Transcript Valuation_Ch17

Security Valuation and Selection
Chapter 17
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Fundamental Analysis versus
Technical Analysis
Fundamental analysis
 the practice of evaluating the information
contained in financial statements, industry
reports, and economic factors to determine
the intrinsic value of a firm
Fundamental Analysis versus
Technical Analysis
Intrinsic value
 the “true” or economic, value of a firm
Fundamental Analysis versus
Technical Analysis
Fundamentalists
 analysts who utilize fundamental analysis in
an attempt to forecast future stock price
movements
Fundamental Analysis versus
Technical Analysis
Technical analysis
 examination of supply and demand for
securities to determine trends in price
movements of stocks or financial
instruments
Fundamental Analysis versus
Technical Analysis
Technicians
 the term given to analysts who examine
stocks and financial markets using
technical analysis
Economic Analysis
Forecasting business cycles
 to determine when to expect changes in the
business cycle, or the direction in which
aggregate economic activity is moving
Economic Analysis
Business cycle
 the movement in aggregate economic
activity as measured by the gross domestic
product (GDP)
Economic Analysis
Expansion
 increasing economic activity
Economic Analysis
Contraction
 decreasing economic activity
Economic Analysis
Gross Domestic Product (GDP)
 a measure of all of the goods and services
produced in the economy during a specified
time period
Economic Analysis
Recession
 two consecutive quarters of economic
contraction, or decline, in the GDP
Recessions and Stock Price Movements 1975 - 2005
Economic Analysis
Economic indicators
 Leading economic indicators
 economic measures that tend to move prior to,
or precede, movements in the business cycle
Economic indicators
Lagging economic indicators
economic measures that tend to move
after, or follow, movements in the
general economy (business cycles)
Economic indicators
Coincident indicators
economic measures that tend to
mirror, or move at the same time as,
business cycles
Business Cycle Indicators
Business Cycles - Monetary Policy
and Fiscal Policy
Monetary Policy
 the means by which the Federal Reserve
influences economic conditions by
managing the nation’s money supply
Business Cycles - Monetary Policy
and Fiscal Policy
Fiscal Policy
 Government spending, which is primarily
supported by the government’s ability to tax
individuals and businesses
Business Cycles - Monetary Policy
and Fiscal Policy
Deficit spending
 situation that occurs when the government
spends more than it collects in taxes
Industry Analysis
Cyclical industries
 industries that tend to be directly related to
business cycles such that they perform
best during expansions and worst during
contractions
Industry Analysis
Defensive, or countercyclical, industries
 industries that tend to perform best when
the economy is in a contraction or
recession, but are generally the poorest
performers in expanding economies
Industry Analysis
Industry life cycle
 the various phases of an industry with
respect to its growth in sales and its
competitive conditions
Industry Life Cycle
Industry
Sales
Mature
Expansion
(Growth)
Introductory
Life-Cycle Stages
Evaluating the Firm’s Financial
Position
 Financial statement analysis
1.
2.
3.
4.
comparison to other similar firms
forecast direction for future
predict earnings and dividends
risk evaluation
Stock Valuation Techniques
Dividend discount models (DDM)
 a model that utilizes the discounted cash
flow principle to value common stock
 value is represented by the present value
of the dividends expected to be received
from investing in the stock
Stock Valuation Techniques
Dividend discount models (DDM)
Value of stock  Vs  P̂0  PV of expected future dividends

D̂1
1  k s 
1


t 1
D̂ 2

1  k s 
D̂ t
1  k s 
t
2

D̂ 
1  k s 
Stock Valuation Techniques
Valuation using P/E ratios
 ratio computed by dividing the current
market price per share, P0, by the earnings
per share, EPS0
 used to estimate the value of a stock; P0 ≈
(P/E) x EPS0
Stock Valuation Techniques
Evaluation using the economic value
added (EVA) approach
 method used to evaluate if the earnings
generated by a firm are sufficient to
compensate the suppliers of funds - both
the bondholders and the stockholders
Stock Valuation Techniques
Evaluation using the economic value
added (EVA) approach
Invested 
EVA  IRR - WACC  

 capital 

Invested 
 EBIT 1- T  WACC 

capital 

Economic Value Added (EVA)
Changing the capital structure can
change value because the WACC is
affected
Increasing the efficiency of the firm
through reductions in operating
expenses or increases in revenue will
increase operating income and thus
increase value
Technical Analysis
Charting - using charts and graphs
Bar chart
a graph that indicates the high, low,
and closing price movements for a
stock during a specified period
Technical Analysis
Charting - using charts and graphs
Trend line
 a line that indicates the direction of the
stock price movements
 it is drawn so that it touches either the
high prices or the low prices for some of
the trading days
Technical Analysis
Charting - using charts and graphs
Trend line penetration
 the point at which the trading line
crosses the trend line
Trend Line Penetration
Technical Analysis
Measures and indicators used by
technical analysts
The Dow Theory
 a technique used to predict reversals in
market patterns by examining the
movements of the Dow Jones Industrial
Average and the Dow Jones
Transportation Average
Measures and indicators used by
technical analysts
Moving averages
stock price averages for a fixed
time frame, say 100 days,
computed for a particular period
of time
Measures and indicators used by
technical analysts
Technical indicators
measures used by technical
analysts to forecast future
movements in stock prices
Measures and indicators used by
technical analysts
Market breadth indicators
measure the trading volume and
the range of trading that takes
place in the market
Measures and indicators used by
technical analysts
Advance/decline line
a graph that depicts the results
computing the difference between
the number of advancing stocks
and the number of declining
stocks over some time period
Measures and indicators used by
technical analysts
Sentiment indicators
technical indicators that are used
to monitor the “mood” or
psychology of the market
Stock Selection Criteria
Growth stocks
 stocks of firms that have many positive net
present value opportunities
 in general, these firms exhibit sales and
earnings growth that significantly exceed
the industry averages
Stock Selection Criteria
Value stocks
 stocks of firms that are mispriced,
especially those that are undervalued
$1.99
Investment Professionals’ Advice
1. Be disciplined with your investment
approach
2. Know the company in which you invest
3. Choose firms that are in strong
financial positions
4. Stay with the investment until it no
longer satisfies your investment goals
Investment Selection in Efficient
Markets
Abnormal returns
 returns that exceed the returns earned by
investments with similar risks
Weak form efficiency
 current market prices reflect all historical
information, including any information that
might be provided by examining past price
movements and trading volume data
Investment Selection in Efficient
Markets
Semistrong form efficiency
 current market prices reflect all publicly
available information, including information
contained in historical data and
information contained in current financial
statements
Strong form efficiency
 current market prices reflect all
information, whether it is public or private
Investment Selection in Efficient
Markets
Even if we accept that abnormal returns
cannot be earned on a consistent basis,
we still need to evaluate the investments
we select to ensure the risk position is
appropriate and that our investment
goals are being met
End of Chapter 17
Security
Valuation
and Selection