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Series 86 > Chapter 2 > Flashcards

Chapter 2 Flashcards

1
Q

True or false: Utility, tobacco, alcohol, cosmetics, and food company stocks are all example of cyclical stocks?

A

False, defensive

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2
Q

True or false: Utility stocks are sensitive to higher interest rates?

A

True. These companies are highly leveraged.

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3
Q

Sectors that show their best relative performance at the early-to-middle part of a bull market:

A
  • Credit-related industries
  • Construction
  • Durable consumer goods
  • Transportation
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4
Q

Sectors that show their best relative performance at the middle-to-late part of a bull market:

A
  • Capital goods
  • Financials
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5
Q

Sectors that show their best relative performance at the late part of a bull market:

A
  • Non-durable consumer goods
  • Utilities
  • Energy stocks
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6
Q

Stages of an industry’s life cycle:

A
  • First stage: Characterizd by high growth rates and potentially high profits.
  • Second stage: Characterized by rapid growth. Due to consolidation, compared to the first stage, there are fewer companies.
  • Third stage: Similar to stage two. Slower growth. The industry’s products begin to face competition from other products and markets may start to become saturated.
  • Fourth stage: Growth substantially slows. In some industries, there is no growth at all, or a decline.
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7
Q

3 ways an industry can maintain a good rate of growth:

A
  1. Steady penetration of rapidly growing markets
  2. Accelerating penetration of markets w/ stable growth rates
  3. Accelerating penetration of rapidly growing markets
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8
Q

Unit costs

A

1/2 major factors that influence the pattern of industry profits. For most industries, as output increases in the early stages of growth, cost per unit decreases due to economies of scale.

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9
Q

Learning curve

A

A graph that illustrates the output and the industry’s unit cost.

  • This curve begins to flatten as unit costs stop falling w/ increases in production.
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10
Q

Unit pricing

A

1/2 major factors that influnce the pattern of industry profits. With this, attention is more paid to companies w/ large market share. The pricing strategies of industry leaders have an impact on the profitability of the entire industry.

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11
Q

Umbrella pricing

A

A type of pricing strategy where the market leaders set their prices just above the unit costs of the industry’s highest cost producers. This allows the low-cost producers to earn an attractive rate of return, while other producers earn only modest returns.

  • Cartels can generate a price umbrella effect, enabling less efficient rivals to charge higher prices than they might otherwise be able to
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12
Q

Learning curve pricing strategy

A

Low-cost producers use their cost advantage by regularly lowering prices. This puts pressure on the high-cost producers to improve efficiency in order to maintain profitability

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13
Q

True or false: Counter-cyclical stocks and defensive stocks are the same thing?

A

False, counter cyclical stocks do better during economic hardship, whereas defensive stocks are just more resistant and suffer less than cyclical stocks.

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14
Q

Monopsony

A

A market w/ a single buyer.

  • Opposite of a monopoly.
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15
Q

Common examples of things that create barriers to entry:

A
  • Market share (brand name)
  • Possession of proprietary knowledge (patents/research)
  • Ownership of raw materials
  • Regulatory things
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16
Q

Items important for fundamental analysis

A
  • A firm’s financial statements
  • Details regarding the firm’s product line
  • The experience and expertise of the firm’s mgmt
  • The outlook for the industry
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17
Q

Components of company analysis

A
  1. Product line analysis
  2. Quality of mgmt analysis
  3. Analysis of costs and sources of revenue and growth
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18
Q

Product line analysis

A

Now that industry analysis has been performed, product line analysis is often the first step of fundamental analysis. If a firm produces one product, the industry’s potential for growth will heavily influence the growth potential for the firm. If a firm operates in multiple product lines, each product must be analyzed and then an overall prospect for the company can be deciphered from a weighting of the individual product line analysis. This requires an understanding of market share.

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19
Q

Analysis of costs and sources of revenue and growth

A

This often requires analysis of a firm’s supply chain. Often, analysts look to see if a firm is reliant on a small # of suppliers. Analysts usually look at a firms’ policies to determine how well it could cope w/ future uncertainities.

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20
Q

Key components of FSA:

A
  • Operating leverage
  • Financial leverage
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21
Q

Operating leverage

A

The degree to which a firm or project relies on fixed rather than variable costs.

Calculation: FC ÷ (FC + VC)

  • The higher the degree of operating leverage, the greater the potential dangers from forecasting risk (small error made in forecasting sales can be magnified into large errors in CF projections).
  • Companies w/ high operating leverage will have longer breakeven points.
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22
Q

True or false: Firms w/ higher variable costs will have faster margin growth as opposed to firms w/ higher fixed costs if sales increase?

A

False, firms w/ higher operating leverage will have faster margin growth if sales increase.

This is only true is the total costs are the same!!!!!

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23
Q

BE point calculation

A

FC ÷ contribution margin

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24
Q

Contribution margin

A

Sales price - VC

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25
Q

Financial leverage

A

The degree to which an investor or business is utilizing borrowed money.

26
Q

Pros and cons of using leverage

A

Pros:
- Can increase shareholders’ ROI
- Tax advantages
Cons:
- May be risk of bankruptcy if the firm can’t make debt payments.

27
Q

Basic categories of assets

A
  1. Current assets: Assets that WILL be used or converted into cash within a year or one operating period, whichever comes first.
  2. Fixed assets: Assets that WON’T be used or converted into cash within a year or one operating period, whichever comes first.
  3. Intangible assets

  • Fixed assets are shown on the b/s at carrying value
28
Q

Valuation methods for current assets

A
  • FIFO
  • LIFO

  • FIFO is considered more aggressive
29
Q

True or false: In a period of rising prices, LIFO will result in greater profits?

A

False

30
Q

True or false: In a period of rising prices, LIFO will result in lower taxes?

A

True

31
Q

Basic categories of liabilities

A
  1. Current liabilities: Obligations that WILL come due in one year or one operating period, whichever comes first. Current liabilities can be easily identified by the term ‘payables’.
  2. Long-term liabilities: Obligations that WON’T come due in one year or one operating period, whichever comes first.
32
Q

Working capital

A

The net amount of a firm’s liquid resources.

Formula: CA - CL

33
Q

Tangible book value

A

Book value less intangible assets

Formula: TA - intangible assets - TL

34
Q

True or false: If a company buys back stock at a market price that’s less than its BVPS, its total BV will increase?

A

True, and if it buys back stock at a price more than its BVPS, its total BV will decrease.

35
Q

Basic components of shareholders’ equity

A
  1. Different classes of stock
  2. RE
  3. Capital surplus (a.k.a. paid-in capital)
36
Q

True or false: Chipholders tend to have high D/E ratios?

A

False

37
Q

True or false: Service industries are less vulnerable to swings in interest rates?

A

True

38
Q

True or false: Telecommunications companies typically have a balance sheet that is dominated by a large amount of fixed assets, long-term debt, and long-term liabilities. Inventory is insignificant as a percentage of total assets. Utility companies have similar balance sheets?

A

True

39
Q

Capital surplus

A

The amount of premium paid by shareholders above par value for shares being sold to the public by the corporation

40
Q

3 general resources for industry info:

A
  1. Business Info Sources
  2. Data Sources for Business and Marketing Analysis
  3. Directory of Business and Financial Services
41
Q

The North American Industry Classification System (NAICS)

A

The standard that’s used by Federal statistical agencies in classifying business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy.

42
Q

True or false: Annually, the IRS publishes the Corporation Source Book of Statistics of Income that provides annual financial info by industry based on corporate tax returns?

A

True

  • The U.S. Census Bureau also publishes the Census of Manufacturers and Census of Retail Trade that measures business activity.
43
Q

How does the government gauge the economy’s plans for spending and investment?

A

Surveys

44
Q

Sources of info for industry analysis

A
  • Government publications
  • Surveys
  • Industry studies
  • Trade/press associations
  • Business and financial press
  • Business Info Services
45
Q

Sources of info for company analysis

A
  1. SEC filings
  2. Info provided by companies (ex: press releases)
  3. Company directories (Moody’s Manuals, S&P’s Corporation Descriptions)
  4. Electronic sources
  5. Field data (interviewing companies or site visits)
46
Q

Market reaction question:
How to analyze the effects of a supplier’s stock that is in a highly regulated industry and is about to experience deregulation:

A

What to look for in the question: Does the deregulation free the company up to spend funds on new business opportunities OR does the company now have funds to spend more on existing business?

If companies begin to spend money on new business ventures, this can be bad for suppliers. However, if they increase spending on existing ventures, this is good for suppliers.

In general, the expected initial impact of deregulation would be for industry prices to rise and for production to expand. Therefore, suppliers to the industry should benefit. However, in the longer term, prices are expected to fall as competition increases supply.

47
Q

Most prevelant SEC filings for company analysis

A
  1. Registration statements and prospectuses
  2. 10-Ks: Annual audited financial statements
  3. 10-Qs: Unaudited quarterly financial statements
  4. 8-Ks
  5. Form DEF 14A/Proxy statements: Filed when a corporation intends to solicit proxies from shareholders regarding issues to be voted on at shareholder meetings (best source to get info about mgmt and executive compensation).
  6. Form 13Ds: Filed by any person that acquires > 5% of equity of an issuer
  7. Form 4: Insider/affiliate ownership filing
  8. Form 144: When someone wants to sell restricted/control stock

  • Footnotes in the 10-K will also have info about executive compensation. But the proxy has more detailed and specific info about executive compensation.
48
Q

When must a firm file a 10Q or 10K

A

If the firm is a large accelerated filer (has a public float >= $700MM, has filed one 10-K beofre, and has been subject to SEC requirements for at least a year) the 10-K must be filed within 60 days of calendar year-end and the 10-Q must be filed 40 days after the quarter end.

If the firm is an accelerated filer (has a public float >= $75MM but less than $700MM, has filed one 10-K before, and has been subject to SEC requirements for at least a year) the 10-K must be filed within 75 days after the fiscal year-end and the 10-Q must be filed within 40 days of the quarter-end.

If a company’s public float < $75MM, it’s defined as a non-accelerated filer and must file the 10-K within 90 days of fiscal year-end and 45 days of quarter-end.

49
Q

3 committees that SEC-filing companies are required to have

A
  1. The compensation committee
  2. The audit committee
  3. The corporate governance committee
50
Q

3 services that provide info about key financial ratios of a company and a comparison to industry norms:

A
  • Annual statement studies (produced by Risk Management Association)
  • Industry Norms and Key Business Ratios (Produced by Dun & Bradstreet)
  • Almanac of Business Ratios and Industrial Financial Ratios (Produced by CCH)
51
Q

How to calculate residual income

A

NOPAT - (Total capital * WACC)

52
Q

Seven industry sectors for the exam:

A
  1. Paper and forest products
  2. Media publishing
  3. Beverages
  4. Pharmaceutical services
  5. Public utilities
  6. REITs
  7. Speciality chemicals
53
Q

Key drivers of paper and forest products sector

A
  • GDP: As the economy grows, paper and forest products are needed more.
  • Per Capita income Growth: Since income growth is correlated w/ literacy growth, this growth leads to increased need for paper to write
  • Inventory swings: As the price of paper and forest products rise, paper users increase inventory stocks to more effectively cost average the product pricing.

  • Environmental regulations have negatively effected this sector in recent years.
54
Q

True or false: The paper and forest products industry’s demand is not sensitive to economic swings?

A

False, it’s highly cyclical. The cycle usually lasts for 4-6 years.

55
Q

Key products for the paper and forest products industry

A
  • Timber
  • Pulp
  • Newsprint
  • Printing and writing paper
  • Containerboard
  • Tissue
  • Building Products
56
Q

Key drivers of the media publishing sector:

A
  • GDP
  • Retail advertising spending

  • Media publishing is very cyclical since earnings depend on revenue generated from advertisements being placed in their publications. If the economy contracts, spending on advertising slows.
  • Competition is high.
  • There are regulatory limitations regarding cross-ownership of firms in the same market. However, regulations have eased in recent years and M&A activity is more likely in the future.
57
Q

Key drivers of the beverages sector

A
  • GDP
  • Short and long-term trends: People now prefer drinks they can consume while traveling (driving, walking, etc.) Also, vitamin drinks and healthy beverages have increased in popularity in recent years.
58
Q

Key drivers of the pharmaceuticals sector

A
  • R&D spending
  • Capital investments by private companies in biotech
  • Industry consolidation

  • R&D spending is cyclical. R&D spending tends to accelerate in Q3 and Q4 of each year.
59
Q

Key drivers of the public utilities sector

A
  • Climate conditions
60
Q

Key drivers of the REITs sector

A
  • Economic growth
  • Employment growth
  • New business formations
  • Demographic changes

  • This is a cylical industry.
61
Q

What do analysts review when making projections for a REIT?

A
  1. The mgmt team
  2. How consistent is the CF growth
  3. ROIC and ROE
  4. Stable and safe dividend
62
Q

True or false: Both operating and finance leases will increase assets and liabilities?

A

True

Series 86 (7 decks)

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