V. STOCKS I. Fundamental Analysis (Continued)


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V. STOCKS I. Fundamental Analysis (Continued)

  1. 1. V. STOCKS
  2. 2. I. Fundamental Analysis (Continued) <ul><ul><li>Components of the Income Statement </li></ul></ul><ul><ul><ul><li>Total Revenue = gross receipts, total received from operations </li></ul></ul></ul><ul><ul><ul><li>Cost of Revenue = cost of goods sold, direct costs for components of the product </li></ul></ul></ul><ul><ul><ul><li>Gross Profit = revenues less cost of revenues </li></ul></ul></ul><ul><ul><ul><li>Operating Expense = costs related to production of product or services </li></ul></ul></ul><ul><ul><ul><li>Operating Income or Loss = profits generated by sales, net of cost of goods sold and operating expense </li></ul></ul></ul><ul><ul><ul><li>Earnings Before Interest, Taxes, Depreciation, and Amortization = income generated by operations before accounting adjustments </li></ul></ul></ul><ul><ul><ul><li>Operating Free Cash Flow = calculated by subtracting all cash expenses from all sources of operating revenue </li></ul></ul></ul>
  3. 3. I. Fundamental Analysis (Continued) <ul><li>Balance Sheet </li></ul><ul><ul><li>A “snapshot” of corporate assets and liabilities at a particular time </li></ul></ul><ul><ul><li>Components of the Balance Sheet </li></ul></ul><ul><ul><ul><li>Current Assets – items owned by a corporation that can be readily turned into cash </li></ul></ul></ul><ul><ul><ul><li>Current Liabilities – short term debt </li></ul></ul></ul><ul><ul><ul><li>Common Stock & Retained Earnings – accumulated profits allocated to shareholders </li></ul></ul></ul><ul><ul><ul><li>Treasury Stock – a negative number indicates a stock buy back – increases per share earnings and potentially stock price </li></ul></ul></ul>
  4. 4. I. Fundamental Analysis (Continued) <ul><li>Statement of Cash Flows </li></ul><ul><ul><li>Measures cash generated or consumed by a corporation </li></ul></ul><ul><ul><li>Components </li></ul></ul><ul><ul><ul><li>Cash flows provided by or used in operations – shows whether core operations are generating or consuming cash </li></ul></ul></ul><ul><ul><ul><li>Cash flows provided by or used in capital expenditures – shows whether a firm is investing in its business </li></ul></ul></ul><ul><ul><ul><li>Cash flows provided by or used in financing – can show a company’s ability to raise capital or whether capital is being used by financing activities (stock buy backs, paying off debt) </li></ul></ul></ul><ul><ul><ul><li>Change in cash and cash equivalents – total effect – whether the corporation is generating or consuming cash (firm’s liquidity) </li></ul></ul></ul>
  5. 5. I. Fundamental Analysis (Continued) <ul><li>Sample Statements: e10vq , e10vq </li></ul>
  6. 6. I. Fundamental Analysis (Continued) <ul><li>Basic Ratios </li></ul><ul><ul><li>i. Earnings per Share = total earnings </li></ul></ul><ul><ul><li> outstanding shares </li></ul></ul><ul><ul><li>Tracks profitability regardless of firm size </li></ul></ul><ul><ul><li>Price/Earnings Ratio (P/E Ratio) = </li></ul></ul><ul><ul><ul><ul><ul><li>current share price </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>earnings per share </li></ul></ul></ul></ul></ul><ul><ul><ul><li>Provides a rough estimate of market opinion of current and future corporate operations </li></ul></ul></ul>
  7. 7. I. Fundamental Analysis (Continued) <ul><ul><li>iii. Return on Assets = earnings </li></ul></ul><ul><ul><li> assets </li></ul></ul><ul><ul><li>Measures efficiency of use of firm assets </li></ul></ul><ul><ul><li>iv. Return on Equity = earnings </li></ul></ul><ul><ul><ul><ul><ul><li> common stock equity </li></ul></ul></ul></ul></ul><ul><ul><ul><li>Measures efficiency of the use of shareholder capital </li></ul></ul></ul>
  8. 8. I. Fundamental Analysis (Continued) <ul><ul><li>v. Return on Invested Capital (ROIC) </li></ul></ul><ul><ul><li>= EBITD </li></ul></ul><ul><ul><li>common and preferred stock equity & long term debt </li></ul></ul><ul><ul><li>Measures efficiency of the use of the entire corporate capital structure </li></ul></ul><ul><ul><li>vi. Debt/Equity Ratio = total debt </li></ul></ul><ul><ul><ul><ul><ul><li> market capitalization </li></ul></ul></ul></ul></ul><ul><ul><ul><li>Measures the leverage in a company and thus </li></ul></ul></ul><ul><ul><ul><li>its vulnerability to interest rate changes </li></ul></ul></ul>
  9. 9. I. Fundamental Analysis (Continued) <ul><ul><li>vii. Current Ratio = Current Assets </li></ul></ul><ul><ul><li> Current Liabilities </li></ul></ul><ul><ul><li> A measure of liquidity, whether a company </li></ul></ul><ul><ul><li>has sufficient assets to pay current debts </li></ul></ul>
  10. 10. I. Fundamental Analysis (Continued) <ul><li>Issues Regarding Outstanding Shares </li></ul><ul><ul><li>Float – the number of shares outstanding (available for purchase) </li></ul></ul><ul><ul><li>Stock repurchase (buy back) program – where a company purchases its own shares on the open market – reduces float (reduces supply of shares), decreasing number of shares outstanding, increasing earnings per share, and increasing share price </li></ul></ul>
  11. 11. I. Fundamental Analysis (Continued) <ul><li>Choosing Stocks Based Upon Fundamentals </li></ul><ul><ul><li>Stock Market Selection Methods </li></ul></ul><ul><ul><ul><li>Dogs of the Dow – buy highest yielding Dow stocks at the beginning of the year, selling best of stocks after 12 months </li></ul></ul></ul><ul><ul><ul><li>Relative Strength from Investors Business Daily – compares stocks with the overall market Investors.com : HELP </li></ul></ul></ul>
  12. 12. I. Fundamental Analysis (Continued) <ul><ul><ul><ul><ul><li>S&P Star Quality Rankings – stocks are ranked by anticipated performance based upon fundamentals http://www2.standardandpoors.com/spf/pdf/index/SP_Citigroup_Global_STARS_Methodology_Web.pdf?vregion= us&vlang =en </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Value Line Value Line - The Most Trusted Name in Investment Research </li></ul></ul></ul></ul></ul>
  13. 13. I. Fundamental Analysis (Continued) <ul><li>Diversification – Selecting stocks that respond to the market in different ways – stocks should not all be positively correlated (prices moving in the same direction), in the same industry, or with the same market cap </li></ul><ul><ul><li>Large Cap = market capitalization in excess of $5,000,000,000 </li></ul></ul><ul><ul><li>Midcap = market capitalization from $1,000,000,000 to $5,000,000,000 </li></ul></ul><ul><ul><li>Small Cap = market capitalization of less than 1,000,000,000 </li></ul></ul>
  14. 14. I. Fundamental Analysis (Continued) <ul><li>Growth versus Value Stocks </li></ul><ul><ul><li>Growth Stock – High P/E ratio, earnings expected to grow at an above average rate </li></ul></ul><ul><ul><li>Value Stocks – Low P/E ratio, searching for “bargains” – stocks that are out of favor or in industries out of favor with investors but with good fundamentals </li></ul></ul><ul><ul><li>Value Trap – Low P/E ratio stock that is a bad investment – P/E is low for a reason </li></ul></ul>
  15. 15. I. Fundamental Analysis (Continued) <ul><li>Cyclical Stocks – Rise and fall with the economy in general – ex. Transports </li></ul><ul><li>Defensive Stocks – Product demand exists in all phases of the business cycle – consumer staples, drugs, etc. </li></ul><ul><li>Domestic versus International – If markets are performing poorly in one country, stocks from another country could be performing well </li></ul>
  16. 16. I. Fundamental Analysis (Continued) <ul><li>Data Sources </li></ul><ul><ul><li>Financial press and Internet sites – provide readily available information, but may not be in depth or timely </li></ul></ul><ul><ul><li>Professional research – can have greater “depth,” can reveal more obscure information, but can be biased and expensive </li></ul></ul><ul><ul><li>Companies – can provide fairly detailed information, but biased towards the company </li></ul></ul><ul><ul><li>SEC filings – very detailed and thorough, must be accurate, but difficult to read and not timely </li></ul></ul>
  17. 17. I. Fundamental Analysis (Continued) <ul><li>Other Approaches </li></ul><ul><ul><li>“Buy what you know” – Purchase shares of companies that you do business with and are impressed by </li></ul></ul><ul><ul><li>Consensus information – Agreement among analysts or researchers regarding whether a stock is a good value </li></ul></ul>
  18. 18. J. Technical Analysis <ul><li>50 Day Moving Average – provides guidance regarding long term stock price movement trends (200 day = very long term) </li></ul><ul><ul><li>Positive Momentum – Above the moving average </li></ul></ul><ul><ul><li>Negative Momentum – Below the moving average AVAV: Technical Analysis for AEROVIRONMENT, INC. - Yahoo! Finance </li></ul></ul><ul><li>5 - 20 Day Moving Average – Shows very short term trend </li></ul>
  19. 19. J. Technical Analysis (Continued) <ul><li>Support – Stock “Bottom,” price below which shares have historically not traded </li></ul><ul><li>Resistance – Stock “Top,” the price that the stock tends to “bounce off of,” a stop to further price advances </li></ul><ul><li>Volume – Shares traded per day, indicates whether a price movement is “real” (ex. – stock trading higher on high volume shows interest in stock during price advances, stock price increasing on low volume is “drifting” </li></ul>
  20. 20. J. Technical Analysis (Continued) <ul><li>Bollinger Bands – One standard deviation above and below the stock price, based upon 20 day moving average – a measure of stock price volatility http:// us.rd.yahoo.com/finance/chart/overlay/bollinger /*http:/ finance.yahoo.com/q/ta?s = CSX&t =1y&l= on&z = m&q = l&p = b&a =&c= </li></ul><ul><ul><li>Sharp price changes tend to occur after the bands tighten, indicating a “break out” from a less volatile pattern </li></ul></ul><ul><ul><li>Prices moving outside the bands indicate a continuing trend </li></ul></ul><ul><ul><li>Trend reversal is indicated by bottoms or tops outside the band, followed by bottoms and tops inside the band </li></ul></ul><ul><ul><li>A move originating at one band tends to move all the way to the other band </li></ul></ul>
  21. 21. J. Technical Analysis (Continued) <ul><li>Stock Chart Types – In all types, y axis indicates price, x axis is time </li></ul><ul><ul><li>Line </li></ul></ul><ul><ul><li>Bar (High, Low, Close) </li></ul></ul><ul><ul><li>Candlesticks – White = stock up, Black = stock down </li></ul></ul><ul><ul><li>Point and figure </li></ul></ul><ul><li>Chart Scaling </li></ul><ul><ul><li>Arithmetic – Even scale of price movements </li></ul></ul><ul><ul><li>Logarithmic – Scale by percentage change, works best for highly volatile stocks </li></ul></ul>
  22. 22. K. Reading Corporate Annual Reports <ul><li>Highlights – Contains basic information presented in a manner favorable to the corporation </li></ul><ul><ul><li>Highlights statistics of which the firm is most proud </li></ul></ul><ul><ul><li>Generally includes total sales and net income </li></ul></ul><ul><ul><li>http://www.fanniemae.com/ir/pdf/annualreport/2007/2007_annual_report.pdf </li></ul></ul>
  23. 23. K. Reading Corporate Annual Reports (Continued) <ul><li>Letter to Shareholders – Review of the year just past and potential highlights of the year to come </li></ul><ul><ul><li>Is a statement of management’s intentions </li></ul></ul><ul><ul><li>Can be checked with previous years’ statements to develop a sense of management’s credibility </li></ul></ul><ul><li>Review of Operations – Provides an overview of a company’s products, services, facilities, and future direction </li></ul>
  24. 24. K. Reading Corporate Annual Reports (Continued) <ul><li>Financial Statements </li></ul><ul><ul><li>Report of the Independent Auditor – Can be at either the beginning or the end of the financial statements http://library.corporate-ir.net/library/11/112/112348/items/276539/TYC_AR.pdf (p. 98) </li></ul></ul><ul><ul><ul><li>“ Clean” or unqualified opinion – statements present fairly the corporation’s financial position </li></ul></ul></ul><ul><ul><ul><li>“ Qualified” or “Modified” opinion – specific problems exist which must be addressed before the auditor can claim a fair and accurate presentation of the corporation’s financial position (page 122) http://www.ford.com/doc/2007_ar.pdf </li></ul></ul></ul>
  25. 25. K. Reading Corporate Annual Reports (Continued) <ul><ul><li>Disclaimer of Opinion – A true opinion is not possible because of inability to fairly value assets, liabilities, etc. </li></ul></ul><ul><ul><li>Adverse Opinion – The firm’s financial statements are inacurate. </li></ul></ul><ul><li>Report by Management – certification of accuracy of report pursuant to Sarbanes – Oxley </li></ul>
  26. 26. K. Reading Corporate Annual Reports (Continued) <ul><li>Balance Sheet </li></ul><ul><ul><li>Current Assets </li></ul></ul><ul><ul><ul><li>Cash and Cash Equivalents – Cash and marketable securities with less than 3 months maturity when purchased </li></ul></ul></ul><ul><ul><ul><li>Accounts and Notes Receivable – Customer balances owed to the company </li></ul></ul></ul><ul><ul><ul><li>Inventories – Finished goods, work in process, and raw materials – LCM is most conservative, but can also be carried at FIFO & LIFO – LIFO cushion is used in an inflationary environment, undervalued inventory reduces assets </li></ul></ul></ul><ul><ul><ul><li>Prepaid Expenses – Payments in advance for rent, insurance, subscriptions, utilities, etc. – listed as an asset that depreciates over time </li></ul></ul></ul>
  27. 27. K. Reading Corporate Annual Reports (Continued) <ul><li>Net Fixed Assets – Includes plant, property, and equipment – also known as capital or long term assets – carried at cost with accumulated depreciation, except for land, which does not depreciate </li></ul><ul><li>Other Assets </li></ul><ul><ul><li>Miscellaneous – Life insurance policies on key executives, notes receivable after more than one year, long term prepaid expenses, and minority stock ownership in other companies </li></ul></ul>