Chapter One : Economic Factors and Business Information Flashcards
Business Cycle
- Expansion
- Peak
- Contraction
- Trough
Expansion
- Economy shows above average grows
-Economy activity increases
-GDP goes UP
-Unemployment Falls
Peak
- A maximum point of economic activity
-Marks the end of the expansion and beginning of contraction
Contraction
-Below average economic growth
-Unemployment rises
-Two quarters is a recession (6 months)
-Six quarters is a depression (18 months)
Trough
-When contraction reaches lowest point
-Beginning of Expansion
Cyclical Stocks
-Stocks whose performances track the ups and downs of the business cycle
-When the economy is expanding, these stocks do well, but when the economy is contracting, they do poorly.
-To maximize profits, buy them at the beginning of the expansion phase and sell at the peak
-These issuers include automotive, specialty retail, home furnishings, apparel, and air travel companies.
Non-Cyclical Stocks / Defensive Stock
-Less sensitive to changes in the economy.
-Issuers produce goods and services that people need, in good times and bad; tobacco, alcoholic beverages, pharmaceuticals, toothpaste, toilet paper, groceries, and utilities, such as water and electricity.
-They are believed to provide more stable earnings and dividends during the various phases of the business cycle
Economic Indicators - What is it & How Many
- Statistics that indicate the future, current or historical performance of the economy
- 3; Leading, Coincident & Lagging
Leading Indicators - General Explanation
PREDICT
- a change in advance of the economy as a whole
- they have predictive power, and therefore, allow economists to tell us what the economic future may hold
Leading Indicators - Name Them
HBBIIINYC500
1. Housing Start
2. Business Inventories
3. Building Permits
4. Initial Claims for Unemployment
5. Inflation Adjusted Money Supply
- an increase signals expansion
6. Index of Consumer Spending
-an increase signals expansion
7. New Manufacturing Orders for Consumer Goods
8. Yield Curve
- a flattening or inverted curve may signal contraction
9. Consumer Confidence
10. Performance of S&P 500
- an increase signals expansion)
Coincident Indicators
REFLECT
a. Change same time economy changes
b. Reflects where the economy is right now (identifies peaks and troughs)
Coincident Indicators - Name Them
GGPPBNR
- GDP
2.GNP
3.Balance of Trade - Non-Farm Payroll
- an increase in hours worked and hourly wages
across the country indicates an expansion phase
- an increase in hours worked and hourly wages
- Producer Price Index (PPI)
- increase in the price of materials and wholesale
goods indicates inflation
- increase in the price of materials and wholesale
- Personal Income Levels
- Retail and Manufacturing Sales
Lagging Indicators
OCCURRED (already)
a. Reflect changes in the economy that have already occurred.
c. Tells you were the economy has been
Example: Department of Labor’s unemployment report is a lagging indicator because employers lay off employees after a downturn has already begun
Lagging Indicators - Name Them
CUPEBB
1. Consumer Price Index (CPI)
2. Business Spending
3. Unemployment Report
4. Prime Rate Charged by Banks
5. Bank Loans Outstanding
6. Employment Cost Index (ECI)
-monthly changes in employee wages and benefits
Bond Yields ; follows what pattern? when does it rise and fall? When does it have higher yields? When are they bought and why? When are they not bought and why?
Follow the interest rate pattern, rises in later stages of expansion, and falls in the later stages of contraction
Yields in the EARLY and MIDDLE stages of Contraction = HIGHER YIELDS than expansion
Bonds generally perceived to be safer than stocks in an economic downturn bc stock prices often fall as buyers shun the higher perceived risk of the equities market
In good times, investors tend to stay away from bonds that pay lower interest payments
Price in the what generally indicates inflation?
Produce Price Index (PPI)
Monetary Policy - Name the Tools
- Change Reserve Requirements
- Open Market Operations
- Modifying Discount Rate
Changing Reserve Requirements
Amount of customers’ money that banks are required to keep in reserve
To grow the econ -> fed lowers reserve (more $ to lend, more customers spend)
To slow growth -> raises requirement (less to lend, less to spend, slows inflation)
Open Market Operations
a. Buy (Big) U.S Treasuries = Grows Economy
i. More money in economy and lower interest rates
ii. More spending, will grow economy
iii. Too much can increase inflation
b. Sells (Small) U.S Treasuries = Slows Inflation
i. Less money in economy, less spending
ii. Slows economy, slows inflation
Which of the following leading indicators does not indicate an expansion of the economy?
A. Growing business inventories
B. Increase in building permits
C. Decrease in unemployment claims
D. Widening liquidity spread
A. Growing business inventories can signal a slowing of the expansion phase and a coming contraction, because consumer demand has declined.
GDP vs GNP
Gross Domestic Product
A measure of value of all finished goods and services produced WITHIN the geographic boundaries of a country during a specific period of time (typically quarterly or annually)
- Where production takes place is determining factor, and product must be a finished product
Gross National Product
Measures production of the residents of one country, regardless of boundries
- Who produces, not where
Assuming these are all equally available and you have equal knowledge of each and their relationship to the economy, which of the following indicators would be the best predictor of future economic expansion?
A. Prime rate charged by banks
B. Employment cost index
C. Performance of the S&P 500
D. Producer Price Index
- C. Performance of the S&P 500 is a leading indicator that may suggest the future direction of the economy.
How are Inflation and Deflation measured?
They are measured in the Consumer Price Index (CPI)
2-3% inflation generally thought to be ideal
Modifying the Discount Rate
The rate banks have to pay when borrowing from the Federal Reserve
- to GROW economy -> lower the discount rate
- to SLOW economy (& fight inflation) -> raise the discount rate
Fiscal Policy
What the Federal Gov can do to effect change in the economy -
Tax and Spend (to create overall demand)
- STIMULATE economy - cut taxes and increase government spending
example: building highways - SLOW economy - raise taxes and lower government spending
Balance of Payments
A record of a country’s international economic activity over a period of time, usually a quarter or annually
- Current Account
- tracks imports, exports, services and business consulting
- Financial Account
- records capital transfers
- such as U.S. investment abroad (capital outflows) (debit)
and foreign investment in the U.S. (capital inflows) (credit)
What Affects the Balance of Payments?
- Economic Growth
- Prices
- Education and Technology
Balance of Trades
Difference between the value of a country’s exports and imports
- EWIS : Exporters prefer a Weaker dollar, Importers prefer a Stronger dollar
EWIS
Exporters prefer a Weaker dollar, Importers prefer a Stronger dollar
Credit Spreads
Spreads widen during contractionary periods of the business cycle, and they narrow during periods of expansion
They tend to widen just before an economic downturn, as investors anticipate a recession
Order of the Interest Rates from Lowest to Highest
(Discount, Federal Funds, Prime and Broker Call)
FDBP
Lowest to highest
1. Federal Funds Rate (the rate banks charge each other to
borrow funds overnight)
2. Discount Rate (the rate the fed charges banks to borrow
funds)
3. Broker Call Rate (the rate at which broker-deals are
(allowed to borrow money to fulfill requirements)
4. Prime Rate (The rate banks charge their best customers
to borrow money)
Money Aggregates
Measures of Money Supply in the US, to judge how fast the money supply is growing
M1 - Physical Money, Immediate Funds (funds that can be spent
immediately, and Traveler’s Checks
M2 - M1, Savings Accounts, Short-term Market Accounts, Time
deposits of less than $100,000
M3 - M2, Long-term deposits, Institutional Money Market Accounts
Spot Rate vs. Forward Rate
Within the foreign currency exchange, the spot rate is the exchange rate that is available today. The forward rate is the exchange rate for a contract to exchange a currency at a future date.
What are the types of securities analysis
fundamental analysis and technical analysis
What’s the difference between Fundamental Analysis and Technical Analysis?
Fundamental Analysis - Uses published information to determine whether a security is overpriced, underpriced, or fairly valued; income statement, balance sheet, and cash flow statement.
Technical Analysis - Examines the patterns of a stock’s price movements, and based on these patterns, makes a forecast about where the stock’s price will go in the future
Bearish Patterns
Head and Shoulders
Double Top
Inverse Saucer
Bullish Patterns
Reverse Head Shoulders
Double Bottom
Saucer
Cup and Handle
Consolidation
Consolidation is a period when the market price of an asset is relatively stable and moves between support and resistance. Consolidation ends when the price breaks through support or resistance.
Technical Analysis Tools: Moving Average & What do they Identify?
Long-term average (e.g., 200 day) and short-term (e.g, 20 days)
– the most recent 200 or 20 days for example
When the short-term moves above long-term, it’s a bullish sign, opposite is true
They are also used to identify support and resistance levels.
Technical Analysis Tools: Short Interest Ratio
of short positions in a stock % by avg daily trading value
If the ratio is high, analyst think price will rise because short sellers will eventually have to close off their short positions
Technical Analyst Tool: Odd Lot Theory
Odd Lot is a transaction of fewer than 100 shares
When odd lot investors are buying a security = go other direction
Time Value of Money / Future Value
FV= Principal * (1+r) t / r = rate of return
Example: $100 with a 4% annual return
FV= 100 * (1+.04)1 =
FV= 100 * (1.04)
Answer: $104
Example: $100 with a 4% annual return for 3 years
FV= 100 *( 1.04 * 1.04 * 1.04)
Answer: $112.49
FV uses COMPOUND interest, not simple interest
so, interest times interest times interest
Present Value
PV = FV (1+r)t
AKA Discounted Future Cash Flow
If someone promises you $100 in three years at 3% interest, how much is it worth today?
PV = 100 / (1.031.031.03)
PV = $91.51
Net Present Value
Helps determine whether an investment is worth making
-An investment with a negative NPV will not be profitable
-An investment with a positive NPV will be profitable
-When given choice, chose the investment that offers highest NPV
Corporate SEC Filings: Prospectus
Filed prior to new security being issued
Contains material information ; all info about the issuer potential investors need to evaluate, and potential risks and rewards before investing
Corporate SEC Filings: Annual Report
Provided to shareholders annually to summarize the issuer’s financial operations
Corporate SEC Filings: Form 10-K
More detailed than annual report;
financial reports audited by independent firm;
filed with the SEC
Corporate SEC Filings: Form 10-Q
Quarterly version of 10-K
Does not need to be audited; Certified & Signed by CEO & CFO
Appears online for investor and adviser review
Corporate SEC Filings: Form 8-K
Filed with the SEC by the issuer within four days of a MATERIAL EVENT, used to disclose the event to the public
Example: Changes in key management personnel, the signing of a merger agreement, filing for bankruptcy, etc.
Corporate SEC Filings: Schedule: 13D
Filed with the SEC by any investor who acquires more than 5% of the company; can signal a possible takeover
Corporate SEC Filings: Form 144
Filed with the SEC when an insider sells more than 5,000 shares (or $50,000) of the company
Insider: Someone who is an officer, director, or someone who owns more than 10% of the company.
Auditors Report - What are the possible Auditor opinions from best to worst?
- Unqualified Opinion
- Qualified Opinion
- Adverse Opinion
Disclaimer of Opinion - Not Enough Info
Internal Rate of Return (IRR)
Is a method of calculating the average annualized yield of a series of cash flows associated with an investment.
The IRR is often used to value investments that have known future payments (also called cash flows), such as bonds or annuities. The IRR is rarely used to value stocks, because the future cash flows are not known and there is no fixed maturity date for a stock.
Once this rate is calculated, the investor or company can then compare it against other choices of how to use funds over the same period and decide whether or not to make the investment.
Note: To justify making an investment, an investment’s internal rate of return needs to be higher than the internal rate of return on competing investments or the cost of borrowing money.
Systemic Risk: Market Risk
The largest and broadest form of risk, since it applies to all investments within a respective market.
How to Reduce Risk?
Hedging can protect an investor against market risk. If an investor buys several puts on the S&P 500 or shorts broad index ETFs, the investor can profit when the market turns downward, reducing his overall losses.
Holding a diversified portfolio of different assets—stocks, bonds, real estate, and cash—can help an investor reduce market risk.
Systematic Risk: Inflation Risk / Purchasing Power Risk
Fixed-income investments tend to have more purchasing power risk than stocks. (Preferred Stock, Corporate Bonds, CDs, Municipal Bonds, Treasury Bonds, etc.)
How to Reduce Risk?
A mix of common stocks, preferred stocks, and bonds can protect a portfolio against inflation during an expansionary period and protect against deflation during a contractionary period.
Systematic Risk: Interest Rate Risk
….is the risk that when interest rates rise, the price of the bond or preferred stock will decline (Fixed-income securities, bonds and preferred stock)
How to reduce risk?
An optimal strategy is a mix of maturities in bonds
Systematic Risks - Name Them
market risk, inflation risk, and interest rate risk.
Unsystematic Risk: Credit Risk aka Default Risk
Significant to holders of Bonds for 2 reasons
1. Risk that an issuer’s perceived or actual creditworthiness will drop, causing the bond’s price to drop
2. Risk that the issuer will default on the bond issue and, therefore, not pay bondholders the interest or principal that is due to them.
Unsystematic Risks - What helps this risk?
Diversification
Examples: Different maturities on bonds, Different credit rating bonds, etc.
Unsystematic Risk: Business Risk
The primary source of this risk is an issuing company that underperforms investor expectations.
Risk that a particular business or industry might face
Unsystematic Risk: Regulatory Risk / Legislative Risk
Regulations in an industry change and influence the value of the investment
Example: Tobacco & Firearms
Problem in US markets
Unsystematic Risk: Political Risk
Risk that the political situation may change and cause the investment to lose value
Example: Venezuela
More of a risk in overseas markets, particularly “emerging” markets
Usually associated with foreign securities
Unsystematic Risk: Liquidity Risk
….is the risk that an investor will not be able to sell his investment quickly at a fair price
Stocks and bonds NOT usually not subject to liquidity risk (active secondary market)
Thinly traded stocks and bonds, direct participation programs (DPPs), municipal securities, real estate, private equities and hedge funds are because buyers are few and difficult to find
Unsystematic Risk: Currency Risk & How to Reduce it?
…is the risk that an investment in a foreign security may lose its value due to a strengthening of the U.S. dollar against the foreign country’s currency
An investor can buy puts against the foreign currency to protect himself against currency risk.
Unsystempatic Risk: Call Risk
…is the risk that a bond will be called when interest rates are declining.
Benefits the issuer, only for obviously callable bonds
Unsystematic Risk: Opportunity Cost
Is a risk of what you could earn in another investment, the cost of a missed opportunity
Liquidation Priority - Creditor Distribution Order
- Secured Creditors - “secured” = assets pledged as collateral
- Unsecured Senior Creditors
- Unsecured Junior (subordinate) Creditors
- Preferred Stockholders
- Common Stockholders
Income Statement
-Summarizes the company’s
1. Sales
2. Expenses
3. Profits
…..over a period of time
Gross Profit, Operating Profit (EBIT), EBT, Net Income, EBITA
Gross Profit & COGS
What remains after COGS has been subtracted
COGS - cost of producing the goods and services offered by the company, such as the cost of materials and labor
Operating Profit (EBIT)
What is left after operating expenses have been subtracted, most of the time will be equal to EBITA (Earnings Before Interest, Taxes and Amortization)
These are the costs of running a business that are not directly related to the production of goods and services, including:
- SG&A :selling, general, and administrative expenses
- R&D :Research and Development
- Depreciation and Amortization
What do analysts rely on for Fundamental Analysis?
….is a method of assessing a security’s value by examining the underlying factors that affect its issuing company’s present and future business operations.
Analysts who use fundamental analysis rely on three financial statements when analyzing securities
1. Income Statement
2. Balance Sheet
3. Cash flow Statement
Earnings Before Taxes (EBA)
Interest expenses, which are interest payments on loans, are subtracted
Net Income
Taxes have been subtracted, the remainder is net income.
Alternative names: earnings after taxes (EAT), bottom line, profit (or loss), net profit, or simply, earnings.
EBITA
EBITDA = EBIT + depreciation and amortization
The Balance Sheet
A document that summarizes a company’s
1. Assets
2. Liabilities
3. Shareholders’ equity
The Balance Sheet: Assets
Current Assets: Anything that can be converted to cash within a year
- Cash & Cash Equivalents
-Accounts Receivable ($ owed to company)
-Prepaid Expenses
- Inventory (FIFO or LIFO)
-
Long-term Assets:
- Property
- Plant
- Equipment
- Intangible Assets (patents, trademarks, etc.)
Intangible Assets:
- Goodwill / Reputation
The Balance Sheet: Liabilities
Liabilities are what a company owes to others
Current Liabilities: Debts that will be paid back within a year
- Accounts Payable
- Accrued Expenses
- Short-term notes & other debt due in current year
Long-Term Liabilities: need to be paid back in over a year’s time
- Deferred tax liability
The Balance Sheet: Shareholders’ Equity / Book Value
Capital invested by share holders, There are three categories of shareholders’ equity
- Paid-in-Capital: The amount of money “paid-in” or invested by the preferred and common stockholders of the company, and it is the amount received from shareholders in public offerings.
- Retained Earnings: The amount of the company’s earnings that is either reinvested in the business or used to pay debts
- Treasury Stock: Represents shares of issued stock that have been repurchased by the company and removed from public circulation.
Cash Flow Statement
This records how much cash a firm is generating, where the cash comes from, and how it is spent.
The Cash Flows from Investment Activity section includes capital expenditures, such as the purchase of new plants, equipment, and property.
How to Calculate Gross Profit?
Revenue - COGS = Gross Profit
COGS is Cost of Goods Sold (materials and labor)
How to Calculate Operating Expenses/ EBIT? and What is included in Operating Expenses?
Revenue - COGS - Operating Expenses = Operating Expenses
Operating Expenses Include: SG&A, R&D, A&D
Selling, General & Administration, Research & Development, Amortization & Depreciation
How to Calculate EBT?
Revenue - COGS - Operating Expenses - Interest
How to Calculate Net Income / Net Profit / Earnings?
Revenue - COGS - Operating Expenses - Interest - Taxes
How to Calculate EBITDA?
EBIT + D&A
Revenue - COGS - Operating Expenses + Depreciation + Amortization
…is often used by analysts and investment bankers when companies have comparable EBITDAs but different net incomes
Accounts Receivable
Money that is owed to the company
How is the Book Value or Shareholder’s Equity Calculated?
Assets - Liabilities
How to Calculate the Gross Profit Margin?
Gross Profit / Sales = %
How to Calculate the Operating Margin?
Operating Profits / Sales = %
How to Calculate the Net Profit Margin?
Net Profit / Sales = %
Working Capital / Net Current Assets
Assets - Liabilities = $
A dollar amount used to assess a company’s ability to meet its short-term commitments
(+ #) means the company can likely meet its short-term commitments
(- #) suggests it cannot, financial trouble
Current Ratio
Assess the company’s ability to meet current short-term debt obligations
Current Assets / Current Liabilities = Current Ratio
- higher the number the better
-a # below 1 is worrisome
Quick Ratio / Acid Test
(Current Assets - Inventory) / Current Liabilities
The quick ratio is meant to give a sense of a company’s ability to stay afloat without having to liquidate its inventory.
- higher the better
- The measure between the current ratio and the quick ratio, the closer it is the greater a company’s true ability to pay all its short-term debts on a moment’s notice.
Debt to Equity / Leverage Ratio
Debt (liabilities) / Shareholder’s Equity
A company’s leverage, or how much debt is used to run the business
- higher the number the more leverages a company is
Measures of Profitability: Earnings Per Share (EPS)
Net Income - preferred shareholder dividends / # common stock outstanding
Measures how much of a company’s earnings belong to each share of stock
- Indicates a company’s profitability
The fully diluted EPS splits more of the pie, so it will always be lower
Measure of Profitability: Price to Earnings (P/E Ratio) ; Why to analysts use it and what does a lower/higher ratio mean?
Share Price / Earnings Per Share
Measures the price investors are willing to pay for a stock per dollar of earnings
-It is used by analysts to determine whether a stock is over- or undervalued
HIGHER RATIO indicates future profits, thus pay a higher price + is risky = Growth Stocks
LOWER RATIO = Value Stocks
Measure of Profitability: LTM P/E, TTM P/E, Forward P/E
What do the ratios mean in comparison to reach other
Forward P/E is based on future Earnings
LTM P/E and TTM P/E is based on past 12 months
When the Forward P/E ratio is HIGHER than the Trailina P/E ratio, analysts expect a company’s earnings to DECREASE over time. Opposite is true.
What is a Trading Channel?
The price range between support and resistance
What are the 3 Profit Margins and what are they measured in?
They are measured in Percentages,
The percentage of sales that is profit
- Gross Profit Margin (Gross Profit/ Sales)
- Operating Margin (Operating Income/ Sales)
- Net Profit Margin (Net Income / Sales)
What is the Market Value of a stock?
The share price at which it is currently trading
What is the earnings per share of ABC Corporation, which reported before tax and interest earnings of $13,000,000; net income of $10,000,000; preferred dividends to be paid of $1,000,000; 5,000,000 issued shares of stock; and 3,000,000 outstanding shares of stock?
A. $10
B. $4
C. $3
D. $2
Net Income - Preferred Dividends to be Paid / Outstanding Shares of Stock
EBIT: 13
Net Income: 10
Preferred dividends to be paid: 1
Issued shares of stock: 3
10 - 1 / 3 = $3
