Transcript Document

Security Valuation
and Selection
Chapter 17
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
 Fundamentalist
 analysts who utilize 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
Economic Analysis
Economic Analysis
 Economic indicators
 Leading economic indicators
 economic measures that tend to move prior to,
or precede, movements in the business cycle
Economic Analysis
 Economic indicators
 Lagging economic indicators
 economic measures that tend to move after, or
follow, movements in the general economy
(business cycles)
Economic Analysis
 Economic indicators
 Coincident indicators
 economic measures that tend to mirror, or
move at the same time as, business cycles
Business Cycles
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
 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
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
Technical Analysis
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
Technical Analysis
 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
Technical Analysis
 Measures and indicators used by
technical analysts
 Technical indicators
 measures used by technical analysts to forecast
future movements in stock prices
Technical Analysis
 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
Technical Analysis
 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
Technical Analysis
 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 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