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V. STOCKS. I. Fundamental Analysis (Continued). Components of the Income Statement Total Revenue = gross receipts, total received from operations Cost of Revenue = cost of goods sold, direct costs for components of the product Gross Profit = revenues less cost of revenues

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I. Fundamental Analysis (Continued)

  • Components of the Income Statement

    • Total Revenue = gross receipts, total received from operations

    • Cost of Revenue = cost of goods sold, direct costs for components of the product

    • Gross Profit = revenues less cost of revenues

    • Operating Expense = costs related to production of product or services

    • Operating Income or Loss = profits generated by sales, net of cost of goods sold and operating expense

    • Earnings Before Interest, Taxes, Depreciation, and Amortization = income generated by operations before accounting adjustments

    • Operating Free Cash Flow = calculated by subtracting all cash expenses from all sources of operating revenue


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I. Fundamental Analysis (Continued)

  • Balance Sheet

    • A “snapshot” of corporate assets and liabilities at a particular time

    • Components of the Balance Sheet

      • Current Assets – items owned by a corporation that can be readily turned into cash

      • Current Liabilities – short term debt

      • Common Stock & Retained Earnings – accumulated profits allocated to shareholders

      • Treasury Stock – a negative number indicates a stock buy back – increases per share earnings and potentially stock price


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I. Fundamental Analysis (Continued)

  • Statement of Cash Flows

    • Measures cash generated or consumed by a corporation

    • Components

      • Cash flows provided by or used in operations – shows whether core operations are generating or consuming cash

      • Cash flows provided by or used in capital expenditures – shows whether a firm is investing in its business

      • Cash flows provided by or used in financing – can show a company’s ability to raise capital or whether capital is being used by financing activities (stock buy backs, paying off debt)

      • Change in cash and cash equivalents – total effect – whether the corporation is generating or consuming cash (firm’s liquidity)


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I. Fundamental Analysis (Continued)

Sample Statements: e10vq , e10vq


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I. Fundamental Analysis (Continued)

  • Basic Ratios

    i. Earnings per Share = total earnings

    outstanding shares

    Tracks profitability regardless of firm size

    • Price/Earnings Ratio (P/E Ratio) =

      current share price

      earnings per share

      Provides a rough estimate of market opinion of current and future corporate operations


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I. Fundamental Analysis (Continued)

iii. Return on Assets = earnings

assets

Measures efficiency of use of firm assets

iv. Return on Equity = earnings

common stock equity

Measures efficiency of the use of shareholder capital


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I. Fundamental Analysis (Continued)

v. Return on Invested Capital (ROIC)

= EBITD

common and preferred stock equity & long term debt

Measures efficiency of the use of the entire corporate capital structure

vi. Debt/Equity Ratio = total debt

market capitalization

Measures the leverage in a company and thus

its vulnerability to interest rate changes


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I. Fundamental Analysis (Continued)

vii. Current Ratio = Current Assets

Current Liabilities

A measure of liquidity, whether a company

has sufficient assets to pay current debts


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I. Fundamental Analysis (Continued)

  • Issues Regarding Outstanding Shares

    • Float – the number of shares outstanding (available for purchase)

    • Stock repurchase (buy back) program – where a company purchases its own shares on the open market – reduces float (reduces supply of shares), decreasing number of shares outstanding, increasing earnings per share, and increasing share price


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I. Fundamental Analysis (Continued)

  • Choosing Stocks Based Upon Fundamentals

    • Stock Market Selection Methods

      • Dogs of the Dow – buy highest yielding Dow stocks at the beginning of the year, selling best of stocks after 12 months

      • Relative Strength from Investors Business Daily – compares stocks with the overall market Investors.com: HELP


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I. Fundamental Analysis (Continued)

  • S&P Star Quality Rankings – stocks are ranked by anticipated performance based upon fundamentals http://www2.standardandpoors.com/spf/pdf/index/SP_Citigroup_Global_STARS_Methodology_Web.pdf?vregion=us&vlang=en

  • Value Line Value Line - The Most Trusted Name in Investment Research


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I. Fundamental Analysis (Continued)

  • Diversification – Selecting stocks that respond to the market in different ways – stocks should not all be positively correlated (prices moving in the same direction), in the same industry, or with the same market cap

    • Large Cap = market capitalization in excess of $5,000,000,000

    • Midcap = market capitalization from $1,000,000,000 to $5,000,000,000

    • Small Cap = market capitalization of less than 1,000,000,000


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I. Fundamental Analysis (Continued)

  • Growth versus Value Stocks

    • Growth Stock – High P/E ratio, earnings expected to grow at an above average rate

    • Value Stocks – Low P/E ratio, searching for “bargains” – stocks that are out of favor or in industries out of favor with investors but with good fundamentals

    • Value Trap – Low P/E ratio stock that is a bad investment – P/E is low for a reason


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I. Fundamental Analysis (Continued)

  • Cyclical Stocks – Rise and fall with the economy in general – ex. Transports

  • Defensive Stocks – Product demand exists in all phases of the business cycle – consumer staples, drugs, etc.

  • Domestic versus International – If markets are performing poorly in one country, stocks from another country could be performing well


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I. Fundamental Analysis (Continued)

  • Data Sources

    • Financial press and Internet sites – provide readily available information, but may not be in depth or timely

    • Professional research – can have greater “depth,” can reveal more obscure information, but can be biased and expensive

    • Companies – can provide fairly detailed information, but biased towards the company

    • SEC filings – very detailed and thorough, must be accurate, but difficult to read and not timely


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I. Fundamental Analysis (Continued)

  • Other Approaches

    • “Buy what you know” – Purchase shares of companies that you do business with and are impressed by

    • Consensus information – Agreement among analysts or researchers regarding whether a stock is a good value


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J. Technical Analysis

  • 50 Day Moving Average – provides guidance regarding long term stock price movement trends (200 day = very long term)

    • Positive Momentum – Above the moving average

    • Negative Momentum – Below the moving average AVAV: Technical Analysis for AEROVIRONMENT, INC. - Yahoo! Finance

  • 5 - 20 Day Moving Average – Shows very short term trend


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J. Technical Analysis (Continued)

  • Support – Stock “Bottom,” price below which shares have historically not traded

  • Resistance – Stock “Top,” the price that the stock tends to “bounce off of,” a stop to further price advances

  • Volume – Shares traded per day, indicates whether a price movement is “real” (ex. – stock trading higher on high volume shows interest in stock during price advances, stock price increasing on low volume is “drifting”


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J. Technical Analysis (Continued)

  • Bollinger Bands – One standard deviation above and below the stock price, based upon 20 day moving average – a measure of stock price volatilityhttp://us.rd.yahoo.com/finance/chart/overlay/bollinger/*http:/finance.yahoo.com/q/ta?s=CSX&t=1y&l=on&z=m&q=l&p=b&a=&c=

    • Sharp price changes tend to occur after the bands tighten, indicating a “break out” from a less volatile pattern

    • Prices moving outside the bands indicate a continuing trend

    • Trend reversal is indicated by bottoms or tops outside the band, followed by bottoms and tops inside the band

    • A move originating at one band tends to move all the way to the other band


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J. Technical Analysis (Continued)

  • Stock Chart Types – In all types, y axis indicates price, x axis is time

    • Line

    • Bar (High, Low, Close)

    • Candlesticks – White = stock up, Black = stock down

    • Point and figure

  • Chart Scaling

    • Arithmetic – Even scale of price movements

    • Logarithmic – Scale by percentage change, works best for highly volatile stocks


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K. Reading Corporate Annual Reports

  • Highlights – Contains basic information presented in a manner favorable to the corporation

    • Highlights statistics of which the firm is most proud

    • Generally includes total sales and net income

      http://www.fanniemae.com/ir/pdf/annualreport/2007/2007_annual_report.pdf


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K. Reading Corporate Annual Reports (Continued)

  • Letter to Shareholders – Review of the year just past and potential highlights of the year to come

    • Is a statement of management’s intentions

    • Can be checked with previous years’ statements to develop a sense of management’s credibility

  • Review of Operations – Provides an overview of a company’s products, services, facilities, and future direction


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K. Reading Corporate Annual Reports (Continued)

  • Financial Statements

    • Report of the Independent Auditor – Can be at either the beginning or the end of the financial statements http://library.corporate-ir.net/library/11/112/112348/items/276539/TYC_AR.pdf (p. 98)

      • “Clean” or unqualified opinion – statements present fairly the corporation’s financial position

      • “Qualified” or “Modified” opinion – specific problems exist which must be addressed before the auditor can claim a fair and accurate presentation of the corporation’s financial position (page 122) http://www.ford.com/doc/2007_ar.pdf


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K. Reading Corporate Annual Reports (Continued)

  • Disclaimer of Opinion – A true opinion is not possible because of inability to fairly value assets, liabilities, etc.

  • Adverse Opinion – The firm’s financial statements are inacurate.

  • Report by Management – certification of accuracy of report pursuant to Sarbanes – Oxley


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    K. Reading Corporate Annual Reports (Continued)

    • Balance Sheet

      • Current Assets

        • Cash and Cash Equivalents – Cash and marketable securities with less than 3 months maturity when purchased

        • Accounts and Notes Receivable – Customer balances owed to the company

        • Inventories – Finished goods, work in process, and raw materials – LCM is most conservative, but can also be carried at FIFO & LIFO – LIFO cushion is used in an inflationary environment, undervalued inventory reduces assets

        • Prepaid Expenses – Payments in advance for rent, insurance, subscriptions, utilities, etc. – listed as an asset that depreciates over time


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    K. Reading Corporate Annual Reports (Continued)

    • Net Fixed Assets – Includes plant, property, and equipment – also known as capital or long term assets – carried at cost with accumulated depreciation, except for land, which does not depreciate

    • Other Assets

      • Miscellaneous – Life insurance policies on key executives, notes receivable after more than one year, long term prepaid expenses, and minority stock ownership in other companies