods and services

  • Employment rate:measures the extent that the economy is operating at full capacity
  • Inflation measures the general level of prices increase Phillip’s curve
  • Interest Ratehigh interest rate reduces PV of cashflows, thus stock values
  • Budget Deficit large deficit means more borrowing, which implies higher interest rate.
  • Sentiment consumers and producers confidence
business cycles
Business Cycles
  • business cycles: pattern of recession and recovery
  • peak: the end of expansion and start of recession
  • trough: the bottom of the recession
  • stock returns are decreasing when at peak and increasing at trough
  • cyclical industries: do well in expansionary periods but poorly in recession, e.g., durable goods such as automobile and wash machines
  • defensive industries: little sensitive to business cycles, such food
industry analysis
Industry Analysis
  • Select a good industry to invest. It is difficult for a firm to do well in a troubled industry
  • Standard Industry Classification (SIC) code
  • Value line Investment Survey - reports 1700 firms in 90 industries
  • Two factors that determine the sensitivity of a firm’s earnings to business conditions:business risk,financial risk
business risk
Business risk
  • Sales sensitivity to business conditionsome industries are robust (food) while others are not (movie)
  • operating leverage: the division between fixed and variable costs.
  • firms with greater amounts of variable cost relative to the fixed cost are subject less to business fluctuations, thus profits are more stable

Financial Risk

  • the degree in using financial leverage (the amount of interest payment)
  • leverage firm is more sensitive to business cycles
industry cycles
Industry cycles

Start-up Build-up Maturity Decline

Start-up: increasing growth

Build-up/consolidation: stabilized growth

maturity: slower growth

Decline: shrinking growth

equity valuation model
Equity Valuation Model
  • Dividend Discount Model (DDM)V0= (D1+P1)/(1+k) = D1/(1+k) + D2/(1+k)2 ...+ Dn/(1+k)n
  • constant growth assumptionV0 = D1/(1+k) + D1(1+g)/(1+k)2 +D1(1+g)2/(1+k)3 + ... = D1/(k-g)or k = expected return = D1/P0 + g
multistage growth model
Multistage Growth Model
  • Growth profile may not be constant such as:

Expected Growth





V=D0(1+g1)/(1+k)+...+D0(1+g1)n/(1+k)n + D0(1+g1)n(1+g2)/(1+k)n+1+ ... and so on

illustration of two stage growth model
Illustration of two-stage Growth Model
  • A stock pays $1 dividend now and its g1=30% for 6 yrs. Thereafter, its g2=6%, its k=15%
  • yr 1: $1(1+0.3) =1.13yr 2: 1(1+0.3)2=1.69yr 3: 1(1+0.3)3=2.20yr 4: 1(1+0.3)4 =2.86.yr 7: 1(1+0.3)6(1+6%)=5.12yr 8: 1(1+0.3)6(1+6%)2 =5.42 .
market value equity
Market Value (equity)

Market value is the present value of its future dividendsTime PV(Dt) Growth rate0 34.0 -

1 37.8 11.17%

2 41.78 10.52

3 45.85 9.74At time 1:

FV(Dividends) = 34.00(1.15) - 1.3= 37.8

At time 2:

FV(dividends) = 37.80(1.15) - 1.69=41.78Expected return at time 0 (15%)

= Yr end dividend/current price + growth rate= 1.3/34 + 11.17%

p e ratio behaviors
P/E Ratio Behaviors
  • Price = No growth value/share P0 = E1/k + PVGOor
  • P0/E1= [1+ PVGO]/k





pitfalls in p e analysis
Pitfalls in P/E Analysis
  • Denomination of P/E ratio is the accounting earnings (arbitrary rules or historical cost will distort the earnings figures)
  • Earning should be based on economic earnings (i.e., net of economic deprecation)
  • Earnings are future figures vs P/E ratio (which uses past accounting earnings)
earnings forecast
Earnings Forecast
  • Models for forecasting:Ei,t = gi + Ei,t-4 +ai(Ei,t-1-Ei,t-5)where g: growth factor a: adjustment factor E: Earnings
  • Time Series AnalysisARMA model Exponential smoothing
  • professional institution forecast
  • Performance Evaluation MSE or others
financial statement analysis
Financial Statement Analysis
  • Preparation of Source/Use Fund Statement
  • Ratio Analysis
  • Performance Analysis
  • Du Pont Analysis
use source of fund statement
Use/source of Fund Statement
  • Sources UsesC. Paper $ 5.8 Cash $ 0.4A/P 17.8 A/R 16.2Div/P 1.4 Inv 34.8S/T debt 4.6 Prep. Ex 0.4S/T Lease 3.8 Lease 82.8L/T Debt 20.6 Others 3.6L/T Lease 25.0 Tax 1.0C/S 3.2P/I Cap 0.6NI 54.4 Div. 46.6Depreciation 48.6Total 185.8 185.8
analysis of use source
Analysis of Use/Source
  • Sales growth=3.5%
  • Uses- major componentA/R =8.72%; Inventory = 18.73%; Lease = 44.6%Dividend = 25.1%
  • SourcesA/P = 9.5%; L/T debt = 11.1%; L/T lease = 13.4%Operation profits = 55.4%(NI+depreciation)
  • Why issue shares?
  • S/T-/LT capital increases so much?
ratio analysis
Ratio Analysis
  • Assets Sales Profit
  • Liquidity Ratio
  • Risk Ratio
  • Du Pond Analysis

ROE=Net Income(NI)/Equity (E)= NI Pretax Prof EBIT Sale TA P.Prof EBIT Sales TA E TB IB GPM TAT EMPretax profit =EBIT - InterestTB = Tax burdenIB = interest burden