•Fundamental Analysis
•Approach to Fundamental Analysis:
–Domestic and global economic analysis
–Industry analysis
–Company analysis
•Why use the top-down approach?
Framework of Analysis

•Performance in countries and regions is highly variable.
•Political risk
•Exchange rate risk
–Sales
–Profits
–Stock returns
Global Economic Considerations

Table 17.1 Economic Performance in Selected Emerging Markets
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Figure 17.1 Change in Real Exchange Rate: Dollar versus Major Currencies, 1999 – 2005
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•Gross domestic product
•Unemployment rates
•Interest rates & inflation
•Budget deficit
•Consumer sentiment
Key Economic Variables

Figure 17.2  S&P 500 Index versus Earnings Per Share Estimate
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•Demand shock - an event that affects demand for goods and services in the economy.
–Tax rate cut
–Increases in government spending
Demand Shocks

•Supply shock - an event that influences production capacity or production costs.
–Commodity price changes
–Educational level of economic participants
Supply Shocks

•Fiscal Policy - government spending and taxing actions.
–Direct policy
–Slowly implemented
Federal Government Policy

•Monetary Policy - manipulation of the money supply to influence economic activity.
–Initial & feedback effects
–Tools of monetary policy
•Open market operations
•Discount rate
•Reserve requirements
•Supply Side Policies
Federal Government Policy (cont’d)

•Leading Indicators - tend to rise and fall in advance of the economy.
•Examples:
–Avg. weekly hours of production workers
–Stock Prices
NBER Cyclical Indicators: Leading

•Coincident Indicators - indicators that tend to change directly with the economy.
•Examples:
–Industrial production
–Manufacturing and trade sales
NBER Cyclical Indicators: Coincident

•Lagging Indicators - indicators that tend to follow the lag economic performance.
•Examples:
–Ratio of trade inventories to sales
–Ratio of consumer installment credit outstanding to personal income
NBER Cyclical Indicators: Lagging

Figure 17.3 Cyclical Indicators
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Table 17.2 Indexes of Economic Indicators
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Figure 17.4 Indexes of Leading, Coincident, and Lagging Indicators
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Table 17.3 Economic Calendar
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Figure 17.5 Economic Calendar at Yahoo!
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Table 17.4 Useful Economic Indicators
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•Sensitivity to business cycles
•Factors affecting sensitivity of earnings to business cycles:
–Sensitivity of sales of the firm’s product to the business cycles
–Operating leverage
–Financial leverage
•Industry life cycles
Industry Analysis

Figure 17.6 Returns on Equity, 2005
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Figure 17.7 Rate of Return, 2005
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Figure 17.8 ROE of Money Center Banks
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Table 17.5 Examples of NAICS Industry Codes
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Figure 17.9 Industry Cyclicality
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Table 17.6 Operating Leverage of Firms A and B Throughout the Business Cycle
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Figure 17.10 A stylized Depiction of the Business Cycle
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•Stage Sales Growth
•Start-up Rapid & Increasing
•Consolidation Stable
•Maturity Slowing
•Relative Decline Minimal or Negative
Industry Life Cycles

Figure 17.11 The Industry Life Cycle
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Sector Rotation
•Portfolio is adjusted by selecting companies that should perform well for the stage of the
business cycle
–Peaks – natural resource extraction firms
–Contraction – defensive industries such as pharmaceuticals and food
–Trough – capital goods industries
–Expansion – cyclical industries such as consumer durables
•