Investments Ch 10 Flashcards
EQUITY SECURITIES ANALYSIS
Two approaches:
EQUITY SECURITIES ANALYSIS
Two approaches:
- Fundamental analysis is the process of determining the intrinsic
value of a firm or security and then comparing it to the market
price. - Technical analysis is a method that may help determine the price
at which an investor should buy, sell, or hold an individual equity
security
FUNDAMENTAL ANALYSIS –
BOTTOM-UP APPROACH
- Begins by analyzing individual firms based on an intrinsic value and
relative value basis. - Relevant input variables include operating cash flows, quality of the
board of directors, skill set of the executive leadership team, capital
structure, dividend policy, and mergers. - Direct comparisons between firms is common. For example, an
analyst might compare two retail companies, such as Wal Mart and
target.
FUNDAMENTAL ANALYSIS –
TOP-DOWN APPROACH
- ECONOMY
- INDUSTRY
- COMPANY
- INDUSTRY
ECONOMIC ANALYSIS
- To conduct a thorough equity analysis, one must understand the
macroeconomic environment in which all companies operate. - Some of the most important economic variables to consider are:
- Gross Domestic Product
- Inflation
- Interest Rates
- Unemployment
Gross Domestic Product (GDP)
- A measure of the total output of an economy.
- Total value of goods and services that are produced within a country in a certain period.
- GDP is calculated in both current (nominal) dollars and real dollars.
REAL GDP Suggests in the future
_______________________________________________________________________
higher than long RUN Higher Interest Rates, Neg. for consumer
average durables, housing and industry
Lower than Long Run Low Interest rates, Positive for consumer
average durables, housing and industry
Recession Defensive industries such as food, alcohol,
tobacco may be appropriate
INFLATION
INFLATION
- The inflation rate is the general level of price changes in the
economy. - Inflation has historically averaged 2 to 3 percent per year.
- The Federal Reserve attempts to keep inflation at a “healthy” low
level. - Consumer Price Index
- Producer Price Index
UNEMPLOYMENT
- The unemployment rate is the percentage of people in the
workforce who are seeking but do not have a job. - Calculated by dividing the number of persons unemployed by the
number of persons in the labor force.
INTEREST RATES
INTEREST RATES
- Interest rates are an important economic variable on many levels.
- Rates directly influence the present value of future cash flows, thus
greatly impact the intrinsic value of many investments. - Higher interest rates make many investments unattractive.
MONETARY POLICY
MONETARY POLICY
- Monetary policy represents the intended influence on the money
supply and interest rates by the Federal Reserve.
The four primary monetary policy TOOLS are:
1. Reserve Requirement
2. Discount Rate / Federal Funds Rate
3. Open Market Operations
4. Excess Reserve Deposits
MONETARY POLICY GOALS
The Federal Reserve has 3 primary goals:
1. Maintain price levels
2. Maintain long-term economic growth
3. Maintain full employment
RESERVE REQUIREMENT
RESERVE REQUIREMENT
The Federal Reserve
* Requires that banks maintain a certain percentage of their deposits
on hand, in the form of cash known as their reserve requirement.
- Has the ability to increase or decrease the reserve requirement which directly impacts the money supply and ultimately influences interest rates.
Monetary Policy Reserve Requirement Money Interest
Supply Rates
———————————————————————————————–
TIGHTEN »_space;> increase Decrease Increase
EASE »_space;» Decease Increase Decrease
DISCOUNT RATE
DISCOUNT RATE
- The interest rate that the Federal Reserve charges financial
institutions for short-term loans. - It is the overnight rate that banks are charged for funds used to meet their reserve requirement or other liquidity issues.
OPEN MARKET OPERATIONS
OPEN MARKET OPERATIONS
- Open market operations refers to the buying and selling of U.S.
Treasury securities by the Federal Reserve. - Through open market operations, the Federal Reserve can directly
influence the money supply and interest rates.
EXCESS RESERVES
EXCESS RESERVES
- Excess reserves represent the amount of cash or deposits with the
Federal Reserve in excess of the minimum amount required. - The Fed has the ability to increase or decrease the interest rate paid
on excess reserves to help control the money supply.
FISCAL POLICY
TAX POLICY
SPENDING
FISCAL POLICY
- the responsibility of Congress
- uses taxes and government spending
- attempts to either stimulate or reduce aggregate demand
TAX POLICY
* Congress controls taxes through income tax rates, deductions, and
credits.
* A tax decrease causes aggregate demand to increase.
* A tax increase causes aggregate demand to decrease
SPENDING
* Government spending can directly impact aggregate demand.
* Spending on roads, law enforcement, and national defense, may
result in a positive impact on unemployment.
* Deficit spending: When the U.S. government spends more money
than it collects in taxes. The government borrows money, which
increases the federal deficit.
BUSINESS CYCLES
Business cycles are very difficult to predict.
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months.
- Normally visible in real GDP, real income, employment, industrial
production, and wholesale-retail sales.
INDUSTRY LIFE CYCLE
INDUSTRY LIFE CYCLE
PORTER’S FIVE COMPETITIVE FORCES
Michael Porter identified five forces:
PORTER’S FIVE COMPETITIVE FORCES
Michael Porter identified five forces:
1. Rivalry Among Present Competitors
2. Threat of New Entrants
3. Threat of Substitute Products
4. Bargaining Power of Buyers
5. Bargaining Power of Suppliers
COMPANY ANALYSIS
COMPANY ANALYSIS
- Fundamental or quantitative analysis at the company level is the
process by which investors analyze corporate financial statements
and try to determine the value of a particular stock. - Financial statements include:
- Income statement
- Balance sheet
- Statement of retained earnings
- Statement of cash flows
SWOT ANALYSIS
SWOT (Strengths and Weaknesses, Opportunities and Threats)
SWOT Analysis
SWOT (Strengths and Weaknesses, Opportunities and Threats)
Analysis
- A strategic planning tool to help assess the operating strength and
quality of companies. - Strengths and weaknesses are internal to a firm.
- Opportunities and threats are external forces.
SWOT ANALYSIS: SAMPLE
SWOT ANALYSIS: SAMPLE
RATIO ANALYSIS
RATIO ANALYSIS
- There are several key things to consider when conducting ratio
analysis:
- An appropriate benchmark is needed for meaningful
comparison. - A combination of several different ratios should be used to
assess the financial situation of a company. - Year-end values may not be representative.
- Ratios depend on the accounting methods chosen.
LIQUIDITY RATIOS
LIQUIDITY RATIOS ______________________________________
- Liquidity is defined as a company’s ability to meet its financial
obligations within the current period. - A liquid asset is one that can easily be traded in a market and thus be converted to cash
CURRENT RATIO_________________________________________
* The most important liquidity ratio is the current ratio.
* The current ratio indicates how well current liabilities (obligations) are covered by current assets.
Current Assets Current Ratio = -------------------------------
Current Liabilities
QUICK RATIOS
QUICK RATIOS
- Inventories are the least liquid of the firm’s current assets. The quick ratio adjusts for inventories.
Current Assets - Current Inventory Quick Ratio = ------------------------------------------------------ Current Liabilities Cash+Short Term Marketable Securities+AcctReceiavable Quick Ratio = ------------------------------------------------------------------------------- Current Liabilities
ASSET MANAGEMENT RATIOS
sets.
ASSET MANAGEMENT RATIOS
- Asset management ratios help to determine whether a company is
generating sufficient sales given its investment in assets.
TURNOVER RATIOS________________________________________
* The total assets turnover ratio measures how effectively a company
uses all its assets to generate sales
Sales Total Asset Turnover = -------------------
Total Assets
The inventory turnover ratio measures the efficiency with which a
firm uses its inventory to generate sales. A low value of this ratio can
indicate that the company is holding too much inventory.
Cost of Goods Sold Inventory Turnover Ratio = -----------------------------------
Average Inventory
DAYS SALES OUTSTANDING
Days Sales Outstanding Ratio
- Reflects how long it takes a company on average to collect cash from sales on credit
- Also referred to as Average Collection Period
Receivables Receivables Days Sales Outstanding =--------------------------------- = ------------------------- Average Sales per Day nnual Sales / 365
FINANCIAL LEVERAGE RATIOS
FINANCIAL LEVERAGE RATIOS
Financial Leverage Ratio
* Provide an indication of the long-term solvency of the firm.
* They measure the extent to which the firm is using long-term debt.
Debt Ratio
* The ratio of total debt to total assets
* Includes all current liabilities and long-term debt
* Creditors prefer low debt ratios because it means lower risk.
Total Debt Debt Ratio = ------------------------
Total Assets
PROFITABILITY RATIOS
Gross Profit Margin _____________________________
* Measure the success of the firm at generating profits
Sales - Cost of Goods Sold Gross Profit Margin = ----------------------------------------------
Sales
PROFIT MARGIN_________________
Profit Margin (or net profit margin)
* Measures the percentage of each sale that results in net income
Net Income Profit Margin = ---------------------------
Sales
ROA AND ROE
* Return on assets is a measure of how effectively the firm’s assets are being used to generate profits
Net Income ROA = ------------------------------
Total Assets
- Return on equity measures the profits earned for each dollar of
common equity.Net Income ROE = ------------------------------- Shareholder Equity - A company’s sustainable growth rate is the maximum growth rate for a company, while maintaining its capital structure.
Growth Rate = ROE x ( 1- Payout Ratio )
DUPONT FORMULA
The DuPont formula disaggregates ROE into three basic components:
* Profit margin
* Total asset turnover
* Financial leverage
Net Income Sales Total Assets ROE = ------------------ x ----------------------x ----------------------
Sales Total Assets Equity
DEGREE OF LEVERAGE
DEGREE OF LEVERAGE
Degree of Opening Leverage ( DOL ) _________________
% change in EBIT DOL = ----------------------------
% change in Sales
Degree of Financial Leverage ( DFL )__________________
% change in EPS DOL = ----------------------------
% change in EBIT
Degree of total Leverage ( DTL )______________________
DTL = DOL x DFL
MARKET VALUE RATIOS
- Give insight into how the market and other investors perceive a
company’s risk and future prospects.
PE Ratio
* Expresses how much investors are willing to pay for a dollar of
profits.
Price per Share
PE Ratio = ———————————–
Earnings per Share ( EPS )
OTHER MARKET VALUE RATIOS
PEG Ratio
* Compares a stock’s PE ratio to the expected growth of that stock’s
earnings per share.
PE Ratio PEG Ratio = ------------------------------
Expected EPS Growth
Price-to-Book Ratio
- Expresses how much investors in the market are willing to pay for a
dollar of book value (equity).Share Price Price to Book = ------------------------------ Book Value per Share Shareholders Equity Book Value per Share = --------------------------------- Shares Outstanding
DIVIDEND POLICY RATIOS
DIVIDEND YIELD
* Dividend yield is a company’s dividends relative to the stock price
Dividends per share Dividend Yield = -------------------------------
Share Price
PAYOUT RATIO
* Payout ratio is the percentage of earnings paid out to the shareholders in the form of dividends.
Dividends per Share Payout Ratio = ----------------------------------
Earnings per Share
TECHNICAL ANALYSIS
TECHNICAL ANALYSIS
- Technical analysis is another method that may help determine the
price at which an investor should buy, sell, or hold an individual equity security. - Technical analysis largely ignores the fundamentals
MARKET VOLUME
The total number of shares traded each day:
* Based upon supply and demand of securities
* Indicator of investor sentiment
* Provides insight as to the market’s strength or weakness
BREADTH OF THE MARKET
* Measures the number of advancing stocks versus declining stocks
* Technical analysts use this measure to assess the direction of the
market
ADVANCE-DECLINE LINE
* A/D line is a graphical depiction of periodic changes in advancing and declining issues on an exchange.
* Each point on the chart is determined by taking the difference
between the number of advancing and declining stocks
SHORT INTEREST
* Measurement of the total number of shares currently sold short in a particular market
* An increase in short selling may indicate negative sentiment regarding present market conditions.
ODD LOT TRADING
* A trade in any amount that is less than 100 shares, most made by
individual investors
* Sophisticated investors view the average individual investor as being unable to accurately time market trends.
CHARTING
* The Dow Theory premise is that trend behavior signals the end of
both bear and bull markets.
* Primary trends
* Secondary movements
* Ripples
MOVING AVERAGE
* A tool that smooths out minor, short-term variations in price changes
* Is a useful indicator of long-term trends
* Is an arithmetic mean of stock prices
* The prices used in the calculation “move” or shift forward by one day each trading day
POINT AND FIGURE CHART
POINT AND FIGURE CHART
SUPPORT AND RESISTANCE LEVELS
SUPPORT AND RESISTANCE LEVELS
Support Levels
* Indicate the floor price below which an asset is not expected to trade Resistance Levels
* Represent a “ceiling” for the stock price trading range
A company has 2 million shares of common stock outstanding. Annual sales are $26 million. The net profit margin is 8% and the dividend payout ratio is 40%. Currently the stock trades at $17.68 per share.
What is the P/E ratio of and Dividend yield ?
A 17 and a dividend yield of 3.20%.
B 17 and a dividend yield of 2.35%.
C 16 and a dividend yield of 3.20%.
D 16 and a dividend yield of 2.35%
Solution: The correct answer is B.
Net Income
Profit margin = ——————
Sales
OR
Net Income = Sales x Profit margin = 2 mill x .08 = $ 2,080,000
Net income 2,080,000 EPS = ----------------------------- = --------------- = 1.04 EPS
Shares outstanding 2,000,000 ---------------------------------------------------------------------------------
Price PE = ----------------
EPS OR
Stock Price = P/E x EPS
17.68 = P/E x 1.04
17.68 PE = ------------- = 17
1.04
Div per Share Payout Ratio = --------------------- or Div per Share = Payout Ratio X EPS
EPS
Div Yield= Div per share Payout Ratio x EPS
——————– = —————————
Price Price
.40 x 1.04 .416 so ---------------------- = -------------- -- = .0235 = 2.35 %
$ 17.68 $ 17.68
Given a current ratio of 1.25, which of the following transactions will increase the current ratio?
Sell marketable securities to raise cash.
Prepay part of long-term debt.
Pay accounts payable from cash.
Delay payment of accounts payable.
Pay accounts payable from cash.
Rationale
The current ratio is equal to current assets divided by current liabilities and indicates a company’s ability to cover current liabilities.
Cash and marketable securities are considered current assets, so a sale of marketable securities for cash would not increase current assets or the current ratio.
Prepaying part of long-term debt would decrease the current ratio.
Delaying payment of accounts payable will not change current cash or current liabilities.
The payment of accounts payable with cash will decrease both balances (current assets and current liabilities), but because the old current ratio exceeds 1.0, the impact will be an increase in the new current ratio.
If current assets = 125,000 and current liabilities = 100,000, the current ratio is 1.25.
Payment of 25,000 in current liabilities reduces cash to 100,000 and liabilities to 75,000.
The new current ratio equals 100,000/75,000 = 1.33.
Though cash and payables decrease by the same amount, the new ratio goes up because it is greater than 1.0. Given a current ratio of less than 1, and the same set of circumstances, the new current ratio would be reduced.
Acme Industries manufactures mouse traps in its production facility. It sells its mouse traps for $15 each. Acme’s fixed costs are $540,000. The variable cost for each mouse trap is $1.50.
If Acme sells 70,000 mouse traps, what is its degree of operational leverage?
2.3.
Rationale
% chg in EBIT (Total unitsx $ /unit) - (Total units x var cost/unit) DOL=---------------------= --------------------------------------------
% chg in Sales (the above figure ) - Fixed cost
Q(P-V) DOL = -----------------
(Q(P-V)-F)
70 (15-1.5)
------------------------------- = 2.333
( 70 (15-1.5 ) -540 )
Arrow Inc. earned $1m in EBIT this year. If it earns $1.2m in EBIT next year and it has 2.0 degree of operating leverage, what is the change in EPS?
40%.
Rationale
EBIT x DOL = EPS increase
20% increase in EBIT x 2.0 DOL = 40%: EPS increase
CJD Enterprise’s EPS increased from $2.00 last year to $4.00 this year with a 20% increase in sales. If CJD’s degree of operating leverage is 3.0, then
what is CJD’s degree of financial leverage?
1.67.
Rationale
EPS increased by 100%.
% change in EPS ?? DFL = -----------------------------
% change EBIT
EPS -------------------------------- = DFL ( sales increase x DOL )
100% .10 ----------------------- = ----------- = 1.67 ( 20% x 3.0 ) .06
Acme’s sales increase by 20%. Acme has a degree of operating leverage (DOL) of 3.0 and degree of financial leverage of 1.5.
What is the impact of the increase in sales on EPS?
Rationale
Operating leverage magnifies EBIT and financial leverage magnifies EPS.
Therefore, if sales increase by 20%, then EPS will increase by 90% (20% x 3.0 x 1.5).
% change in EPS <<<<< want to solve for this DFL = ----------------------
% change in EBIT
OR
% change in EPS = % change in EBIT x DFL
- What % change in EBIT ?
% change in EBIT EBIT DOL =------------------------- or 3 = ----------- = .60 = 60 % % change in sales .20
so
% change in EPS = % change in EBIT x DFL
.60 x 1.5 = .90 = 90%
Which statement regarding financial leverage is most accurate?
The variation in ROE and EPS is identical to the variation in EBIT if the firm is unleveraged.
The variation in ROE and EPS is always greater than the variation in EBIT if the firm is leveraged.
Financial risk is the additional variation in ROE and EPS arising from the use of debt.
All of the above.
Rationale
All of the statements are correct.
A firm with a higher concentration of fixed costs than long-term debt is more likely to be exposed to which of the following risks?
Business risk.
Rationale
Business risk refers to the variability in earnings caused by the industry in which the company operates. Variability in income from operations can be caused by volatility in sales and higher than average fixed costs.
Financial risk refers to the variability of returns to stockholders based on the introduction of long-term debt to the capital structure.
Default risk is the risk that the company won’t be able to pay their debt, and systematic risk is market risk (nondiversifiable).
Which of the following amplifies EPS?
Degree of operational leverage.
Degree of financial leverage.
Both of the above.
Neither of the above.
Both of the above.
Rationale
Both DOL and DFL will amplify EPS.
DOL amplifies EBIT, which then amplifies EPS.
DFL does not amplify EBIT, but amplifies EPS.
Prestige has revenue of $50 million with 20% variable costs. It has $20 million of bonds financed at 6% and has fixed costs of $30 million.
What is Prestige’s degree of total leverage?
Must solve for DTL = DOL x DFL
__________________________________________________________________
Sales - ( variable cost ) DOL = ------------------------------------------------
( Sales - Variable cost) - Fixed cost
($50m - (0.2 x $50m)) 40 DOL= ----------------------------------------------= ------------- = 4
[($50m - (0.2 x $50m)) - $30m] 40 - 30
( Sales - variable cost ) - Fixed cost \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
EBIT = ( Sales - Var cost ) - Fixed Cost
EBIT = $50m - $10m VC - $30m FC = $10m
___________________________________________________________________
EBIT DFL = ----------------------------------------
EBIT - interest Expense
Interest = $20 million x 6% = $1.2 million
EBIT $10mill DFL =---------------------------------- = ---------------------------------- = 1.136
(EBIT – I) ($10 million - $1.2 million)
__________________________________________________________________
DTL = DOL x DFL = 4 x 1.136 = 4.545
Use the information below to answer this question.
ABC Corporation
Selected Financial Statement Information for the Year Ended December 31 (In millions except per share data)
BALANCE SHEET
20x1 (Beginning) 20x1 (Endings)
Assets
Cash 360 380
Marketable Securities 300 100
Receivables 1,100 130
Inventories 600 910
Other 1,900 660
Total Current Assets 4,260 2,180
Property, Plant & Equipment 5,230 3,400
Other Assets 2,300 1,000
Total Assets $11,790 $6,580
Liabilities and Shareholder’s Equity
Accounts Payable 2,800 1,300
Long-Term Debt 2,400 900
Other Liabilities 1,500 1,400
Total Liabilities 6,700 3,600
8% Preferred Stock 500 500
Common Stock 2,000 1,800
Retained Earnings 2,590 680
Total Liabilities & Shareholder’s Equity $11,790 $6,580
Which of the following is the quick ratio for ABC Corporation (for this question, assume that the “other” current assets are additional inventory)?
Use the information below to answer this question.
ABC Corporation
Selected Financial Statement Information for the Year Ended December 31 (In millions except per share data)
BALANCE SHEET
20x1 (Beginning) 20x1 (Endings)
Assets
Cash 360 380
Marketable Securities 300 100
Receivables 1,100 130
Inventories 600 910
Other 1,900 660
Total Current Assets 4,260 2,180
Property, Plant & Equipment 5,230 3,400
Other Assets 2,300 1,000
Total Assets $11,790 $6,580
Liabilities and Shareholder’s Equity
Accounts Payable 2,800 1,300
Long-Term Debt 2,400 900
Other Liabilities 1,500 1,400
Total Liabilities 6,700 3,600
8% Preferred Stock 500 500
Common Stock 2,000 1,800
Retained Earnings 2,590 680
Total Liabilities & Shareholder’s Equity $11,790 $6,580
Which of the following is the quick ratio for ABC Corporation (for this question, assume that the “other” current assets are additional inventory)?
0.47.
Rationale
Cash + Marketable Securities + Accts Receivable
Quick Ratio= ————————————————————————
Current Liabilities
380 cash + 100 marketable + 130 receivables
—————————————————————————– = .4692
1300 ( only use Accounts Payable )
Which of the following best describes the usefulness of the Dow theory in technical analysis?
It determines the end of a bull or bear market.
Rationale
According to the Dow Theory once a primary trend is established asset prices tend to move in that direction. The primary trend will be supported by the same directional movement in both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). The primary trend will continue until the trend is reversed, as evidenced by both the DJIA and the DJTA.
A firm has operating leverage if it uses which of the following?
Fixed costs.
Rationale
Operating leverage comes from low variable costs.
Once fixed costs are covered,
increases in sales drop to the bottom line.
Walt Co.’s EBIT increases by 20%. If Walt Co. has a degree of financial leverage (DFL) of 2.5,
what is the expected change in earnings per share (EPS)?
EBIT increase is 20 %
DFL = 2.5
What is the expected change in earnings per share (EPS) ?
% change in EPS DFL = ----------------------- OR % change in EPS = DFL x % change EBIT
% change in EBIT
So
EPS = DFL x % change EBIT
2.5 x 20 % = 50 %
Use the information below to answer this question.
ABC Corporation
Selected Financial Statement Information for the Year Ended December 31 (In millions except per share data)
BALANCE SHEET
20x1 (Beginning) 20x1 (Endings)
Assets
Cash 360 380
Marketable Securities 300 100
Receivables 1,100 130
Inventories 600 910
Other 1,900 660
Total Current Assets 4,260 2,180
Property, Plant & Equipment 5,230 3,400
Other Assets 2,300 1,000
Total Assets $11,790 $6,580
Liabilities and Shareholder’s Equity
Accounts Payable 2,800 1,300
Long-Term Debt 2,400 900
Other Liabilities 1,500 1,400
Total Liabilities 6,700 3,600
8% Preferred Stock 500 500
Common Stock 2,000 1,800
Retained Earnings 2,590 680
Total Liabilities & Shareholder’s Equity $11,790 $6,580
The debt to equity ratio is closest to:
The debt to equity ratio is closest to: 1.21
Rationale
Total Debt 3600
—————– = —————– = 1.21
Total Assets 2,980
Which firm has high operating leverage? One with:
High fixed costs and low variable cost.
High fixed cost and high variable cost.
Low fixed cost and low variable cost.
Low fixed cost and high variable cos
HIGH fixed cost & LOW variable cost.
Rationale
Operating leverage occurs with high fixed costs and low variable costs. Once breakeven has occurred, the majority of sales increases will also increase net income if the firm has low variable costs.
Acme Industries manufactures mouse traps in its production facility. It sells mouse traps for $15 each. Acme’s fixed costs are $540,000. The variable cost for each mouse trap is $1.50.
How many units must Acme sell to break even?
40,000.
Rationale
$540,000 -------------------------- = 40,000 ($15.00 - $1.50) Total Cost -------------------------------- ( total cost - variable cost )
TEST
- Purpose of financial ratios
− Insight into past performance
− Allows for comparison across firms
− Allows for comparison of firms with industry averages
- Calculate
− EPS
− PE Ratio
− Stock Price using PE
− Relative PE ratio
− PEG - Usefulness and meaning
TEST
- Ratio analysis is the study of the relationships between financial
statement accounts, and it provides a historical perspective. - May infer future performance based on historical perspective.
- Understanding key ratios allow investor to better understand
the connection between different elements of financial
performance.
TEST
- Dividend per Share = Annual Dividend / # of Common Shares
Outstanding - Payout Ratio = Dividend per Share / Earnings per Share
- g (growth rate)
− one method of estimating the firm’s growth rate is:
g = b x ROE
b = retention rate ( which is 1 – dividend payout ratio )
ROE = return on equity
Examples of monetary policy would most likely exclude:
Lending at the prime rate of interest.
Rationale
The Federal Reserve Board operates in the open market, can change both the discount rate and excess reserve, but has no direct control over the prime lending rate.
During a period of recession/contraction, which of the following would be true?
The supply of goods and services would increase.
Interest rates would increase.
Unemployment rates would decrease.
Inflation would decrease.
Inflation would decrease.
Rationale
During a recession/contraction, there is a decline in demand. GDP is decreasing, inflation is decreasing, and unemployment is increasing. Since demand is decreasing, the supply of goods and services will also be decreasing. To stimulate economic growth, the money supply will likely increase, causing interest rates to decline.
Which firm has high operating leverage? One with:
High fixed costs and low variable cost.
High fixed cost and high variable cost.
Low fixed cost and low variable cost.
Low fixed cost and high variable cost.
High fixed costs and low variable cost.
Mardt’s, Inc. just announced that they will be paying a $1.80 per share as an annual dividend next year and that the dividends will then be increasing by 2.5% annually thereafter. The common stock of Mardt’s is currently selling at $18.95 a share. What is the dividend yield on this stock?
Solution: The correct answer is B.
DY = Dividend ÷ Stock Price = 1.80 ÷ 18.95 = .0949
