My research paper on stocks.doc


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My research paper on stocks.doc

  1. 1. FUNDAMENTAL ANALYSIS INTRODUCTION Stocks, in business and finance, are certificates representing shares of ownership in a corporation. When individuals or organizations purchase shares in a company they receive stock certificates indicating the number of shares they have acquired. These certificates entitle them to shares in the profits of the company in the form of dividends, which are paid in intervals. In addition to a claim on company profits, stockholders are entitled to share in the sale of the company if it is dissolved. The purpose of investing in the stock market is to obtain a positive return, or positive cash flows, on the investment in the future. The element of risk, or the potential loss in an investment, is deeply integrated into the process of buying and selling stocks. Ownership of common or preferred stock does not guarantee certain future cash flows. However, stock is bought on the expectation of realizing some future minimum cash flow. Careful analysis of both the general economy and the corporation issuing the stock will aid in the decision process. Fundamental analysis is the name associated with the systematic process in determining the profitability of a company's stock PURPOSE, SCOPE, AND LIMITATIONS The purpose of this report is to explain and illustrate the systematic process of fundamental analysis. Fundamental analysis uses a corporation's financial statements to evaluate the value of possible return associated with its stock. Furthermore, it examines the economy as a whole to gain an insight into the risk of investing at a particular moment in the business cycle. Ben & Jerry's Homemade, Incorporated's financial statements have been selected to illustrate the application of fundamental analysis. Ultimately, the decision process of buying a company's stock will be unveiled as well as the profitability of Ben and Jerry's stock. SOURCES AND METHODS In preparing this report, financial statements of Ben & Jerry's Homemade, Inc. were accessed through the Internet. This webpage is considered a valid source, as it is created and copyrighted by Ben & Jerry's Homemade, Inc. The Internet was also used for further financial analysis of Ben & Jerry's Homemade, Inc. Sources used include Salomon Smith Barney, Rapid Research, Quote Central, Edgar Online(sponsored by Fidelity Investments), and Wall Street Snapshot, and all contain financial information deemed appropriate by the Securities Exchange Commission and/or Ben & Jerry's Homemade, Inc. financial statements. Techniques involved in fundamental analysis used in this report were developed by Dr. John C. Ritchie, professor of Finance and Associate Dean for the School of Business and Management at Temple University. REPORT ORGANIZATION
  2. 2. This report reviews the steps involved in fundamental analysis and the application of this process to Ben & Jerry's Homemade, Inc. Information involving Ben & Jerry's will only be used as a supplement to information provided about fundamental analysis. Ultimately, the complete analysis of Ben & Jerry's financial statements will illustrate how fundamental analysis is used and whether investing in Ben & Jerry's will most likely be profitable or not. Ben & Jerry's is only an example in this report, whereas fundamental analysis may be used on any organization. SUCCESSFUL INVESTING USING FUNDAMENTAL ANALYSIS A successful investor must consider several things before entering the stock market. To begin, an investor must remain realistic in his/her expectations. Spectacular results are extremely rare, and therefore should not be considered when investing. Second, the investor should remain immune to changing moods and emotions revolving around the market place. Focusing on the long-term will ultimately generate better results. Next, the investor should only sell her/his securities when specific targets have been realized and/or a more attractive investment opportunity exists. Also, to be a successful investor one must keep a diversified portfolio and invest in different industries and markets to avoid industry-wide problems. Finally, the investor should conduct thorough research on the companies s/he wants to invest in. Only under a complete analysis of a firm's financial position will the investor have the ability to decide whether or not to invest. Fundamental analysis includes making an estimate of expected return and relative risk. The elements of return and risk serve as a basis for appraising relative attractiveness of the particular stock under consideration. Fundamental analysis is concerned with historical performance of the economy, industry, and firms for the insight into future performance. Fundamental analysis explores the relationships in a firm and the general trend of these relationships over time. Four suggestions of where a firm is going include(Ritchie, 15): wcomposition and liquidity of corporate resources wcompany's capital structure and leverage wcompetitive position of the company wcompany earnings over time As of September 26, 1998, Ben & Jerry's had $60.3 million of cash and cash equivalents. This represents a $13 million increase from the previous year. Net cash provided by operations was $22.5 million. The company is in a period of expansion. New company owned "scoop shops" are being constructed in France, while the company is beginning a new chain of theaters in the United Kingdom(Edgar Online). "Management believes that internally generated funds, cash currently on hand, investments held in marketable securities, and equipment lease financing will be adequate to meet anticipated operating and capital requirements(Edgar Online)." Therefore, liquidity in corporate resources is steadily increasing as the company is expanding internationally. Through expansion, it is presumed that the company is in an ideal competitive position. Net income has increased from 2.4% of sales in 1997, to 3.3% of sales in 1998(Edgar Online). This suggests increased earnings and efficiency in the production process. To determine the value of common stock, an analyst must diagnose the future of an organization and the environment in which it operates(Ritchie, 18). Fundamental
  3. 3. analysis is used to offer a range of where stock prices may go based on associated risk, current conditions, and the company's history. Ben & Jerry's is currently earning $0.73 per share. The consensus estimate for next year expects earnings to rise to $0.91 per share(Wall Street Snapshot). This represents a predicted 25% increase in earnings per share for the next fiscal year. SECURITY ANALYSIS Security analysis involves examining a company's qualitative and quantitative aspects. Qualitative factors include management styles, research and development efforts, and projections of earnings and dividends(Ritchie, 18). Quantitative factors include historical values from financial statements and the economy of financial markets(Richie, 18). Fundamental analysis screens and classifies financial assets in terms of investment quality and expected return. An analysis of an individual firm should come only after analyzing the economy as a whole. An analysis of the economy will assure that return from stocks is greater than return from bonds. Bonds legally have to be paid back, whereas stocks do not. Therefore the risk on bonds is much less than that of stocks. An analysis of long-term growth of the economy will provide an outlook and strategy on when it is better to invest in bonds or stocks. Analyzing the economy may include(Ritchie, 61-86): wa change in the labor force (anticipated) wa trend in average number of hours per work week wa trend in output per hour worked wa change in price levels The first three factors involve an anticipated change in the Gross National Product(GNP). The final variable relates to the current GNP. Analyzing corporate profits, common stock price performance, interest rates, and inflation will also help when considering investing. AN INTERNAL LOOK INTO AN ORGANIZATION After analyzing the market a firm operates in, an in-depth analysis must be conducted on a firm's financial statements. Financial statements are the formal presentation of a company's business operations. Financial statements are the underlying continuity in all business affairs. The presentation of financial statements is incorporated in the field of accounting. Webster's defines accounting as the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information. Key areas to examine in a company's financial statements are the income statement, balance sheet, and statement of cash flows. An income statement simply states the net income earned from sales less the cost of goods sold, interest, taxes, and other general expenses. This statement expresses the earnings of the company over time. An income statement may illustrate the company's control of its costs. Finally, the income statement shows the growth and profitability of a firm.
  4. 4. Ben & Jerry's income statement is as follows(in thousands): Years Ended Dec. 27, 1997 Dec. 28, 1996 Dec. 30, 1995 Net Sales $174,206 $167,155 $155,333 Cost of Sales 114,284 115,212 109,125 Gross Profit 59,922 51,943 46,208 Income Before Taxes 6,284 6,335 9,405 Net Income After Tax 3,896 3,926 5,948 Notice that net income after tax has decreased from 1995 to 1997, while gross profit has steadily increased. This represents a change in other expensed like selling and administrative for example. This illustrates how a company may not be able to control its costs, thus affecting its profitability over time. Further analysis of the company’s notes accompanying its Annual Report suggest that selling and administrative costs were higher in 1996 because the company launched a new product line. Analyzing the success of the new product will come in later Annual Reports. Furthermore, costs are going into research involved in the “year 2000 bug”(Ben & Jerry’s Homepage). An examination of the balance sheet determines the company’s current financial position. The balance sheet states the amount and nature of invested capital, the sources of invested capital, the proportionate division of corporate capitalization, and the rate of return earned on total assets. Analysts look at the debt to equity ratio. This tells where the funds are coming from to gain corporate assets. The assets of a corporation indicate the source of the corporation’s income and the manner in which capital was invested. The following are generated from Ben & Jerry’s balance sheet(Rapid Research): 1997 1996 1995 1994 1993 Current Assets($mil) 80.1 68.1 68.1 51.9 42.4 Current Liabilities($mil) 28.7 18.1 17 14.5 13.1 Com. Stock Equity($mil) 86.9 82.6 78.5 72.5 74.3 Shares Out(000) 7235 7195 7177 7153 7174 Profit Margin(%) 2.2 2.3 3.8 -1.3 5.1 Return on Equity(%) 4.5 4.7 7.5 ----- 9.7 Return on Assets(%) 2.7 2.9 4.5 -1.6 6.8 P/E Ratio 29.2 20.1 18 ------ 16 Debt/Equity Ratio 0.3 0.38 0.41 0.45 0.24 Illustrated in the above table, current assets have increased since 1993, while profit margin, return on equity, and return on assets have decreased. These indicate that it may not be a profitable venture to invest in. The statement of cash flows may be used to supplement the balance sheet and income statement. The statement of cash flows yields earnings per share data that may be vital for analysis. However, the statement of cash flows cannot be considered alone. It is important to consider the company as a whole and to understand the reasons behind the nature of income and reasonable projections of earnings and dividends. To obtain the
  5. 5. value for earnings per share, divide the earnings available to common stockholders (after tax) by the weighted average number of common shares outstanding over the year. This ratio is called the Price / Earnings ration(P/E). The P/E ratio for Ben & Jerry’s, as seen in the above table, has increased steadily from 16 to 29.2 in 1993 to 1997, respectively. Thus, the relative value of the common stock is increasing over time. The price of the stock has increased over the past year as well. On November 24, 1997 the price was listed at $16.000. The price peaked during June of 1998 before the market dropped drastically a few months later in September. The following is pictorial representation of the stock price over the last year. Notice record growth in June and a steep drop in September: A WISE INVESTMENT Several characteristics of good companies have been touched upon in this report. Good companies to invest in share the following traits(Ritchie, 218): wability to raise prices to cover increased costs even in poor economic times wincrease/growth in unit and dollar sales woperating and financial leverage is favorable wable to retain high or above average return on total assets and owner’s equity wdecrease labor costs compared to competitors
  6. 6. wadequately funded pension plans; the cash flow seems to support needs without hurting return to owners whistorically, research and development have been successful wlow fixed cost base wincreased earnings retention ratio wa healthy cash flow over an extended period of time After analyzing Ben & Jerry’s Homemade, Inc. financial statements, several factors must be considered. First of all, the company is expanding into the foreign market. Market entry is extremely expensive. Furthermore, new products, containers, and “scoop shops” are being developed. The company is expanding. This may account for the decreased return on assets as potential revenues have not yet been realized. Nevertheless, the profit margin has been decreasing since 1993. The value of the stock, however, has ultimately increased over time. Ben & Jerry’s is known for its humanitarian efforts which no doubt affect sales. Ben & Jerry’s management went through a recent change involving employee empowerment, refocusing on the culture of the organization, and a revamped managerial system. These changes will most likely lead to increased productivity and decreased costs. Ultimately, the long range forecast for the value of Ben & Jerry’s stock is to steadily increase. These increases, however, may only be slight. It may be more profitable to invest in a more attractive company with increased stability and growth. On a scale of 1 to 5, Wall Street Sanpshot has given the following ratings for Ben & Jerry’s common stock: Number of Brokers Recommending (11/16/98) Strong Buy 0 Moderate Buy 2 Hold 2 Moderate Sell 0 Strong Sell 0 Current Average 2.5 Recommendation (1.0=Strg. Buy, 5.0=Str. Sell)