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CHAPTER FOURTEEN. FINANCIAL ANALYSIS OF COMMON STOCKS. FINANCIAL ANALYSIS. REASONS FOR FINANCIAL ANALYSIS TWO PRIMARY REASONS to determine certain securities’ characteristics to attempt to identify mispriced securities. FINANCIAL ANALYSIS.

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chapter fourteen

CHAPTER FOURTEEN

FINANCIAL ANALYSIS OF COMMON STOCKS

1

financial analysis
FINANCIAL ANALYSIS
  • REASONS FOR FINANCIAL ANALYSIS
    • TWO PRIMARY REASONS
      • to determine certain securities’ characteristics
      • to attempt to identify mispriced securities
financial analysis3
FINANCIAL ANALYSIS
  • REASON #1: DETERMINING SECURITY CHARACTERISTICS
    • estimate future sensitivity to major factors
    • estimate dividend yield
financial analysis4
FINANCIAL ANALYSIS
  • REASON #2: ATTEMPTING TO IDENTIFY MISPRICED SECURITIES
    • use fundamental analysis
    • approaches
      • valuation determines the intrinsic value compared to the current market value
      • estimate key financial variables such as
        • EPS next year
        • income growth next year
fundamental analysis
FUNDAMENTAL ANALYSIS
  • TOP-DOWN V. BOTTOM UP
    • TOP-DOWN APPROACH
      • attempts to forecast in the following order

1. economic activity

2. industry performance

3. firm’s performance

slide6

FUNDAMENTAL ANALYSIS

Economic Analysis

fundamental analysis7
FUNDAMENTAL ANALYSIS
  • FINANCIAL STATEMENT ANALYSIS
    • INTEGRAL PART OF FUNDAMENTAL ANALYSIS
      • it helps the analyst understand a firm’s current condition
      • where it is headed
      • what factors affect it
      • how the factors affect it
fundamental analysis8
FUNDAMENTAL ANALYSIS
  • FINANCIAL STATEMENT ANALYSIS
    • Review of Accounting Statements
      • includes a study of the three major statements prepared monthly by most accountants:
        • the balance sheet
        • the income statement
        • the statement of cash flows
fundamental analysis9
FUNDAMENTAL ANALYSIS
  • FINANCIAL STATEMENT ANALYSIS
    • RATIO ANALYSIS
      • DEFINITION: a technique used to examine a company’s financial statements
      • Use of Ratios
        • as an absolute standard
        • as a comparative indicator
        • as a trend over time
fundamental analysis10
FUNDAMENTAL ANALYSIS
  • FINANCIAL STATEMENT ANALYSIS
    • RATIO ANALYSIS
      • Types of Ratios
        • internal liquidity
        • operating performance
        • risk analysis
        • growth analysis
        • profitability
        • market ratios
fundamental analysis11
FUNDAMENTAL ANALYSIS
  • internal liquidity ratios:
    • indicate the ability of the firm to meet future short-term financial obligations
    • some liquidity ratios:
      • current ratio
      • quick ratio
      • cash ratio
      • receivables turnover
fundamental analysis12
FUNDAMENTAL ANALYSIS
  • operating performance ratios:
    • indicate how well the management is operating the business
    • some examples:
      • total asset turnover
      • net fixed asset turnover
      • equity turnover
fundamental analysis13
FUNDAMENTAL ANALYSIS
  • risk analysis ratios:
    • indicates the uncertainty of income flows for the total firm and for the individual sources of capital (debt and stock)
    • some examples:
      • debt to equity ratio
      • long-term debt/total capital ratio
fundamental analysis14
FUNDAMENTAL ANALYSIS
  • growth analysis ratios:
    • indicate how fast a firm should grow
    • it involves analysis using several other ratios
      • net profit margin
      • total asset turnover
      • total assets/equity
profitability ratios

FUNDAMENTAL ANALYSIS

Profitability Ratios
  • Gross Margin
    • Gross profit / Sales
  • Operating Margin
    • Operating income / Sales
  • ROA
    • Net income / Total assets
  • ROE
    • Net income / Owner’s equity
per share calculations

FUNDAMENTAL ANALYSIS

Per Share Calculations
  • Book Value Per Share (BVPS)
    • Total equity / # shares outstanding
  • Earnings Per Share (EPS)
    • Net income / # shares outstanding
  • Cash Flow Per Share (CFPS)
    • Operating cash flow / # shares outstanding
slide17

FUNDAMENTAL ANALYSIS

Market Value Ratios

  • Price / Book (or Market / Book)
    • Stock price / BVPS
  • Price / Earnings (P/E)
    • Stock price / EPS
  • Price / Cash flow (P/CF)
    • Stock price / CFPS
sources of information
Sources of Information
  • Annual reports
  • Wall Street Journal
  • Value Line
  • Standard & Poor’s
  • Research Insight
sources of information19
Sources of Information
  • Internet
    • NYSE (www.nyse.com)
    • Nasdaq (www.nasdaq.com)
    • Text (www.mhhe.com/cj)
    • CNNfn.com
    • CNBC.com
    • Yahoo.com
    • Zacks.com
    • Smartmoney.com
    • Multex.com
    • MSNBC.com
    • Quicken.com
sources of information20
Sources of Information
  • SEC
    • EDGAR
    • 10K & 10Q reports
technical analysis
TECHNICAL ANALYSIS
  • DEFINITION: a form of security analysis that attempts to forecast price changes based on historical price and volume trends
technical analysis22
TECHNICAL ANALYSIS
  • Two Groups of Strategies Used:

1. Momentum and Contrarian Strategies

2. Moving Average and Trading Range Breakout

Strategies

technical analysis23
Technical Analysis
  • Support and resistance areas
    • Support level / Bottom feeders
    • Resistance level / Topping out / profit taking
    • Breakouts
technical analysis24
TECHNICAL ANALYSIS

1. Momentum and Contrarian Strategies

  • METHDOLOGY:
    • examine the returns over a time period just ended to identify
      • momentum investors who seek out stocks recently rising in price for purchase; falling for sale
      • contrarians who follow the opposite strategy of most investors
        • contrarians base their strategy on the overreaction theory
technical analysis25
TECHNICAL ANALYSIS

2. Moving Average and Trading Range Breakout Strategies

  • MOVING AVERAGE STRATEGY:
    • calculate a moving average over the last 200 days of closing prices
    • divide today’s closing price into the moving average (SHORT-TO-LONG RATIO)
    • if short-to-long ratio is greater than 1, buy
    • if ratio is less than 1, sell
technical analysis26
TECHNICAL ANALYSIS
  • 2. Moving Average and Trading Range Breakout Strategies
    • TRADING RANGE BREAKOUT STRATEGY:
      • high and low prices for past 200 trading days are identified
      • if today’s close is greater than the high = buy!
      • if today’s close is less than the low = sell!
technical analysis27
TECHNICAL ANALYSIS

Reading the tea leaves…

  • Advance / decline line: Closing Arms or Trin
  • Relative strength
  • Moving averages
  • Candlestick chart
  • Chart formations: head-and-shoulders
examples

Trin = Declining volume / Declines

Advancing volume / Advances

Examples
  • Closing Arms: Trin

Values > 1 considered bearish

examples30
Examples
  • Advance/Decline Line Calculation

Issues Issues

Weekday Advancing Declining Difference Cumulative

THU 1,162 1,888 -726 -726

FRI 2,275 1,198 1,077 351

MON 1,203 1,849 -646 -295

TUE 1,187 1,878 -691 -986

WED 1,739 1,311 428 -558

THU 2,193 910 1,283 725

FRI 2,178 974 1,204 1,929

MON 1,540 1,525 15 1,944

TUE 1,660 1,540 120 2,064

examples32
Examples
  • Relative strength:

Charts performance relative to industry or market

Value Line Timeliness*

Price performance/Average performance of V-L Stocks

moving average

11 + 12 + 14 = 12.33

3

Moving Average

12 + 14 + 13 = 13.00

3