analyzing common stocks ppt @ bec doms
DESCRIPTION
Analyzing common stocks ppt @ bec domsTRANSCRIPT
Analyzing Common Stocks
2
Analyzing Common Stocks
Learning Goals1. Discuss the security analysis process, including
goals and functions.2. Appreciate the purpose and contributions of
economic analysis.3. Describe industry analysis and note how it
is used.4. Demonstrate a basic understanding of fundamental
analysis and why it is used.
3
Analyzing Common Stocks
Learning Goals (cont'd)5. Calculate a variety of financial ratios and describe
how financial statement analysis is used to gauge the financial vitality of a company.
6. Use various financial measures to assess a company’s performance, and explain how the insights derived form the basic input for the valuation process.
4
What is Security Analysis?
“The process of gathering and organizing information and then using it to determine the intrinsic value of a share of common stock.”
5
What is Intrinsic Value?
Intrinsic Value The underlying or inherent value of a stock, as determined
through fundamental analysis
A prudent investor will only buy a stock if its market price does not exceed what the investor thinks the stock is worth.
Intrinsic value depends upon several factors: Estimates of future cash flows Discount rate Amount of risk
6
“Top Down” Approach to Traditional Security Analysis
Step 1: Economic Analysis State of overall economy
Step 2: Industry Analysis Outlook for specific industry Level of competition in industry
Step 3: Fundamental Analysis Financial condition of specific company Historical behavior of specific company’s stock
7
Efficient Market Hypothesis
Efficient Market: the concept that the market is so efficient in processing new information that securities trade very close to or at their correct values at all times
Efficient market advocates believe: Securities are rarely substantially mispriced in
the marketplace No security analysis is capable of finding mispriced
securities more frequently than using random chance
8
Who Needs Security Analysis in an Efficient Market?
Fundamental analysis is still important because:
All of the people doing fundamental analysis is the reason the market is efficient
Financial markets may not be perfectly efficient
Pricing errors are inevitable
9
Key Economic Measures
Gross Domestic Product (GDP): market value of all goods and services produced in a country over the period of a year Generally, GDP goes C, economy goes C
Industrial Production: measure of the activity/output in the industrial or productive segment of the economy Generally, production goes C, economy goes C
10
Key Economic Factors thatAffect the Business Cycle
Government Fiscal Policy Taxes Government spending Debt management
Monetary Policy Money supply Interest rates
Other Factors Inflation Consumer spending Business investments Foreign trade Currency exchange rates
11
Other Key Economic Measures
Economic Measure What It Tracks
Index of Leading Indicators “Predicts” direction of GDP
Personal Income Consumer buying habits
Retail Sales Consumer attitudes
Money Supply Growth of economy & inflation
Consumer Prices/ InflationProducer Prices
Employment Business Production
Housing Starts Availability & cost of money
12
How Do We Use the Economic Outlook?
Use it to identify areas for additional research What industries will benefit? What industries will be hurt?
Use it to evaluate individual companies Will sales/profits go up or down?
13
Important Point to Remember!
Stock prices usually change before the actual forecasted changes become apparent in the economy
Stock price trends are another leading indicator often used to help predict the direction of the economy itself
14
Step 2: Industry Analysis
Evaluate the competitive position of a particular industry in relation to other industries Looking for new opportunities &
growth potential
Identify companies within the industry that look promising Looking for strong market positions, pricing leadership,
economies of scale, etc.
15
Issues that Affect an Industry
What is the nature of the industry?
Is the industry regulated?
What role does labor play in the industry?
How important are technological developments?
Which economic forces have the most impact on the industry (e.g., interest rates, foreign trade)?
What are the important financial and operating considerations (e.g., access to capital)?
16
Growth Cycle Stages and Investments
Growth Cycle reflects the vitality of an industry or a company over time.
Initial Development: industry is new and risks are very high
Rapid Expansion: product acceptance is growing and investors become very interested
Mature Growth: expansion comes from growth in the economy and returns are more predictable
Stability or Decline: demand for product is diminishing and investors avoid this stage
17
Step 3: Fundamental Analysis
Evaluate the financial condition and operating results of a specific company Competitive position Composition and growth in sales Profit margins and dynamics of earnings Asset mix (i.e. cash balance, inventory, accounts
receivable, fixed assets) Financing mix ( i.e. debt, stock)
The value of a stock is influenced by the financial performance of the company that issued the stock
18
Where Do We Start?
Interpreting Financial Statements
Using Financial Ratios
Fundamental analysis is often the most demanding and most time-consuming phase of stock selection
19
Financial Statements:The Balance Sheet
Summary of a company’s assets, liabilities, and shareholders’ equity at a point in time Assets: what the company owns (i.e. cash, inventory,
accounts receivable, equipment, buildings, land) Liabilities: what the company owes (i.e. bills, debt) Equity: capital the stockholders have invested in
the company
What are we looking for on the balance sheet? Relative amounts (large vs. small) Trends (improving vs. decreasing)
20
Table 7.3 Corporate Balance Sheet
21
Financial Statements:The Income Statement
Summary of a company’s operating results over a specific period of time, usually one year Revenues: funds received for providing products and/or services Expenses: funds used to pay for materials, labor, and other business
costs Profit/Loss: revenues less expenses
What are we looking for on the income statement? Relative amounts (large vs. small) Relationships (Are expenses growing faster or slower
than revenues?) Trends (improving vs. decreasing)
22
Table 7.4 Corporate Income Statement
23
Financial Statements:The Statement of Cash Flows
Summary of a company’s cash flows and other events that caused changes in company’s cash Sources of Cash: proceeds from sale of products/ services,
sales of equipment, borrowing money, sale of stock Use of Cash: payment of wages and/or materials, payment of
operating expenses, purchases of equipment, payment of debt, payment of dividends
What are we looking for on the cash flow statement? Relative amounts (more cash or less cash) Liquidity Trends (improving vs. decreasing)
24
Table 7.5 Statement of Cash Flows
25
Sources for Financial Statements
Company’s Annual Report
Company’s 10K
Company’s 10Q
Securities & Exchange Commission www.sec.gov
Standard & Poor’s or Moody Reports
Internet financial portals
Brokerage firm reports
26
Major Groups of Financial Ratios
Liquidity Ratios: the company’s ability to meet day-to-day operating expenses and satisfy short-term obligations as they become due
Activity Ratios: how well the company is managing its assets
Leverage Ratios: amount of debt used by the company
Profitability Ratios: measures how successful the company is at creating profits
Common Stock Ratios: converts key financial information into per-share basis to simplify financial analysis
27
Liquidity Ratios
Current Ratio: how many dollars of short-term assets are available for every dollar of short-term liabilities owed
Higher ratio: better Lower ratio: worse
Current ratio Current assets
Current liabilities
28
Liquidity Ratios (cont'd)
Net Working Capital: how many dollars of working capital are available to pay bills and grow the business
Higher amounts: better Lower amounts: worse
Net working capital Current assets Current liabilities
29
Activity Ratios
Accounts Receivable Turnover: how quickly the company is collecting its accounts receivable (sales to customers on credit)
Higher ratio: better Lower ratio: worse
Accounts receivable turnover Annual sales
Accounts receivable
30
Activity Ratios (cont’d)
Inventory Turnover: how quickly the company is selling its inventory
Higher ratio: better Lower ratio: worse
Inventory turnover Annual sales
Inventory
31
Activity Ratios (cont'd)
Total Asset Turnover: how efficiently the company is using its assets to support sales
Higher ratio: better Lower ratio: worse
Total asset turnover Annual sales
Total assets
32
Leverage Ratios
Debt-Equity Ratio: how much debt the company is using to support its business compared to how much stockholders’ equity it is using to support its business
Higher ratio: more risk Lower ratio: less risk
Debt-equity ratio Long-term debt
Stockholders’ equity
33
Leverage Ratios (cont'd)
Time Interest Earned: measures the ability of the firm to meet its fixed interest payments
Higher ratio: less risk Lower ratio: more risk
Times interest earned Earnings before interest and taxes
Interest expense
34
Profitability Ratios
Net Profit Margin: amount of profit earned from sales and other operations
Higher ratio: better Lower ratio: worse
Net profit margin Net profit after taxes
Total revenues
35
Profitability Ratios (cont'd)
Return on Assets: amount of profit earned on each dollar invested in assets; measures management’s efficiency at using assets
Higher ratio: better Lower ratio: worse
ROA Net profit after taxes
Total assets
36
Profitability Ratios (cont'd)
Return on Equity: amount of profit earned on each dollar invested by stockholders; measures management’s efficiency at using stockholders’ funds
Higher ratio: better Lower ratio: worse
ROE Net profit after taxes
Stockholders’ equity
37
Breaking DownReturn on Assets (ROA)
Breaking down ROA allows investors to identify the components that are driving company profits.
Investors want to know if ROA is moving up (or down) because of improvement (or deterioration) in the company’s profit margin and/or its total asset turnover.
ROA Net profit margin Total asset turnover
38
Breaking DownReturn on Assets (ROA) (cont'd)
Breaking down ROE allows investors to identify the impact of financial leverage on company return.
Investors want to know if ROE is moving up (or down) because of how much debt the company is using or because of how the firm is managing its assets and operations.
ROE ROA Equity multiplier
Equity multiplier Total assets
Total stockholders’ equity
39
Common Stock Ratios
Price/Equity Ratio: shows how the stock market is pricing the company’s common stock One of the most widely used ratios in common stock selection Often used in stock valuation models
Higher ratio: more expensive Lower ratio: less expensive
P/E Market price of common stock
EPS
EPS Net profit after taxes Preferred dividends
Number of common shares outstanding
40
Common Stock Ratios (cont'd)
What is the P/E ratio for a company with profits of $139.7 million, 61,815,000 outstanding shares of common stock and a current market price of $41.50 per share?
EPS $139,700,000
61,815,000 shares or $2.26
Price/Earnings ratio $41.50
$2.26 or 18.4
41
Common Stock Ratios (cont'd)
Price/Earnings Growth Ratio (PEG): compares company’s P/E ratio to the rate of growth in earnings
Ratio > 1: stock may be fully valued PEG = 1: stock price in line with
earnings growth Ratio < 1: stock may be undervalued
PEG ratio=Stock’s P/E ratio
3- to 5-year growth rate in earnings
42
Common Stock Ratios (cont'd)
Dividends per share: the amount of dividends paid out to common stockholders
Dividends per share Annual dividends paid to common stock
Number of common shares outstanding
43
Common Stock Ratios (cont'd)
Payout Ratio: how much of its earnings a company pays out to stockholders in the form of dividends Traditional payout ratios have been 40% to 60% Recent trends have been lower payout ratios, with more tax efficient
stock buyback programs used frequently High payout ratios may be difficult to maintain and the stock market
does not like cuts in dividends
Payout ratio Dividends per share
Earnings per share
44
Common Stock Ratios (cont'd)
Book Value per Share: difference between assets and liabilities (equity) per share
A company should be worth more than its book value.
Book value per share Common stockholders’ equity
Number of common shares outstanding
45
Common Stock Ratios (cont'd)
Price-to-Book Ratio: compares stock price to book value to see how aggressively the stock is being priced
Higher ratio: stock is fully-priced or overpriced Lower ratio: stock may be fairly priced
or underpriced
Price-to-book-value Market price of common stock
Book value per share
46
Interpreting Financial Ratios
Look at historical ratio trends for the company
Look at ratios for the industry
Evaluate the firm relative to two or three major competitors
Try to determine if the financial information is telling you a good story about the company or a bad story
Use the story to decide if you think the stock has intrinsic value for you as an investor
47
Could There Be Trouble Brewing?
The following financial statement developments could indicate a company heading for financial problems:
Inventories and receivables growing faster than sales
A falling current ratio, caused by current liabilities increasing faster than current assets
A high and rapidly increasing debt-to-equity ratio, suggesting problems with servicing debt in future
Cash flow from operations dropping below net income
Presence of lots of indecipherable off-balance sheet accounts and extraordinary income entries