CHAPTER FOURTEEN

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CHAPTER FOURTEEN

• FINANCIAL ANALYSIS OF COMMON STOCKS

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FINANCIAL ANALYSIS

• REASONS FOR FINANCIAL ANALYSIS
• TWO PRIMARY REASONS
• to determine certain securities characteristics
• to attempt to identify mispriced securities

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FINANCIAL ANALYSIS

• REASON 1 DETERMINING SECURITY CHARACTERISTICS
• estimate future sensitivity to major factors
• estimate dividend yield

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FINANCIAL ANALYSIS

• REASON 2 ATTEMPTING TO IDENTIFY MISPRICED
  SECURITIES
• use fundamental analysis
• approaches
• valuation determines the intrinsic value compared
  to the current market value
• estimate key financial variables such as
• EPS next year
• income growth next year

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FUNDAMENTAL ANALYSIS

• TOP-DOWN V. BOTTOM UP
• TOP-DOWN APPROACH
• attempts to forecast in the following order
• 1. economic activity
• 2. industry performance
• 3. firms performance

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FUNDAMENTAL ANALYSIS
Economic Analysis
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FUNDAMENTAL ANALYSIS

• FINANCIAL STATEMENT ANALYSIS
• INTEGRAL PART OF FUNDAMENTAL ANALYSIS
• it helps the analyst understand a firms current
  condition
• where it is headed
• what factors affect it
• how the factors affect it

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FUNDAMENTAL ANALYSIS

• FINANCIAL STATEMENT ANALYSIS
• Review of Accounting Statements
• includes a study of the three major statements
  prepared monthly by most accountants
• the balance sheet
• the income statement
• the statement of cash flows

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FUNDAMENTAL ANALYSIS

• FINANCIAL STATEMENT ANALYSIS
• RATIO ANALYSIS
• DEFINITION a technique used to examine a
  companys financial statements
• Use of Ratios
• as an absolute standard
• as a comparative indicator
• as a trend over time

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FUNDAMENTAL ANALYSIS

• FINANCIAL STATEMENT ANALYSIS
• RATIO ANALYSIS
• Types of Ratios
• internal liquidity
• operating performance
• risk analysis
• growth analysis
• profitability
• market ratios

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FUNDAMENTAL ANALYSIS

• internal liquidity ratios
• indicate the ability of the firm to meet future
  short-term financial obligations
• some liquidity ratios
• current ratio
• quick ratio
• cash ratio
• receivables turnover

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FUNDAMENTAL ANALYSIS

• operating performance ratios
• indicate how well the management is operating the
  business
• some examples
• total asset turnover
• net fixed asset turnover
• equity turnover

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FUNDAMENTAL ANALYSIS

• risk analysis ratios
• indicates the uncertainty of income flows for the
  total firm and for the individual sources of
  capital (debt and stock)
• some examples
• debt to equity ratio
• long-term debt/total capital ratio

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FUNDAMENTAL ANALYSIS

• growth analysis ratios
• indicate how fast a firm should grow
• it involves analysis using several other ratios
• net profit margin
• total asset turnover
• total assets/equity

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Profitability Ratios
FUNDAMENTAL ANALYSIS

• Gross Margin
• Gross profit / Sales
• Operating Margin
• Operating income / Sales
• ROA
• Net income / Total assets
• ROE
• Net income / Owners equity

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Per Share Calculations
FUNDAMENTAL ANALYSIS

• Book Value Per Share (BVPS)
• Total equity / shares outstanding
• Earnings Per Share (EPS)
• Net income / shares outstanding
• Cash Flow Per Share (CFPS)
• Operating cash flow / shares outstanding

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FUNDAMENTAL ANALYSIS
Market Value Ratios

• Price / Book (or Market / Book)
• Stock price / BVPS
• Price / Earnings (P/E)
• Stock price / EPS
• Price / Cash flow (P/CF)
• Stock price / CFPS

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Sources of Information

• Annual reports
• Wall Street Journal
• Value Line
• Standard Poors
• Research Insight

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Sources of Information

• Internet
• NYSE (www.nyse.com)
• Nasdaq (www.nasdaq.com)
• Text (www.mhhe.com/cj)
• CNNfn.com
• CNBC.com
• Yahoo.com
• Zacks.com
• Smartmoney.com
• Multex.com
• MSNBC.com
• Quicken.com

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Sources of Information

• SEC
• EDGAR
• 10K 10Q reports

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TECHNICAL ANALYSIS

• DEFINITION a form of security analysis that
  attempts to forecast price changes based on
  historical price and volume trends

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TECHNICAL ANALYSIS

• Two Groups of Strategies Used
• 1. Momentum and Contrarian Strategies
• 2. Moving Average and Trading Range Breakout
• Strategies

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Technical Analysis

• Support and resistance areas
• Support level / Bottom feeders
• Resistance level / Topping out / profit taking
• Breakouts

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TECHNICAL ANALYSIS

• 1. Momentum and Contrarian Strategies
• METHDOLOGY
• examine the returns over a time period just ended
  to identify
• momentum investors who seek out stocks recently
  rising in price for purchase falling for sale
• contrarians who follow the opposite strategy of
  most investors
• contrarians base their strategy on the
  overreaction theory

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TECHNICAL ANALYSIS

• 2. Moving Average and Trading Range Breakout
  Strategies
• MOVING AVERAGE STRATEGY
• calculate a moving average over the last 200 days
  of closing prices
• divide todays closing price into the moving
  average (SHORT-TO-LONG RATIO)
• if short-to-long ratio is greater than 1, buy
• if ratio is less than 1, sell

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TECHNICAL ANALYSIS

• 2. Moving Average and Trading Range Breakout
  Strategies
• TRADING RANGE BREAKOUT STRATEGY
• high and low prices for past 200 trading days are
  identified
• if todays close is greater than the high buy!
• if todays close is less than the low sell!

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TECHNICAL ANALYSIS

• Reading the tea leaves
• Advance / decline line Closing Arms or Trin
• Relative strength
• Moving averages
• Candlestick chart
• Chart formations head-and-shoulders

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Examples

• Closing Arms Trin
• Values 1 considered bearish

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Examples

• Advance/Decline Line Calculation
• Issues Issues
• Weekday Advancing Declining Difference Cumulativ
  e
• THU 1,162 1,888 -726 -726
• FRI 2,275 1,198 1,077 351
• MON 1,203 1,849 -646 -295
• TUE 1,187 1,878 -691 -986
• WED 1,739 1,311 428 -558
• THU 2,193 910 1,283 725
• FRI 2,178 974 1,204 1,929
• MON 1,540 1,525 15 1,944
• TUE 1,660 1,540 120 2,064

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Examples

• Relative strength
• Charts performance relative to industry or
  market
• Value Line Timeliness
• Price performance/Average performance of V-L
  Stocks

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Moving Average
12 14 13 13.00 3
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Moving Average Graph
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Candlestick Making
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Head and Shoulders Formation