Chap 1-6 Flashcards
Beta technologies
Calculates the risk measures: Betas
Calculates the normal return for risk
Ignores any arbitrage opportunities
Alpha Technologies
Tries to gain abnormal returns by exploiting arbitrage opportunities from mispricing
Fundamental risk
The chance of losing value because of the outcome of business activities
Price risk
- Is the risk of trading at the wrong price:
- Paying too much
- Selling for too little
Difference between fundamental risk and price risk
- Fundamental risk arises from the inherent risk in the business, from sales revenue falling or expenses rising unexpectedly, for example.
- Price risk is the risk of prices deviating from fundamental value.
Prices are subject to fundamental risk, but can move away from fundamental value, irrespective of outcomes in the fundamentals. When an investor buys a stock, she takes on fundamental risk – the stock price could drop because the firm’s operations don’t meet expectations – but she also runs the (price) risk of buying a stock that is overpriced or selling a stock that is underpriced.
Difference between beta and alpha technologies
A beta technology measures the risk of an investment and the required return that the risk requires. The capital asset pricing model (CAPM) is a beta technology; is measures risk (beta) and the required return for the beta.
An alpha technology involves techniques that identify mispriced stocks than can earn a return in excess of the required return (an alpha return).
Difference between active and passive investor
- A passive investor does not investigate the price at which he buys an investment. He assumes that the investment is fairly (efficiently) priced and that he will earn the normal return for the risk he takes on.
- The active investor investigates whether the investment is efficiently priced. He looks for mispriced investments that can earn a return in excess of the normal return.
P/E Ratio
- Price-to-Earnings Ratio is the ratio for valuing a company that measures its current share price relative to its earnings per share.
- If an investor expects to earn 10% on her investment in a stock, then earnings/price should be 10% and price/earnings should be 10. Any return above this would be considered “high” and any return below it “low.”
The three different business activities
- Financial Activities
Raising cash from investors and returning cash to investors - Investing Activities
Investing cash raised from investors in operational assets - Operating Activities
Utilizing investments to produce and sell products
Value of the firm formula
Value of the firm = Value of Assets = Value of Debt + Value of Equity (Eget kapital).
Difference between the outside analyst and inside analyst
- The outside analyst values the firm
The outside analyst understands the firm’s value in order to advise outside investors - The inside analyst values strategies for the firm
The inside analyst evaluates plans to invest within the firm to generate value
Value-Based Management
(Three steps)
- Develop strategic ideas and plans
- Forecast payoffs from the strategy
- Calculate value from forecasted payoffs
IPO
Initial Public Offering, a stock launch is a public offering in which shares of a company is sold to institutional investors and usually also to individual investors.
The four financial statements
- Balance Sheet
Shareholders equity. lists assets, liabilities, and stockholders/shareholders equity. These are divided into current (generate cash/cash will be needed, within one year) and long-term.
Equity = Assets - Liabilities - Income Statement
Net income available to common. reports how shareholders equity increased or
decreased as a result of business activities with the buttom line being net income/earnings/profit.
o Net income = Revenue – Expenses - Cash Flow Statement
Change in cash. describe how the firm generated and used cash during the
period and are divided into operating-, financing-, and investing activities. o Change in cash = Cash from ops + Cash from inv + Cash fr financing - Statement of Shareholders’ Equity
Ending Equity start with beginning equity and ends with end equity and explain how it changed over the period. Owner’s equity increases from earnings in business activities (comprehensive income) and decrease if there is a net pay out to owners.
Accounting standard: GAAP
General Accepted Accounting Principals
US - Issued by FSAB (Financial Accounting Standards Board)
Oversight by SEC (Securities and Exchange Commission)
Accounting Standard: IFRS
International Financial Reporting Standards
Issued by ISAB (Internatinal Accounting Standards Board)
Mandatory for listed companies in Europe
Arbitrage
Arbitrage is an investment strategy in which an investor simultaneously buys and sells an asset in different markets to take advantage of a price difference and generate a profit
Why is the matching principle important?
- Matching nets expenses against the revenues they generate. Revenues are value added to the firm from operations; expenses are value given up in earning revenues. Matching the two gives the accountant’s measure of net value added, and so measures the success in operations. Matching uncovers profitability.
- Matching principle is the accounting principle that recognizes expenses when the revenue for which they are incurred i recognized.
Total Liabilities
The combined debt and obligations that an individual or company owes to outside parties
Comprehensive income
Totalresultat, “alla förändringar i eget kapital under en period förutom de som är ett resultat av investeringar av ägare och utdelningar till ägare”
Is the sum of a company’s net income
Net income is the profit left after deducting (avdrag) total business expenses from gross income
Holding return
- Holding period return (or yield) is the total return earned on an investment during the time that it has been held.
- A holding period is the amount of time the investment is held by an investor, or period between the purchase and sale of a security.
Glamour stocks and value stocks
- Glamour stock is a stock that is fashionable and trades at high multiples (viewed by contrarian investors as overvalued). Sometimes referred to as a growth stock.
- Value stock is a stock that trades at low multiples (viewed by value investors as undervalued). Compare with growth stock.
EPS
- Earnings per share is a companys net profit divided by the number of common shares it has outstanding.
- EPS indicates how much money a company makes for each share of its stocks and is a widely used metric for estimating corporate value
P/E ratio
P/E ratio compares the stock price to annual earnings
Multiples Approach
A valuation method that compares a target company’s financial metrics to those of similar companies
Multiple
- A valuation metric calculated by dividing the value of an asset or equity by a specific financial metric
- A multiple is simply the ratio of the stock price to a particular number in the financial statements.
- The most common ratios multiply the important summary numbers in the statements-earnings, book values, sales, and cash flows- hence the price-earnings ratio (P/E), the price-to-book ratio (P/B), the price-to-sales ratio (P/S), and the ratio ofprice-to- cash flow from operations (P/CFO).
Intrinsic value
What an investment is worth based on forecasted payoffs from the investment. Payoffs are forecasted with information so intrinsic value is sometimes said to be the value justified by the information
Liability
Someting a person or company owes, usually a sum of money
Cash flow
The sum of the cash flows from the three activities explains the increase or decrease in the firm’s cash (at the bottom ofthe statement):
Cash from operations + Cash from investment (2.3) + Cash from financing = Change in cash
Asset-based valuation
Asset-based valuation estimates a firm ‘s value by identifying and summing the value of its assets.
Leverage
- Financial leverage results from using borrowed capital as a funding source when investing to expand the firm’s asset base and generate returns on risk capital. Leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital—to increase the potential return of an investment. Leverage can also refer to the amount of debt a firm uses to finance assets.
- Examples of financial leverage usage include using debt to buy a house, borrowing money from the bank to start a store and bonds issued by companies.
Fundamental analysis
(5 steps)
uses a company’s revenues, earnings, future growth, return on equity, profit margins, and other data to determine a company’s underlying value and potential for future growth.
- Knowing the business
- Analyzing information
- Developing forecasts
- Converting forecasts to a valuation
- Trading on the valuation
Parsimony
(in valuation) is the ability to value a firm from a reduced amount of information
Perpetuity
A perpetuity is a constant stream that continues without end. The periodic payoff in the stream is sometimes referred as an annuity, so a perpetuity is an annuity that continues forever.
Dividends
Are cash flows paid out of the firm (to shareholders)
