Chapter 10 - Fundamental analysis Flashcards
Interest cover
(Profit before interest and tax)/(Annual interest on debt)
Capital cover
(Total assets - current liabilities - intangibles)/(Balance sheet value of debt)
Net asset value per share
(Ordinary shareholders’ funds - intangibles)/(# issued ordinary shares)
Dividend yield
(Earnings per share)/(Dividends per share)
Return on capital employed
(Profit before interest and tax)/(Share capital & reserves + long-term debt)
or
(Profit before tax)/(Share capital)
Current ratio
(Current assets)/(Current liabilities)
Quick ratio
(Current assets - inventories)/(Current liabilities)
Price-to-earnings ratio
PER= (Share price)/(Earnings per share)
Dividend discount model
P = ∑(D_t v(t))
D_t: Dividend payable at time t
v(t): Discount factor for time t
or
If we assume a constant discount rate (i) and dividend growth rate (d) then:
P = D/(i - g)
where D is the dividend payable in one year’s time
Insider trading
Trading on the basis of privileged information
Key considerations during credit analysis for bond investment (4)
- Purpose
- Payback
- Risks
- Structure
Key considerations during credit analysis for bond investment: Purpose
What the company does and why it needs to borrow
Reasons include:
- Organic growth
- Acquisition
- Investment in an associated company
- Capital expenditure
- Dividend / share buy-back
Key considerations during credit analysis for bond investment: Payback
Relates to the ability to repay the loan
What is expected source of repayment? Is there a secondary source?
Issues to consider include:
- Cashflow / profit profile
- Possible sale of assets and /or businesses
- Refinancing
Key considerations during credit analysis for bond investment: Risks
What risks could jeopardize debt servicing?
Macro factors:
- Industry analysis and competitive trends
- regulatory environment
- sovereign macroeconomic analysis
Company specific factors:
- Qualitative analysis
- Financial performance
- Market position
Key considerations during credit analysis for bond investment: Structure
Does the bond structure reflect the risks and protect investors’ interests?
Factors include:
- Term
- Level and frequency of coupons
- Ranking relative to other bonds issued
- Limits on income and asset cover
- Quality and value of assets on which it is secured
- Ability to vary assets on which it is secured
- Price and yield (particularly in relation to risk-free government bonds)
Operating leverage
(Sales - variable costs)/(Profit before interest and tax)
Gives an indication of a company’s level of fixed operating costs
High value => small increase in sales would lead to big change in profits
Financial leverage
Often used to refer to income gearing which is:
(Interest payments)/(Profit before interest and tax)
Gives an indication of fixed financing costs
Asset or capital leverage
Debt/(debt + equity)
or
Debt/equity
Capital structure
Refers to the financial structure of the company i.e. balance between debt and equity
Cyclical companies
Companies whose fortunes are closely linked to the state of the economy e.g. :
- Property development companies
- Luxury goods retailers
Defensive companies
Companies that are relatively immune to the state of the economy e.g.:
- food retailers
- Insurance companies
- Telecommunication companies
Impact of trade cycle on PER: Economy moderately buoyant
Defensive + cyclical companies might be similarly rated (have similar PERs)
Impact of trade cycle on PER: Economy starts moving into recession
Defensive: Remain stable or rise slightly
Cyclical: Likely to fall as market anticipates a drop in profits
Impact of trade cycle on PER: Economic recession “Bumping along at the bottom”
Cyclical: Will probably have risen from low point as earnings decreased
Defensive: Still higher than cyclical
Impact of trade cycle on PER: Green shoots of recovery
Cyclical: PER will rise in anticipation of future earnings growth. Increase in earnings will likely lag behind price increase leading to very high PERs
Defensive: PER might be below that of cyclical companies
Fundamental share analysis
Aims to assess the “true” value of a share by analysing all of the factors that influence the future returns yielded by investment in that share, and hence aims to determine whether or not it is under- or over-priced
