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
