Lecture Presentation Software   to accompany Investment Analysis and  Portfolio Management Seventh Edition by  Frank K. Re...
Chapter 13 Stock Market Analysis <ul><li>Questions to be answered: </li></ul><ul><li>How do we apply the basic reduced for...
Chapter 13 Stock Market Analysis <ul><li>What are the two components involved in the two-part valuation procedure? </li></...
Chapter 13 Stock Market Analysis <ul><li>What are the variables that determine the level and changes in the market earning...
Chapter 13 Stock Market Analysis <ul><li>What additional factors must be considered when you apply this microanalysis appr...
Applying the DDM  Valuation Model to the Market <ul><li>The stream of expected returns </li></ul><ul><li>The time pattern ...
Applying the DDM  Valuation Model to the Market <ul><li>Determinants of the Earnings Multiplier: </li></ul><ul><li>1.   Th...
Market Valuation Using the  Reduced Form DDM <ul><li>Estimating k and g for the U.S. equity market </li></ul><ul><li>The n...
Estimating Growth Rate <ul><li>Growth rate of dividends is equal to </li></ul><ul><ul><li>Retention rate - the proportion ...
Return on Equity (ROE) Profit  Total Asset  Financial Margin  Turnover  Leverage = x x
Market Valuation Using the Free Cash Flow to Equity (FCFE) Model <ul><li>FCFE is: </li></ul><ul><li>+ Net Income </li></ul...
Market Valuation Using the Free Cash Flow to Equity (FCFE) Model <ul><li>The Constant Growth FCFE Model </li></ul><ul><li>...
Market Valuation Using Relative Valuation Approach <ul><li>The price-earnings ratio (P/E) </li></ul><ul><li>The price-book...
Market Valuation Using Relative Valuation Approach <ul><li>Two-part valuation procedure </li></ul>
Market Valuation Using Relative Valuation Approach <ul><li>Importance of both components of value </li></ul><ul><ul><li>1....
Estimating Expected Earnings Per Share <ul><li>Estimating expected earnings per share </li></ul><ul><ul><li>Estimate sales...
Estimating Expected Earnings Per Share <ul><li>Alternative estimates of corporate net profits </li></ul><ul><ul><li>Direct...
Estimating Expected Earnings Per Share <ul><li>Estimating aggregate operating profit margins </li></ul><ul><ul><li>Capacit...
Estimating Expected Earnings Per Share <ul><li>Estimating depreciation expense </li></ul><ul><ul><li>time series trends </...
Estimating Expected Earnings Per Share <ul><li>Estimating interest expense </li></ul><ul><ul><li>debt levels </li></ul></u...
Estimating Expected Earnings Per Share <ul><li>Estimating the tax rate </li></ul><ul><ul><li>depends on future political a...
Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Determinants of the earnings multiplier </li></ul><ul...
Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Estimating the required rate of return (k) </li></ul>...
Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Estimating an Earnings Mutiplier: An Example </li></u...
Other Relative Valuation Ratios <ul><li>Price to book value ratio (P/BV) </li></ul><ul><li>Price to cash flow ratio (P/CF)...
Analysis of World Markets <ul><li>Individual country analysis </li></ul><ul><ul><li>analyze economy and security markets b...
The Internet Investments Online <ul><li>www.ms.com </li></ul><ul><li>www.yardeni.com </li></ul><ul><li>www.nabe.com </li><...
<ul><li>End of Chapter 13 </li></ul><ul><ul><li>Stock Market Analysis </li></ul></ul>
Future topics Chapter 14   <ul><li>Why do industry analysis? </li></ul><ul><li>Competition and expected industry returns <...
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  1. 1. Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Seventh Edition by Frank K. Reilly & Keith C. Brown Chapter 13
  2. 2. Chapter 13 Stock Market Analysis <ul><li>Questions to be answered: </li></ul><ul><li>How do we apply the basic reduced form dividend discount model (DDM) to the valuation of the aggregate stock market? </li></ul><ul><li>What would be the prevailing value of the market as presented by the S&P 400 based upon the reduced form DDM? </li></ul><ul><li>What would be the prevailing value of the market (S&P 400) based upon the value of free cash flow to equity (FCFE) model? </li></ul>
  3. 3. Chapter 13 Stock Market Analysis <ul><li>What are the two components involved in the two-part valuation procedure? </li></ul><ul><li>Given the two components in the valuation procedure, which is more volatile? </li></ul><ul><li>What steps are involved in estimating the earnings per share for an aggregate market series? </li></ul><ul><li>What variables affect the aggregate operating profit margin and how do they affect it? </li></ul>
  4. 4. Chapter 13 Stock Market Analysis <ul><li>What are the variables that determine the level and changes in the market earnings multiplier? </li></ul><ul><li>How do you arrive at an expected market value and an expected rate of return for the stock market? </li></ul><ul><li>What has happened to the values for the other relative valuation ratios - i.e., the P/BV, P/CF, and P/S ratios? </li></ul>
  5. 5. Chapter 13 Stock Market Analysis <ul><li>What additional factors must be considered when you apply this microanalysis approach to the valuation of stock markets around the world? </li></ul><ul><li>What are some differences between stock market statistics for the U.S. versus other countries? </li></ul>
  6. 6. Applying the DDM Valuation Model to the Market <ul><li>The stream of expected returns </li></ul><ul><li>The time pattern of expected returns </li></ul><ul><li>The required rate of return on the investment </li></ul>
  7. 7. Applying the DDM Valuation Model to the Market <ul><li>Determinants of the Earnings Multiplier: </li></ul><ul><li>1. The expected dividend payout ratio </li></ul><ul><li>2. The required rate of return on the stock </li></ul><ul><li>3. The expected growth rate of dividends for the stock </li></ul>
  8. 8. Market Valuation Using the Reduced Form DDM <ul><li>Estimating k and g for the U.S. equity market </li></ul><ul><li>The nominal risk-free rate </li></ul><ul><li>The equity risk premium </li></ul><ul><li>The current estimate of Risk Premium and k </li></ul><ul><li>Estimating the growth rate of dividends (g) </li></ul><ul><ul><li>g = f(b,ROE) </li></ul></ul><ul><li>ROE = Net Income / Equity </li></ul>
  9. 9. Estimating Growth Rate <ul><li>Growth rate of dividends is equal to </li></ul><ul><ul><li>Retention rate - the proportion of earnings retained and reinvested </li></ul></ul><ul><ul><li>Return on equity (ROE) – rate of return earned on investment </li></ul></ul><ul><ul><li>An increase in either or both of these variables causes an increase in the expected growth rate (g) and an increase in the earnings multiplier </li></ul></ul>
  10. 10. Return on Equity (ROE) Profit Total Asset Financial Margin Turnover Leverage = x x
  11. 11. Market Valuation Using the Free Cash Flow to Equity (FCFE) Model <ul><li>FCFE is: </li></ul><ul><li>+ Net Income </li></ul><ul><li>+ Depreciation Expense </li></ul><ul><li>- Capital Expenditures </li></ul><ul><li>-  in Working Capital </li></ul><ul><li>- Principal Debt Repayments </li></ul><ul><li>+ New Debt issues </li></ul>
  12. 12. Market Valuation Using the Free Cash Flow to Equity (FCFE) Model <ul><li>The Constant Growth FCFE Model </li></ul><ul><li>The Two Stage Growth FCFE Model </li></ul>
  13. 13. Market Valuation Using Relative Valuation Approach <ul><li>The price-earnings ratio (P/E) </li></ul><ul><li>The price-book value ratio (P/BV) </li></ul><ul><li>The price-cash flow ratio (P/CF) </li></ul><ul><li>The price-sales ratio (P/S) </li></ul>
  14. 14. Market Valuation Using Relative Valuation Approach <ul><li>Two-part valuation procedure </li></ul>
  15. 15. Market Valuation Using Relative Valuation Approach <ul><li>Importance of both components of value </li></ul><ul><ul><li>1. Estimating the future earnings per share for the stock-market series </li></ul></ul><ul><ul><li>2. Estimating a future earnings multiplier for the stock-market series </li></ul></ul>
  16. 16. Estimating Expected Earnings Per Share <ul><li>Estimating expected earnings per share </li></ul><ul><ul><li>Estimate sales per share for a stock-market series </li></ul></ul><ul><ul><li>Estimate the operating profit margin for the series </li></ul></ul><ul><ul><li>Estimate depreciation per share for the next year </li></ul></ul><ul><ul><li>Estimate interest expense per share for the next year </li></ul></ul><ul><ul><li>Estimate the corporate tax rate for the next year </li></ul></ul><ul><li>Estimating Gross Domestic Product </li></ul><ul><li>Estimating sales per share for a market series </li></ul>
  17. 17. Estimating Expected Earnings Per Share <ul><li>Alternative estimates of corporate net profits </li></ul><ul><ul><li>Direct estimate of the net profit margin based on recent trends </li></ul></ul><ul><ul><li>Estimate the net before tax (NBT) profit margin </li></ul></ul><ul><ul><li>Estimate an operating profit margin to obtain EBITDA; estimate depreciation and interest to arrive at EBT; estimate the tax rate (T) and multiply by (1-T) to estimate net income </li></ul></ul>
  18. 18. Estimating Expected Earnings Per Share <ul><li>Estimating aggregate operating profit margins </li></ul><ul><ul><li>Capacity utilization rate </li></ul></ul><ul><ul><li>Unit labor costs </li></ul></ul><ul><ul><li>Rate of inflation </li></ul></ul><ul><ul><li>Foreign competition </li></ul></ul>
  19. 19. Estimating Expected Earnings Per Share <ul><li>Estimating depreciation expense </li></ul><ul><ul><li>time series trends </li></ul></ul><ul><ul><li>estimate based on property, plant, and equipment </li></ul></ul><ul><ul><ul><li>sales and turnover </li></ul></ul></ul><ul><ul><ul><li>depreciation </li></ul></ul></ul>
  20. 20. Estimating Expected Earnings Per Share <ul><li>Estimating interest expense </li></ul><ul><ul><li>debt levels </li></ul></ul><ul><ul><ul><li>total assets </li></ul></ul></ul><ul><ul><ul><li>expected capital structure </li></ul></ul></ul><ul><ul><li>interest rates </li></ul></ul><ul><ul><li>subtract result from EBIT to estimate EBT </li></ul></ul>
  21. 21. Estimating Expected Earnings Per Share <ul><li>Estimating the tax rate </li></ul><ul><ul><li>depends on future political action </li></ul></ul><ul><ul><li>multiply (1-T) times the EBT per-share to estimate the net income per share </li></ul></ul>
  22. 22. Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Determinants of the earnings multiplier </li></ul><ul><ul><li>Dividend payout ratio </li></ul></ul><ul><ul><li>required rate of return on common stock </li></ul></ul><ul><ul><li>the expected growth rate of dividends for the stocks </li></ul></ul>
  23. 23. Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Estimating the required rate of return (k) </li></ul><ul><ul><li>inversely related to the earnings multiplier </li></ul></ul><ul><ul><li>determined by risk-free rate, expected inflation, and the risk premium for the investment </li></ul></ul><ul><li>Estimating the dividend payout ratio (D/E) </li></ul><ul><ul><li>active decision or residual outcome? </li></ul></ul><ul><ul><li>time series plots </li></ul></ul><ul><ul><li>long-run perspective </li></ul></ul>
  24. 24. Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Estimating an Earnings Mutiplier: An Example </li></ul><ul><ul><li>The Direction of Change Approach </li></ul></ul><ul><ul><li>Specific Estimate Approach </li></ul></ul><ul><li>Calculating an Estimate of the Value for the Market series </li></ul>
  25. 25. Other Relative Valuation Ratios <ul><li>Price to book value ratio (P/BV) </li></ul><ul><li>Price to cash flow ratio (P/CF) </li></ul><ul><li>Price to sales ratio (P/S) </li></ul>
  26. 26. Analysis of World Markets <ul><li>Individual country analysis </li></ul><ul><ul><li>analyze economy and security markets before analyzing alternative industries or companies </li></ul></ul><ul><ul><li>macro techniques </li></ul></ul><ul><ul><li>micro techniques </li></ul></ul><ul><ul><li>technical analysis </li></ul></ul><ul><ul><li>top down approach </li></ul></ul>
  27. 27. The Internet Investments Online <ul><li>www.ms.com </li></ul><ul><li>www.yardeni.com </li></ul><ul><li>www.nabe.com </li></ul><ul><li>www.agedwards.com </li></ul>
  28. 28. <ul><li>End of Chapter 13 </li></ul><ul><ul><li>Stock Market Analysis </li></ul></ul>
  29. 29. Future topics Chapter 14 <ul><li>Why do industry analysis? </li></ul><ul><li>Competition and expected industry returns </li></ul><ul><li>Estimating an industry earnings multiplier </li></ul>

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