Investment Analysis
Jan Oplatek
2007
Investment Analysis
Economic Analysis
Reading Economic Indicators
Industry Analysis
Fundamental Analysis
Reading Financial Statements
Ratio Analysis
Stock Valuations
Technical Analysis
Chart Patterns
Moving Averages
Advanced Technical Analysis
Behavioral Analysis
Stock picking
Business Cycle
Source: Wikipedia
Economic Analysis
Business Cycle
The movement in aggregate economic activity as
measured by the gross domestic product (GDP)
GDP = consumption + investment + (government
spending) + (exports - imports)
Monetary & Fiscal Policies
Fiscal Policies
The size of the government deficit and the methods it uses to
finance it
Taxes
Government Spending
Monetary Policies
concerned with the amount of money in circulation and,
consequently, interest rates and inflation.
Interest rates, if set by the Government
Incomes policies which aim at imposing non-monetary controls on
inflation
Bank regulations which affect the money multiplier
Economic Indicators
Anything that can be used to predict future
financial or economic trends
Economic Indicators
Leading
Signal future events
Example: bond yields indicates future for stock mkt
Lagging
Follows an event ­ confirm trends
Example: unemployment
Coincident
These indicators occur at approximately the same time as
the conditions they signify
Example: personal income
The Leading Economic Indicators
Gross Domestic Product
Consumer Price Index
Producer Price Index
Employment Indicators
Retail Sales Indicator
The Institute for Supply Management index (former
NAPM Index)
Consumer Confidence Index
Beige Book
http://www.briefing.com/Investor/Public/Calendars/EconomicCalendar.htm
US Economic Indicators 1
Beige Book
Business Outlook Survey
Consumer Confidence Index (CCI)
Consumer Credit Report
Consumer Price Index (CPI)
Durable Goods Report
Employee Cost Index (ECI)
Employee Situation Report
Existing Home Sales
Factory Orders Report
Gross Domestic Product (GDP)
Housing Starts
US Economic Indicators 2
Industrial Production
Jobless Claims Report
Money Supply
Mutual Fund Flows
Non-Manufacturing Report
Personal Income and Outlays
Producer Price Index (PPI)
Productivity Report
Purchasing Managers Index (PMI)
Retail Sales Report
Trade Balance Report
Wholesale Trade Report
Industry Analysis
Porters 5 factor model
1. Competition in the industry
2. Potential of new entrants into industry
3. Power of suppliers
4. Power of customers
5. Threat of substitute products
http://www.investopedia.com/features/industryhandbook/
Industry Analysis
Cyclical stocks
Automotive
Housing
Counter-cyclical stocks / Defensive
Utilities
Household non-durables
Tobacco
Food
Oil
Industry Analysis
http://biz.yahoo.com/ic/index.html
http://biz.yahoo.com/p/sum_conameu.html
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.
The basic idea is to identify "undervalued" stocks to buy and
"overvalued" stocks to sell.
In practice however, such stocks may in fact be correctly priced for
reasons not immediately apparent to the analyst.
Qualitative & Quantitative Factors
Fundamental Analysis Answers:
Is the company's revenue growing?
Is it actually making a profit?
Is it in a strong-enough position to beat out
its competitors in the future?
Is it able to repay its debts?
Is management trying to "cook the
books"?
FA - Qualitative Factors
Company Related
Business model
Competitive Advantage
Management
Corporate Governance
Industry Related
Customers
Market Share
Industry Growth
Competition
Regulation
FA ­ Quantitative Factors
Financial Statements
Profit & Loss / Income Statement
Balance Sheet
Cash Flow Statement
Annual Report
SEC Filings ­ 10K
Income Statement
summarizes a company's revenues (sales)
and expenses quarterly and annually for
its fiscal year.
The final net figure, as well as various
others in this statement, are of major
interest to the investment community
Income Statement
Multi-Step Format Single-Step Format
Net Sales Net Sales
Cost of Sales Materials and Production
Gross Income Marketing and Administrative
Selling, General and Administrative Expenses (SG&A) Research and Development Expenses (R&D)
Operating Income Other Income & Expenses
Other Income & Expenses Pretax Income
Pretax Income Taxes
Taxes Net Income
Net Income (after tax) --
Balance Sheet
Snapshot of Company's position
Assets = Liabilities + Shareholders' Equity
Assets
Assets are what a company uses to operate its
business
Current Assets
Non-Current Assets
Depreciation is calculated and deducted from
most of these assets, which represents the
economic cost of the asset over its useful life.
Current Assets
Current assets have a life span of one year or less,
meaning they can be converted easily into cash.
Cash, the most fundamental of current assets, also includes
non-restricted bank accounts and checks. Cash equivalents are
very safe assets that can be are readily converted into cash such
as U.S. Treasuries.
Accounts receivable consists of the short-term obligations
owed to the company by its clients. Companies often sell
products or services to customers on credit, which then are held
in this account until they are paid off by the clients.
Inventory represents the raw materials, work-in-progress goods
and the company's finished goods..
Non-current Assets
Non-current assets, are those assets that are not turned
into cash easily, expected to be turned into cash within a
year and/or have a life-span of over a year.
Tangible assets such as machinery, computers,
buildings and land.
Intangible assets, such as goodwill, patents or copyright.
While these assets are not physical in nature, they are
often the resources that can make or break a company the
value of a brand name, for instance, should not be
underestimated
Liabilities
Financial obligations a company owes to outside
parties
Long Term Liabilities
debts and other non-debt financial obligations, which are due
after a period of at least one year from the date of the
balance sheet
Current Liabilities
liabilities which will come due, or must be paid, within one
year. This is comprised of both shorter term borrowings, such
as accounts payables, along with the current portion of
longer term borrowing, such as the latest interest payment on
a 10-year loan.
Shareholder's Equity
Shareholders' equity is the initial amount of
money invested into a business.
If, at the end of the fiscal year, a company
decides to reinvest its net earnings into the
company (after taxes), these retained earnings
will be transferred from the income statement
onto the balance sheet into the shareholder's
equity account.
This account represents a company's total net
worth.
Balance Sheet - Example
Cash Flow Statement
shows how much cash comes in and goes out of
the company over the quarter or the year.
Difference to Income statement ­ accrual
accounting
Accrual accounting requires companies to record revenues
and expenses when transactions occur, not when cash is
exchanged. At the same time, the income statement, on the
other hand, often includes non-cash revenues or expenses,
which the statement of cash flows does not include.
System
Cash Flow
Free Cash Flow
Ratio Analysis
Ratios
Performance
Activity
Financing
Liquidity Warnings
Performance Ratios
Average Interest rate
Book Value per Share
Cash Flow to Assets
Common Size Analysis
Dividend payout ratio
Earnings per Share
Gross Profit margin
Price/Earning ratio
Profit margin
Return on Assets
Return on equity
Average Interest Rate
Indicates the average interest rate that a
company borrows at.
This is a rough estimate, the ratio does not
account for everything.
Using the before tax or after tax interest expense
will produce different results
= (Interest Expense - Accounts Payable)/Liabilities
Book Value Per Share
Stockholder's equity to the number of shares
outstanding, giving the shares a raw value.
Comparing the market value to the book value can indicate
whether or not the stock in overvalued or undervalued.
During bull markets the stock price is more likely to trade
significantly higher than book value, and in a bear market the
two value's may be close to equal.
=(Stockholders Equity - Preferred Stock) / Average Outstanding Shares
Cash Flow to Assets
This ratio indicates the cash a company
can generate in relation to its size.
Comparing to previous years is important, if the
company's ratio is decreasing then they may
eventually run into cash problems.
Ratio below 10 % signals possible problems
= Cash from Operations / Assets
Common Size Analysis
Indicates the proportion of an asset/liability/expense is
as a function of total assets/liabilities/revenue.
Compares what proportion that an expense reduces sales,
especially useful when comparing previous years.
It is also useful when comparing similar companies of different
sizes to see if they have the same financial structure.
= Entity / Total Entity
ABC 2006 2007
Sales 100% 100%
COGS 35% 34%
Other Expenses 40% 41%
Net Income 17% 16%
Dividend Payout Ratio
Indicates the proportion of earnings that
are used to pay dividends to shareholders.
A reduction in dividends paid is looked poorly upon
by investors, and the stock price usually
depreciates as investors seek other dividend
paying stocks.
A stable dividend payout ratio indicates a solid
dividend policy by the company's board of
directors.
= Yearly Dividend per Share / Earnings per Share
Earnings Per Share - EPS
The most widely used ratio, it tells how much
profit was generated on a per share basis.
Diluted EPS means that the outstanding shares includes any
convertible's or warrants outstanding.
If the company issues more shares then EPS are much
harder to compare to previous years.
EPS growth !!!
= (Net Income - Dividends on Preferred Stock) / Aver. Outstanding Shares
Gross Profit Margin
Indicates what the company's pricing
policy is and what the true mark-up
margins are.
The results may skew if the company has a very
large range of products.
This is very useful when comparing against the
margins of previous years.
= Revenue - Cost of Goods Sold / Revenue
Price to Earnings Ratio - P/E Ratio
One of the most widely used ratios, it compares
the current price with earnings to see if a stock is
over or under valued.
Generally a high P/E ratio means that investors are
anticipating higher growth in the future.
The p/e ratio can use estimated earnings to get the forward
looking P/E ratio.
Companies that are losing money do not have a P/E ratio.
= Market Value per Share / Earnings Per Share
S&P 500 - P/E
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09/30/1991
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12/31/1984
09/30/1982
06/30/1980
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6/30/1944
3/31/1942
12/31/1939
9/30/1937
S&P 500 and P/E Ratio
http://tickersense.typepad.com
Net Profit Margin
Indicates what portion of sales contribute
to the income of a company.
This ratio is not useful for companies losing
money, since they have no profit.
A low profit margin can indicate pricing strategy
and/or the impact competition has on margins.
= Net Income / Revenue
Return On Assets - ROA
Indicates what return a company is generating on the
firm's investments/assets.
The ROA is often referred to as ROI
We add the interest expense to ignore the costs associated with
funding those assets.
This is an important ratio for companies deciding whether or not to
initiate a new project. The basis of this ratio is that if a company is
going to start a project they expect to earn a return on it, ROA is the
return they would receive.
Simply put, if ROA is above the rate that the company borrows at
then the project should be accepted, if not then it is rejected.
= Net Income + Interest Expense / Total Assets
Return On Equity - ROE
Indicates what return a company is generating
on the owners' investment.
If new shares are issued then use the weighted average of
the number of shares throughout the year.
For high growth companies you should expect a higher ROE.
Averaging ROE over the past 5-10 years can give you a
better idea of the historical growth.
= Net Income / Shareholder's Equity
Asset Turnover
Indicates the relationship between assets and
revenue.
Companies with low profit margins tend to have high asset
turnover, those with high profit margins have low asset
turnover - it indicates pricing strategy.
This ratio is more useful for growth companies to check if in
fact they are growing revenue in proportion to sales.
= Revenue / Total Assets
Collection Ratio
This indicates the average number of days it
takes a company to collect unpaid invoices.
A high ratio indicates that the company is having problems
getting paid for services or products.
The ratio is sometimes seasonally affected, rising during
busy seasons and falling during the off-season. To account
for this seasonality, the average accounts receivable
((beginning + ending accounts receivable)/2) could be used
instead.
= Accounts Receivable / (Revenue/365)
Inventory Turnover
An important and often overlooked ratio that
indicates inventory levels.
A low turnover is usually a bad sign because products tend to
deteriorate as they sit in a warehouse.
Companies selling perishable items have very high turnover.
For more accurate inventory turnover figures, the average
inventory figure, ((beginning inventory + ending inventory)/2),
is used when computing inventory turnover. Average
inventory accounts for any seasonality effects on the ratio.
=Cost of Goods Sold / Average or Current Period Inventory
Debt-Asset Ratio
Indicates what proportion of the company's
assets are being financed through debt.
This ratio is very similar to the debt-equity ratio.
A ratio under 1 means a majority of assets are financed
through equity, above 1 means they are financed more by
debt.
You can interpret a high ratio as a "highly debt leveraged
firm".
= Total Liabilities / Total Assets
Debt-Equity Ratio
Indicates what proportion of equity and debt that the
company is using to finance its assets. Sometimes
investors only use long term debt instead of total
liabilities for a more stringent test.
A ratio greater than one means assets are mainly financed with
debt, less than one means equity provides a majority of the
financing.
If the ratio is high (financed more with debt) then the company is in
a risky position - especially if interest rates are on the rise.
= Total Liabilities / Shareholder's Equity
Acid Test (Quick Ratio)
A stringent test that indicates if a firm has enough short-term assets
(without selling inventory) to cover its immediate liabilities.
It is similar but a more strenuous version of the "working capital"
ratio, indicating whether liabilities could be paid without selling
inventory.
An extreme version of the working capital ratio because it only uses
cash and equivalents.
The ratio excludes inventory, which for some companies can make
up a large portion of its assets.
Preferably above 1.....
= (Cash + Accounts Receivable + Short-term Investments)
/ Current Liabilities
Interest Coverage
Indicates what portion of debt interest is
covered by a company's cash flow
situation.
A ratio under 1 means that the company is having
problems generating enough cash flow to pay its
interest expenses.
Ideally you want the ratio to be over 1.5.
= EBITDA / Interest Expense
Current Ratio (Working Capital Ratio)
Indicates if a firm has enough short-term assets
to cover its immediate liabilities.
A high working capital ratio isn't always a good thing, it could
indicate that they have too much inventory or they are not
investing their excess cash.
Anything below 1 indicates negative W/C (working capital).
While anything over 2 means that the company is not
investing excess assets. Most believe that a ratio between
1.2 and 2.0 is sufficient
= Current Assets / Current Liabilities
Valuations
Discounted Cash Flow models (DCF)
a model that utilizes the discounted cash flow principle to
value common stock
Dividend discount model
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
Valuation using P/E ratios
ratio computed by dividing the current market price per share
by the earnings per share
Discounted Cash Flow Model
Discounted Cash Flow Model
Calculating growth rate
Calculating free cash flow
Free cash flow to Equity
Free cash flow to Firm
Dividend discount model
Calculating discount rate
Weighted Average Cost of Capital (WACC)
DCF
Intrinsic value
Inputs & sensitivity
Detailed modeling needed