The document discusses company analysis and stock valuation. It provides guidance on analyzing a company's competitive strategies, growth potential, management quality, and financials to estimate intrinsic value. Key steps include conducting a SWOT analysis, comparing intrinsic value to market price, and monitoring assumptions to determine when to sell. The overall aim is to identify undervalued stocks by focusing on long-term prospects and downside protection.

1. Company Analysis and Stock
Valuation
 After analyzing the economy and stock
markets for several countries, you have
decided to invest some portion of your
portfolio in common stocks
 After analyzing various industries, you have
identified those industries that appear to
offer above-average risk-adjusted
performance over your investment horizon
 Which are the best companies?
 Are they overpriced?
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2. Company Analysis and Stock
Valuation
 Good companies are not necessarily good
investments
 Compare the intrinsic value of a stock to its
market value
 Stock of a great company may be overpriced
 Stock of a growth company may not be
growth stock
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3. Growth Companies
 Growth companies have historically
been defined as companies that
consistently experience above-average
increases in sales and earnings
 Financial theorists define a growth
company as one with management and
opportunities that yield rates of return
greater than the firm’s required rate of
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4. Growth Stocks
 Growth stocks are not necessarily
shares in growth companies
 A growth stock has a higher rate of
return than other stocks with similar
risk
 Superior risk-adjusted rate of return
occurs because of market
undervaluation compared to other
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5. Defensive Companies and
Stocks
 Defensive companies’ future earnings
are more likely to withstand an
economic downturn
 Low business risk
 Not excessive financial risk
 Stocks with low systematic risk
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6. Cyclical Companies and Stocks
 Cyclical companies are those whose
sales and earnings will be heavily
influenced by aggregate business
activity
 Cyclical stocks are those that will
experience changes in their rates of
return greater than changes in overall
market rates of return
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7. Speculative Companies and
Stocks
 Speculative companies are those whose
assets involve great risk but those that
also have a possibility of great gain
 Speculative stocks possess a high
probability of low or negative rates of
return and a low probability of normal
or high rates of return
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8. Value versus Growth Investing
 Growth stocks will have positive
earnings surprises and above-
average risk adjusted rates of return
because the stocks are undervalued
 Value stocks appear to be
undervalued for reasons besides
earnings growth potential
 Value stocks usually have low P/E
ratio or low ratios of price to book
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9. Economic, Industry, and Structural
Links to Company Analysis
 Company analysis is the final step in the
top-down approach to investing
 Macroeconomic analysis identifies
industries expected to offer attractive
returns in the expected future
environment
 Analysis of firms in selected industries
concentrates on a stock’s intrinsic value
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10. Economic and Industry
Influences
 If trends are favorable for an industry,
the company analysis should focus on
firms in that industry that are
positioned to benefit from the economic
trends
 Firms with sales or earnings particularly
sensitive to macroeconomic variables
should also be considered
 Research analysts need to be familiar
with the cash flow and risk of the firms
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11. Structural Influences
 Social trends, technology, political, and
regulatory influences can have
significant influence on firms
 Early stages in an industry’s life cycle
see changes in technology which
followers may imitate and benefit from
 Politics and regulatory events can
create opportunities even when
economic influences are weak
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12. Company Analysis
 Industry competitive
environment
 SWOT analysis
 Present value of cash flows
 Relative valuation ratio
techniques
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13. Firm Competitive Strategies
 Current rivalry
 Threat of new entrants
 Potential substitutes
 Bargaining power of suppliers
 Bargaining power of buyers
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14. Firm Competitive Strategies
 Defensive strategy involves positioning firm
so that its capabilities provide the best
means to deflect the effect of competitive
forces in the industry
 Offensive strategy involves using the
company’s strength to affect the
competitive industry forces, thus improving
the firm’s relative industry position
 Porter suggests two major strategies: low-
cost leadership and differentiation
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15. Porter's Competitive Strategies
 Low-Cost Strategy
 The firm seeks to be the low-cost
producer, and hence the cost leader
in its industry
 Differentiation Strategy
 firm positions itself as unique in the
industry
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16. Focusing a Strategy
 Select segments in the industry
 Tailor strategy to serve those
specific groups
 Determine which strategy a firm is
pursuing and its success
 Evaluate the firm’s competitive
strategy over time
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17. SWOT Analysis
 Examination of a firm’s:
 Strengths
 Weaknesses
 Opportunities
 Threats
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18. SWOT Analysis
 Examination of a firm’s:
 Strengths INTERNAL ANALYSIS
 Weaknesses
 Opportunities
 Threats
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19. SWOT Analysis
 Examination of a firm’s:
 Strengths
 Weaknesses
 Opportunities
EXTERNAL ANALYSIS
 Threats
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20. Some Lessons from Peter
Lynch
Favorable Attributes of Firms
1. Firm’s product should not be faddish
2. Firm should have some long-run comparative
advantage over its rivals
3. Firm’s industry or product has market
stability
4. Firm can benefit from cost reductions
5. Firms that buy back shares show there are
putting money into the firm
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21. Tenets of Warren Buffet
 Business Tenets
 Management Tenets
 Financial Tenets
 Market Tenets
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22. Business Tenets
 Is the business simple and
understandable?
 Does the business have a consistent
operating history?
 Does the business have favorable long-
term prospects?
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23. Management Tenets
 Is management rational?
 Is management candid with its
shareholders?
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24. Financial Tenets
 Focus on return on equity, not earnings
per share
 Calculate “owner earnings”
 Look for companies with high profit
margins
 For every dollar retained, make sure the
company has created at least one dollar
of market value
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25. Market Tenets
 What is the value of the business?
 Can the business be purchased at a
significant discount to its fundamental
intrinsic value?
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26. Estimating Intrinsic Value
A. Present value of cash flows (PVCF)
 1. Present value of dividends (DDM)
 2. Present value of free cash flow to equity
(FCFE)
 3. Present value of free cash flow (FCFF)
B. Relative valuation techniques
 1. Price earnings ratio (P/E)
 2. Price cash flow ratios (P/CF)
 3. Price book value ratios (P/BV)
 4. Price sales ratio (P/S) Mahakud
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27. Analysis of Growth Companies
 Generating rates of return greater than
the firm’s cost of capital is considered
to be temporary
 Earnings higher than the required rate
of return are pure profits
 How long can they earn these excess
profits?
 Is the stock properly valued?
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28. Negative Growth Model
 Firm retains earnings, but reinvestment
returns are below the firm’s cost of
capital
 Since growth will be positive, but slower
than it should be, the value will decline
when the investors discount the
reinvestment stream at the cost of
capital
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29. Measures of Value-Added
 Economic Value-Added (EVA)
 Compare net operating profit less adjusted
taxes (NOPLAT) to the firm’s total cost of
capital in dollar terms, including the cost of
equity
 EVA return on capital
EVA/Capital
 Alternative measure of EVA
 Compare return Jitendracapital to cost of capital
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on Mahakud 29

30. Measures of Value-Added
 Market Value-Added (MVA)
 Measure of external performance
 How the market has evaluated the firm’s
performance in terms of market value of
debt and market value of equity compared
to the capital invested in the firm
 Relationships between EVA and MVA
 mixed results
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31. Measures of Value-Added
 The Franchise Factor
 Breaks P/E into two components
 P/E based on ongoing business (base P/E)
 Franchise P/E the market assigns to the expected
value of new and profitable business opportunities
Franchise P/E = Observed P/E - Base P/E
Incremental Franchise P/E = Franchise Factor X Growth
Factor
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32. Intra-Industry Analysis
 Directly compare two firms in the same industry
 Factors to consider
 A major difference in the risk involved
 Inaccurate growth estimates
 Stock with a low P/E relative to its growth rate is
undervalued
 Stock with high P/E and a low growth rate is overvalued
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33. Site Visits and the
Art of the Interview
 Focus on management’s plans, strategies, and
concerns
 Restrictions on nonpublic information
 “What if” questions can help gauge sensitivity
of revenues, costs, and earnings
 Management may indicate appropriateness of
earnings estimates
 Discuss the industry’s major issues
 Review the planning process
 Talk to more than just the top managers
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34. When to Sell
 Holding a stock too long may lead to lower returns
than expected
 If stocks decline right after purchase, is that a
further buying opportunity or an indication of
incorrect analysis?
 Continuously monitor key assumptions
 Evaluate closely when market value approaches
estimated intrinsic value
 Know why you bought it and watch for that to
change Dr. Jitendra Mahakud 34

35. Efficient Markets
 Opportunities are mostly among less well-
known companies
 To outperform the market you must find
disparities between stock values and market
prices - and you must be correct
 Concentrate on identifying what is wrong
with the market consensus and what earning
surprises may exist
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36. Global Company and Stock
Analysis
Factors to Consider:
 Availability of Data
 Differential Accounting Conventions
 Currency Differences (Exchange Rate
Risk)
 Political (Country) Risk
 Transaction Costs
 Valuation Differences
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