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Chapter 14

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Chapter 14

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

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