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  • 1. Chapter 14 Stock Analysis and Valuation
  • 2. Chapter Objectives
    • Describe how to interpret stock quotations
    • Illustrate how to conduct an analysis of a firm
    • Describe how to conduct an industry analysis of stocks
    • Explain how to value stocks
  • 3. Stock Quotations
    • Price quotations readily available from the Internet, stock brokers or financial newspapers
    • Provide information about the price of each stock over the previous day or a recent period
  • 4. Stock Quotations
  • 5. Financial Planning Online: Stock Information
    • Go to: www. bloomberg .com
    • This Web site provides stock quotations for the stocks that you specify. It also provides a summary of financial market conditions and links to information about investments.
  • 6. Analysis of the Firm
    • Annual report
      • Balance sheet: a financial statement that indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time
      • Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time
  • 7. Analysis of the Firm Exhibit 14.2: Balance Sheet for Stewart Corporation (numbers are in millions)
  • 8. Analysis of the Firm Exhibit 14.3: Income Statement for Stewart Corporation (number are in millions)
  • 9. Analysis of the Firm
    • Firm-specific characteristics
      • Analysis of a firm’s income statement and balance sheet can reveal the following characteristics:
      • Liquidity
        • Current ratio: the ratio of a firm’s short-term assets to its short-term liabilities
        • Show the firm’s ability to cover expenses
  • 10. Analysis of the Firm
      • Financial leverage: a firm’s reliance on debt to support its operations
        • Debt ratio: a measure of financial leverage that measures the proportion of total assets financed with debt
        • Times interest earned ratio: a measure of financial leverage that measures the ratio of the firm’s earnings before interest and taxes to its total interest payments
  • 11. Analysis of the Firm
      • Efficiency
        • Inventory turnover: a measure of efficiency; computed as the cost of goods sold divided by average daily inventory
        • Average collection period: a measure of efficiency; computed as accounts receivable divided by average daily sales
        • Asset turnover ratio: a measure of efficiency; computed as sales divided by average total assets
  • 12. Analysis of the Firm
      • Profitability
        • Operating profit margin: a firm’s operating profit divided by sales
        • Net profit margin: a measure of profitability that measures net profit as a percentage of sales
        • Return on assets: a measure of profitability; computed as net profit divided by total assets
        • Return on equity: a measure of profitability; computed as net profit divided by stockholder’s equity
  • 13. Analysis of the Firm Exhibit 14.4: Ratios Used to Analyze Stewart Corporation
  • 14. Financial Planning Online: Determining Industry Norms
    • Go to: http://biz.yahoo.com/research/ indgrp
    • This Web site provides information on various industry groups and allows you to obtain financial information on firms you specify in any industry.
  • 15. Analysis of the Firm
      • Information provided by Value Line
        • Recent stock price
        • PE ratio
        • Dividend yield
        • Rating of the firm
        • Beta
        • Financial statistics
        • Trading volume
  • 16. Analysis of the Firm Exhibit 14.5: An Example from Value Line Investment Survey
  • 17. Analysis of the Firm
    • Go to: http://www. bloomberg .com/ bbn /economies.html
    • This Web site provides information about economic conditions that can affect the values of investments.
  • 18. Analysis of the Firm
    • Focus on Ethics: Accounting fraud
      • Many firms recently used fraudulent financial statements
      • Motivation for fraud
        • Manager compensation
        • Short-tem focus
      • Revenue-inflating techniques
        • Recognizing revenue before it is earned
        • Recognizing revenue from cancelled orders
  • 19. Analysis of the Firm
      • The Enron and WorldCom scandals
        • Over-reported revenue and under-reported expenses
        • Many stockholders lost their entire investment
      • Preventing future accounting fraud
        • Use independent auditor
        • New rules from Security and Exchange Commission
  • 20. Economic Analysis of Stocks
    • Involves assessing economic conditions that can affect a firm’s stock price
    • Economic growth: a measure of growth in a country’s economy over a particular period
      • Gross domestic product (GDP): the total market value of all products and services produced in a country
  • 21. Economic Analysis of Stocks
      • Weak economic conditions
        • Lowers demand and stock prices
        • Consumers spend less, further lowering demand
      • Fiscal policy effects
        • Fiscal policy: the means by which the U.S. government imposes taxes on individuals and corporations and by which it spends its money
  • 22. Economic Analysis of Stocks
    • Interest rates
      • Stocks perform better when interest rates are low
      • Some stocks are more sensitive to interest rates than others
      • The Federal Reserve uses monetary policy to influence interest rates
  • 23. Economic Analysis of Stocks
    • Inflation: the increase in the general level of prices of products and services over a specified period
      • Consumer price index (CPI): a measure of inflation that represents prices of various consumer products
      • Producer price index (PPI): a measure of inflation that represents prices of products used to produce other products
  • 24. Economic Analysis of Stocks Exhibit 14.6: Sources of Economic Information
  • 25. Industry Analysis of Stocks
    • Stock prices susceptible to industry conditions
      • Increased demand generally leads to higher stock prices
      • Changes in competition also affect demand, earnings, and stock prices
  • 26. Industry Analysis of Stocks
    • Industry indicators
      • Various publications and online sources for information on specific industries
      • Industry stock index measures how the market value of firms within an industry has changed over time
  • 27. Industry Analysis of Stocks Exhibit 14.7: Sources of Economic Information
  • 28. Stock Valuation
    • Estimate the market value of a stock before purchasing
    • Price of stock based on the demand for the stock versus its supply
    • Technical analysis: the valuation of stocks based on historical price patterns
  • 29. Stock Valuation
    • Fundamental analysis: the valuation of stocks based on an examination of fundamental characteristics such as revenue or earnings, or the sensitivity of the firm’s performance to economic conditions
  • 30. Stock Valuation
    • Price-earnings (PE) method: a method of valuing stocks in which a specific firm’s earnings per share are multiplied by the mean industry price-earnings (PE) ratio
    • Price-Earnings (PE) Ratio = P/E
  • 31. Stock Valuation
      • You can use the PE ratios of stocks to value a firm as follows:
        • Look up the PE ratios of stocks in the firm’s industry.
        • Multiply the average industry PE ratio times the firm’s earnings per share.
        • Compare your estimated value of the firm’s stock to its market value to determine whether the stock is undervalued or overvalued.
  • 32. Stock Valuation
      • Deriving an estimate of earnings
        • May use last year’s earnings or estimate expected earnings
        • Value Line and other investment services provide such forecasts
      • Limitations of the PE method
        • Forecasting earnings is difficult
        • Some firms are involved in multiple industries
  • 33. Financial Planning Online: Earnings Estimates for Valuing Your Stock
    • Go to: http://biz.yahoo.com/research/ earncal /today.html
    • This Web site provides recent earning per share estimates of a firm that you specify, which you can use when applying the PE method of valuation.
  • 34. Stock Valuation
    • Price-Revenue (PR) method: a method of valuing stocks in which the revenue per share of a specific firm is multiplied by the mean industry ratio of share price to revenue
      • Limitations of the PR method
        • Difficulty in deciding which firms to use for comparison
        • Revenues don’t indicate how well a firm is managed
  • 35. Integrating Your Analyses
    • Analyzing the firm, the economy and the industry allows assessment of future performance
    • Economic, industry, and firm-specific conditions impact a firm’s stock price
  • 36. Analysis of the Firm Exhibit 14.8: Factors That Increase and Decrease the Stock’s Price
  • 37. Financial Planning Online: Screening Stocks for Investment Decisions
    • Go to: http://screen.yahoo.com/stocks.html
    • This Web site provides a list of stocks that meet criteria that you specify for performance over the last year, such as PE ratio and other characteristics.
  • 38. Stock Market Efficiency
    • Efficient stock market: a market in which stock prices fully reflect information that is available to investors
      • Indicates that investors should be able to accurately identify undervalued stocks
    • Inefficient stock market: a market in which stock prices do not reflect all information that is available to investors
  • 39. How Stock Valuation Fits within Your Financial Plan
    • Key decisions about stock for your financial plan are:
      • Should you consider buying stock?
      • How should you value stocks when determining whether to buy them?
      • What methods should you use for investing in stocks?
  • 40. Integrating Key Concepts
  • 41. Integrating Key Concepts
    • Part 1: Financial Planning Tools
    • Part 2: Liquidity Management
    • Part 3: Financing
    • Part 4: Protecting Your Assets and Income
    • Part 5: Investing
      • In Chapter 13 we learned about investment fundamentals
      • In Chapter 14 we learned about stock analysis and valuation
      • In Chapter 15 we will cover investing in stocks
      • In Chapter 16 we will learn about investing in bonds
      • In Chapter 17 we will learn about investing in mutual funds
      • In Chapter 18 we will cover asset allocation
    • Part 6: Retirement and Estate Planning