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Chapter 1


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  • 1. Chapter 1 What is Financial Analysis?
  • 2. Defining Financial Analysis • Financial analysis is the process of evaluating financial and other information for decision-making. • A six-step approach is suggested for systematic financial analysis.
  • 3. Six-step Process • Identify purpose of financial analysis • Corporate overview • Financial analysis techniques • Detailed accounting analysis • Comprehensive analysis • Decision or recommendation
  • 4. Corporate Overview • Industry analysis--key economic characteristics, historical context, profit drivers, business risks • Firm’s business strategy--competitive strategy given the industry characteristics
  • 5. Industry Analysis • Competition--growth rates, concentration ratios, degree of product differentiation, economies of scale (& relative fixed & variable costs), substitute products • Legal barriers--patent & copyrights, licensing, regulation • bargaining power of buyers (& suppliers) & price sensitivity
  • 6. Industry Analysis Criteria • What is the industry? • Relative size & significance • Largest companies • Geographic presence • Business cycle effects, current situation • Future potential
  • 7. Business Strategy • Cost leadership: low cost producer, economies of scale, efficient production, low input prices • Product differentiation: specific attributes that customers value (e.g., quality, variety, service, delivery time), brand name • Importance of core competencies
  • 8. Business Strategy Criteria • Historical perspective • Primary focus of operations • Most important strategy • Major operating segments • Corporate outlook/ forecast
  • 9. Qualitative Analysis--Dell Computer • Industry—primarily PCs: high tech, competitive (e.g., Gateway, IBM, Apple, others), changing products, high growth rates, low barriers of entry • Business strategy--(1) cost leadership strategy: direct selling, made-to-order manufacturing, early on the internet, low receivables; (2) product differentiation?? [IBM clones, Intel & Microsoft components] • Current situation—market share; what is the impact of the business cycle (e.g., PCs are durable goods)?
  • 10. Quantitative Financial Analysis • Systematic analysis of key elements based on analysis context • Ratios, cash flows, common-size, time series, comparative (e.g., specific firms, industry, all firms), models (e.g., DuPont, Altman’s) • In-depth analysis for ―red flag‖ items
  • 11. Quantitative Financial Analysis • Financial Statements • Common-size Analysis • Financial Ratios • Growth/trend Analysis • Quarterly analysis • DuPont Model • Market Analysis
  • 12. Detailed Accounting Analysis • Does accounting information capture the underlying business reality? • Identify areas of ―accounting flexibility‖ & evaluate accounting policies (choices) & disclosures; especially notes & MD&A • Evaluate earnings management potential • Recast accounting numbers when necessary
  • 13. Comprehensive Analysis • Summarize key points: what is particularly important for decision making? • ―Red flags‖ are particularly important • Consider a written executive summary • Consider a rating scale, such as 1-10
  • 14. Decision • What is the recommendation or decision? • What is the key rationale for this decision? [This is based on the specific decision: for a credit decision the key factors relate to credit risk, with particular focus on leverage and liquidity.] • Be prepared to defend this decision.
  • 15. Chapter 2 The Financial Environment
  • 16. Capital Markets Equity Debt Primary Initial public Bank loan, offering initial debt security offering Secondary Buying & Buying & selling of stocks selling on on securities secondary debt markets market
  • 17. Credit Decisions • Commercial banks provide short-term commercial loans • The major concern: will the company pay interest & principal when due? • Loan terms: interest rate, collateral, debt covenants
  • 18. Equity Investment Decisions • Public securities trade on formal market exchanges (these are secondary markets) • Buying & selling are now relatively cheap transactions • Mutual funds are a useful alternatives to individual securities • Stock investing has high short-term risks
  • 19. SEC Regulation • Mission: Protect investors & maintain integrity of the securities markets • Established following the Great Market Crash (SEC Act of 1934) • SEC requires public registration, proxy statements & annual (10-K) and quarterly (10-Q) reports, 8-K for specific events • Update: Sarbanes-Oxley Act of 2002 & Public Company Accounting Oversight Board
  • 20. Goals of Financial Accounting in a Market Economy? • Capture business economics of the firm (e.g., relationship to industry, competitive strategy, business model). How does firm create value? • Reduce management discretion on financial reporting (what is reality? Vs. misleading information--analysts sort this out). Note management incentives for earnings management
  • 21. Accounting Regulators • Securities & Exchange Commission (SEC)-- regulates securities markets and financial reporting (10-K, 10-Q, 8-K) • Financial Accounting Standards Board (FASB)-- promulgates GAAP • International Accounting Standards Board (IASB)—issuing International Financial Reporting Standards (IFRS)
  • 22. U.S. Standard Setters: 1938-Present • Committee on Accounting Procedures (CAP) issued 51 Accounting Research Bulletins (ARBs)--1938-59 • Accounting Principles Board (APB) issued 31 Opinions--1959-73 • Financial Accounting Standards Board (FASB) has issued 168 Statements through 2008 (SFASs) plus other standards—now Standards Codification
  • 23. The FASB Structure Sponsoring Organizations FAF FASAC FASB GASB GASAC Due Process Due Process Pronouncements Pronouncements
  • 24. The FASB • Seven member board, full time, appointed by FAF, presumed independent • Extensive due process: agenda items, discussion memoranda (DM), exposure drafts (ED), pronouncements, public exposure with written & oral comments • Super-majority (5-2 vote) [simple majority used 1977-90] • Standard setting a political process
  • 25. Annual Report Information • Corporate Overview • MD&A • Financial Statements: Balance Sheet, Income Statement, Statement of Cash Flows, Statement of Equity • Notes to financial statements • Auditor’s Opinion
  • 26. Management Incentives • Managers have incentives to present information in the most favorable light (e.g., bonuses, stock options, promotions) • Accounting choice: accounting polities, estimates, additional disclosures • Standardize vs. estimates: what is reality? • Management have best information, but communications to investors may not be completely credible
  • 27. Financial Statement Considerations • Managers’ information on economic reality • Estimation errors • Distortion from managers’ accounting choices & disclosure • Question: Can investor perceptions be manipulated?
  • 28. Finance Theory Perspectives • Efficient Markets • Random Walk • Portfolio Theory • Beta Analysis • Economic Behavior & Agency Theory • Earnings Management & Accounting Choice
  • 29. Efficient Markets • Markets are efficient if information is impounded immediately in capital prices in an unbiased fashion • Research supports market efficiency in the semi-strong form, for short windows • Why?—Analyst following • Note long-term anomalies & other challenges (e.g., behavioral economics)
  • 30. Random Walk • The concept that a professional portfolio cannot outperform a randomly selected stock portfolio • Research generally confirms this result • Consistent with efficient markets; that is, all information has been impounded in stock price
  • 31. Portfolio Theory • Harry Markowitz introduced the concept of portfolio diversification with his 1952 dissertation • Portfolio theory insists that investment portfolios should be diversified to reduce the risk relative to return • Capital asset pricing model: E(Ri) = Rf + [E(Rm) – Rf)
  • 32. Beta Analysis • Beta ( ) comes directly from the slope of the market model: Rit = i + iRmt + eit • Beta measures the relationship between price movements of the individual stock to market averages • Beta is a measure of systematic risk, where a =1 stock should move with the market; a >1 stock has greater market risk
  • 33. Economic Behavior • Rationality: assume bounded rationality— people are intendedly rationale but limited • Self-interest behavior: Obedience Simple self interest Opportunism (self interest with guile-- that is, willing to violate normal ethical boundaries for personal benefit)
  • 34. Agency Theory • Contracts have a principal (e.g., owners) and agent (e.g., managers). The principal will attempt to maximize wealth, contract to avoid conflict, and minimize transaction and agency costs. • Agency costs: information asymmetries (limited information by one side), adverse selection, moral hazard (e.g., shirking).
  • 35. How to Reduce Agency Costs • Better acquisition decisions • Monitoring--including audits and financial reporting • Align preferences of agents with principals (e.g., debt covenants, management compensation)--a reason for stock options • Control devises such as budgets
  • 36. Earnings Management • Operations and discretionary accounting methods to adjust earnings to a desired outcome, often income smoothing • Underlying theory: agency theory, transaction cost economics • Importance of efficient contracting: corporations are a network of contracts and exist because they write contracts efficiently
  • 37. Accounting Choice • Discretionary choices to optimize behavior, using techniques such as: 1. Select alternative accounting methods (e.g., inventory) & level of disclosure (e.g., contingencies) 2. Lobbying (e.g., on proposed standards) 3. Financial, production & investment activities
  • 38. Discretion Under GAAP • Taking a bath • Creating hidden reserves • Off-balance-sheet financing • Overstating performance (e.g., aggressive revenue recognition) • Not reporting obligations (contingencies, commitments, other liabilities)
  • 39. Earnings Manipulation • Because alternatives are allowed, financial accounting has many discretionary aspects. • Managers can manipulate income by timing (e.g., recognition this year v next year) and classification (e.g., ordinary v extraordinary) • Accruals can be mandatory (e.g., other post employment benefits) or voluntary (e.g., depreciation)
  • 40. Earnings Quality • Importance of full disclosure • Look for ―conservative‖ reporting • Review indicators of high quality • Relationship of risk to earnings quality • Be aware of earnings management incentives and evidence of earnings manipulation
  • 41. Normalizing Income • Attempt to determine earning power--related to normal operating earnings • Remove the ―noise‖--usually associated with nonrecurring items • Separate analysis of nonrecurring items-- reorganization, ―big bath‖ write-offs, changing GAAP • Evidence of earnings manipulation may require substantial adjustments to arrive at ―normal earnings‖
  • 42. Financial Analysis Decision • Based on Elliott’s ―value chain of information‖: this is the $1,000 per hour stage • The purpose of financial analysis is to arrive at an informed recommendation or decision
  • 43. Chapter 3 The Financial Statements
  • 44. Financial Statements • Balance Sheet • Income Statement • Statement of Cash Flows • Statement of Stockholders’ Equity
  • 45. Balance Sheet • Assets: probable future economic benefits • Liabilities: probable future economic sacrifices • Stockholders’ Equity: residual interest, representing ownership interest (also called net assets)
  • 46. Assets • Current Assets (cash & cash equivalents, short-term marketable securities), accounts receivable, inventory, other) • Property, plant & equipment • Long-term investments • Other assets
  • 47. Liabilities • Current Liabilities (accounts payable, accrued & other current liabilities) • Long-term debt • Commitments & contingencies • Other liabilities • Potential off-balance sheet debt
  • 48. Stockholders’ Equity • Preferred stock • Common stock • Other paid-in capital • Retained earnings • Treasury stock • Other comprehensive income • Other equity items
  • 49. Income Statement • Revenues: inflows from major operations • Expenses: outflows from major operations • Gains & Losses: changes in equity from peripheral activities • Net income: bottom line all operating activities recorded on the income statement • Comprehensive income: Changes in equity from all non-owner sources
  • 50. Revenue • Sales • Services • Other revenue items • Importance of revenue recognition criteria
  • 51. Operating Expenses • Cost of goods sold (manufacturing) • Cost of sales (services or services included) • Operating expenses (selling, general & administrative, research & development, other) • Interest income & expenses & related • Provision for tax
  • 52. Non-recurring Items • Extraordinary items • Discontinued operations • Accounting changes • Other non-recurring items • Other gains & losses
  • 53. Earnings Measures • Gross profit • Operating income • Income before tax • Income from continuing operations • Net income • Comprehensive income
  • 54. Cash Flow Statement • Cash Flows from Operations • Cash Flows from Investing Activities • Cash Flows from Financial Activities • Statement of Stockholders’ Equity
  • 55. Cash From Operations • Net income • Depreciation & amortization • Other operating adjustments • Changes in non-cash working capital items
  • 56. Cash From Investing & Financing • Cash from investing Investment purchases Investment maturities & sales Capital expenditures • Cash from financing Issuance of equity Purchase/acquisition of equity New debt Debt maturities or retirement
  • 57. Statement of Stockholders’ Equity • Reconciliation of stockholders’ equity, alternative formats used • Key categories (changes) Common stock, other paid-in capital Retained earnings Treasury stock Other comprehensive income
  • 58. Chapter 4 Quantitative Financial Analysis Using Financial Statement Information
  • 59. Quantitative Financial Analysis • Systematic analysis of key elements based on analysis context • Quantitative techniques to standardize financial information for relevant comparisons • In-depth analysis for key factors, including ―red flags‖
  • 60. Quantitative Financial Analysis • Financial Statements • Common-size Analysis • Financial Ratios • Growth Analysis • Du Pont Model • Earnings Quality/Normalizing Earnings
  • 61. Useful Financial Comparisons • Benchmarks: rules of thumb or averages • Common Sense • Trend Analysis (analysis over time) • Near Competitors • Industry Averages • Market Averages
  • 62. Common-size Analysis • Overview vs. detail • Balance sheet: total assets = 100% • Income Statement: sales (or total revenues) = 100% • Comparisons over time & across firms (or industry averages) • Useful starting point for financial overview
  • 63. Ratio Analysis • A ratio converts financial information to a percentage, one approach to standardization • Each ratios provides a somewhat different analysis • Ratios overlap—a problem in one area should show up as problems in other areas • The importance of specific ratios differs, based on the purpose of the financial analysis • Ratios for the most recent period are usually the most important
  • 64. Ratio Categories • Liquidity—cash, working capital & cash flow related • Activity—turnover ratios as possible efficiency measures • Leverage—debt & solvency analysis • Performance (or profitability)—bottom line or earnings related
  • 65. Liquidity Ratios • Current ratio: current assets/current liabilities • Quick (acid test) ratio: (cash+marketable securities+net receivables)/current liabilities • Cash ratio: (cash+marketable securities)/current liabilities • Operating ratio: cash flows from operations/current liabilities
  • 66. Leverage Ratios • Debt to equity ratio: total liabilities/total stockholders’ equity • Debt ratio: total liabilities/total assets • Interest coverage: (income before tax +interest expense)/interest expense [note that the numerator is earnings before interest and taxes or EBIT]* • Long-term debt to equity: long-term liabilities/total stockholders’ equity • Debt to market equity: total liabilities at book value/total equity at market value *alternatively: (income from continuing operations + interest expense + tax expense)/interest expense
  • 67. Activity Ratios • Inventory turnover: cost of sales [or COGS]/average inventory • Receivables turnover: sales/average accounts receivable • Payables turnover: sales/average accounts payable • Working capital turnover: sales/average working capital • Fixed asset turnover: sales/average property, plant & equipment • Total asset turnover: sales/average total assets
  • 68. Activity Ratios in Days • Average days inventory in stock: 365/inventory turnover • Average days receivables outstanding: 365/receivables turnover • Average days payable outstanding: 365/payables turnover • Length of operating cycle: average days inventory + average days receivables
  • 69. Profitability • Gross margin: (Sales-COGS)/sales • Return on sales: net income/sales • Return on assets: net income/average total assets • Pretax return on assets: earnings before interest & taxes/average total assets • Return on total equity: net income/average stockholders’ equity • Dividend payout: common dividends/net income [per share basis: dividends per share / EPS]
  • 70. Du Pont Model • ROE = Profitability x Activity x Solvency • Net Income / Average Common Equity = (Net Income / Sales) x (Sales / Average Total Assets) x (Average Total Assets / Average Common Equity) • ROA = Profitability x Activity
  • 71. Decomposition using Du Pont • Start with Return on Sales • Activity is avg. total asset ratio—this is a measure of asset turnover or efficiency • ROS x ATAR is Return on Assets (calculate as net income / average total assets) • Solvency is ATA / Avgas. Common Equity—this is a standard leverage ratio • ROA x Solvency is Return on Equity (calculate as net income / average common equity) • In summary, the differences between ROS, ROA & ROE depend on activity & solvency
  • 72. Du Pont Model Ratio Calculation Profit (Return on Sales) Net Income/Sales Activity (Asset Sales/Avg. Total Assets Turnover) (ATA) Return on Assets Net Income/ATA Solvency (Common ATA/Average Common Equity Leverage) Equity (ACE) Return on Equity Net Income/ ACE
  • 73. Ratio Analysis Limitations • Ratios are presented on a percentage basis • Relative size is ignored (e.g., both large & small firms can be compared) • It is assumed that all numbers used are correct (consider both possible errors and earnings management) • If the numbers are not reliable, ratios are not particularly useful
  • 74. Rating the PC Companies Dell Gateway Apple Liquidity 4 5 8 Activity 9 6 8 Leverage 6 6 8 Perform. 6 1 RF 2 RF Du Pont 6 1 RF 2 RF Overall 6 2 RF 4
  • 75. Chapter 5 Multiperiod Quantitative Financial Analysis
  • 76. Growth Analysis (period-by-period change) • Long-term trends over time can be significant. Are current year performance measures consistent with earlier years (e.g., maintaining consistent ratios while sales are rising smoothly)? • As a first step, present growth rates (including % increases) for the last 5-10 years • Declining or negative growth rates might be obvious red flags; Red flags and other indicators of poor growth performance require further analysis
  • 77. Base-Year Analysis (also called Trend Analysis) • Set the earliest year, evaluated as the base year, at 100. [Note: this assumes that earliest year is ―normal.‖] Calculate growth by dividing the more current year numbers by the base year number. • This is an alternative presentation to growth rate percentages over 5-10 years (or more)
  • 78. Quarterly Analysis • The most recent financial data is presented quarterly (e.g., 10-Q). [The one exception is at year end, with annual information is presented] • Financial analysts focus on quarterly data and the quarterly earnings announcement is the most important (& earliest) information • Common-size and ratios analysis is conducted, and compared over earlier quarters: particularly important are current quarter data to (1) the previous quarter and (2) the same quarter one year ago
  • 79. Chapter 6 Quantitative Financial Analysis Techniques: Incorporating Market Information
  • 80. Quantitative Market Analysis • Stock prices & stock charts • Earnings per share—actual & forecast • Price earnings ratios (PE) • Dividend yield • Market value & market-to-book • Price earnings to growth ratios (PEG) • Valuation models
  • 81. Stock Prices • Prices change continuously • Using daily closing price • Stock charts, various periods • Industry & market comparisons • Internet sites
  • 82. Earnings Per Share (EPS) • Performance measure on per share basis • Basic vs. diluted • Forecasted EPS (Analysts’ Estimates on Yahoo) • Annual vs. quarterly EPS • Annual—last 4 quarters • 5 year forecasts (relevance vs. reliability)
  • 83. PE Ratios • Stock price as a market premium for earnings • Which price? (most current, historic…) • Which EPS? (current year actual--usually last 4 quarters, future forecast, basic vs. diluted) • Closing prices • Alternatives & how to evaluate them
  • 84. Market-based Ratios • Price earnings ratio (PE): Stock price / EPS • Dividend Yield: Dividend per share / Stock price • Market value: stock price x shares outstanding • Market-to-book: market value / stockholders’ equity
  • 85. Dividends • Dividends given on a per share basis; focus on dividends per share, last 4 quarters. [Note— equivalent to dividends/shares outstanding.] • Dividend yield: dividends per share/stock price— income focus; average yield is about 2% for the S&P 500. • Dividend payout: dividends per share/earnings per share.
  • 86. Market-related Ratios • Market-to-book: market value / stockholders’ equity [or measure on a per share basis—stock price / book value per share]—why is a ―market premium to book‖ common? • Sales to market value: annual sales to outstanding shares x (1) year-end closing market price or (2) most recent closing market price.
  • 87. Price Earnings to Growth (PEG) • High PE is usually associated with the expectation of high earnings growth, which can be evaluated with PEG • ―Historic PEG‖ = PE based on actual EPS / 5-year historic earnings growth • ―Forecast PEG‖ = PE based on forecast EPS / 5- year earnings forecast • PEG is useful to evaluate growth stocks, less useful for income stocks
  • 88. Earnings-based Growth Model • P = kE / (r – g) where P is ―expected‖ stock price, k is dividend payout rate (actual or predicted), E is EPS, r is the discount rate, and g the projected earnings growth rate • This model requires dividends, the discount rate is arbitrary (it could be the actual cost of capital—or based something else), and the growth rate is a forecast; results can change substantially using different assumptions
  • 89. Stock Screening • The purpose of stock screening is the determine which firms meet specific criteria (such as minimum ROE or dividend yield) • Several internet sites have stock screeners, such as Yahoo • The technique is useful to limit the number of companies on which to conduct a complete financial analysis
  • 90. Chapter 11 Capital Structure & Credit Risk
  • 91. Corporate Liabilities • Accounts Payable • Commercial Paper & other short-term market liabilities • Other current liabilities • Corporate Bonds • Other long-term market debt • Other liabilities
  • 92. Credit Risk • Credit risk: probability that a corporation will either default on debt or declare bankruptcy. Default risk: probability that a corporation will not pay interest & principal when they come due Bankruptcy risk: probability that a corporation will file for bankruptcy
  • 93. Default Risk • What is the chance (probability) that the corporation will fail to make interest or principal payments when due? • Because of high collection costs, creditors evaluate credit risk carefully • Failure events: restructurings, especially troubled debt restructuring; default; bond rating down- grading; going-concern qualifications; bankruptcy
  • 94. Bankruptcy Risk • Probability that a firm will file for Chapter 11 bankruptcy. • Importance of failure events: losses, defaults, troubled debt restructuring, going concern qualified audit opinion • Altman’s Z-score can be used as a prediction model for credit risk
  • 95. Financial Leverage • Financial leverage is the relative mix of debt (especially long-term debt) & equity • Long-term debt increases credit risk & has interest charges • The financial leverage index (FLI) is ROE/ROA • A high FLI indicates the increasing use of leverage to raise ROE relative to ROA • The financial structure leverage ratio (FSLR) is average total assets/average common equity. This is the same ratio used in the DuPont Model for solvency. A higher ratio means higher leverage, but also a higher ROE. The ratio is identical to FL1 if there is no preferred stock. When preferred stock is present, the FSLR is higher than FLI.
  • 96. Altman’s Z-score, 1983 Model • 6.56 x (working capital / total assets) • + 3.26 x (retained earnings / total assets) • + 6.72 x (EBIT / total assets) • + 1.05 x (book value of equity / book value of debt) • = Altman’s Z-score
  • 97. Altman’s Z-score • Indicator of overall financial health • Cutoffs: les than 1.1 bankrupt 1.1 – 2.6 gray area greater than 2.6 healthy • A Z-score of 1.1 or less does not mean the company is bankrupt, but does suggest that financial problems may exist
  • 98. Bond Ratings • Bond rating agencies include Standard & Poor’s & Moody’s • Corporations are expected to have investment grade ratings, Baa and above (for Moody’s) • Bond ratings below investment grade are junk bonds, which is usually recognized as a red flag
  • 99. Bond Ratings S&P Moody’s Category Highest AAA Aaa Investment Very High AA Aa Investment High Qual. A A Investment High Qual. BBB Baa Investment Speculative BB Ba Below Speculative B B Below Speculative CCC Caa Below Speculative D C Below
  • 100. Chapter 12 Credit Analysis
  • 101. Credit Analysis Process • Loan Purpose • Corporate Overview • Financial Analysis • Accounting Analysis • Comprehensive Analysis • Loan Decision
  • 102. Loan Purpose • Commercial Bank Loan: term loan revolving line of credit other • Commercial Paper • Corporate Bonds
  • 103. Corporate Overview • Wide variety of firms need bank loans • Size characteristics—local or regional to national & global • Industry specializations, including impact on bank credit risk • Large companies have more credit options
  • 104. Quantitative Financial Analysis • Primary focus is on financial report analysis, with less emphasis on market information • Particular interest in liquidity & leverage • Evidence of financial health (as measured by credit risk) rather than earnings performance & forecasts
  • 105. Accounting Analysis • Emphasis on liquidity & cash flow information • Analysis of unrecorded obligations & potential overstated assets • Forecasts of sales & operations plus future cash flows
  • 106. Comprehensive Analysis • Summary of key information (executive summary recommended) • Importance of credit risk • Adequate information to make informed recommendations/decisions
  • 107. Loan Decisions • Yes/ No on loan • What interest rate (prime rate +)? • What collateral? • What Debt covenants? • Other considerations (e.g., compensating balances)
  • 108. Chapter 13 Equity Investment Analysis
  • 109. Investment Portfolio • Importance of Portfolio Diversification • Based on Investor Goals • Short-term, liquidity focus • Mid-term, return but limited risk focus • Long-term, return focus
  • 110. Mutual Funds • Investment portfolios managed by professionals & regulated by the SEC • Advantages: diversification, professional management, liquidity, small investment • Disadvantages: Fees, average returns less than expected, lack of control over investments, taxes
  • 111. Mutual Fund Categories • Money Market Funds • Bond • Stock: growth, income, value, asset allocation, international, sector, regional • Balanced • Real estate, usually REITs
  • 112. Gotrocks Funds • Growth Fund: maximize long-term market appreciation using large-cap stocks (focus on earnings & earnings growth potential) • Income Fund: maximize intermediate- & long-term income using bonds and large-cap stock that pay high dividends (+ total return as a secondary goal) • Value Fund: invest in large-cap stocks that out of favor— requires evidence of substantial stock price drop & ongoing restructuring (usually low market-to-book)
  • 113. Investment Strategies • Buy & hold • Index funds • Dollar-cost averaging • Risk measures, such as Beta analysis • Asset allocation decisions; e.g., % of cash, bonds & stocks
  • 114. Six-step Analysis • Investment purpose • Corporate overview • Quantitative financial & market analysis • Detailed accounting analysis • Comprehensive analysis • Recommendation or decision
  • 115. Investment Purpose • Short-term (stressing liquidity & low risk) • Long-term (e.g., retirement—stressing long- term return, willing to accept more risk) • Using market averages such as the Dow Jones Industrial Average • Utilities may fit income funds because of high dividend yields • High tech firms may fit growth funds
  • 116. Decisions • Decisions: buy, sell, hold (& how much?) • Different important characteristics based on investment goals: Income Investment: importance of dividend yield Growth fund: importance of profit & earnings growth forecast Values funds: importance of ―bargain price‖