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?
Dr. Jitendra Mahakud 1
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
Dr. Jitendra Mahakud 2
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
return Dr. Jitendra Mahakud 3
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
stocks Dr. Jitendra Mahakud 4
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
Dr. Jitendra Mahakud 5
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
Dr. Jitendra Mahakud 6
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
Dr. Jitendra Mahakud 7
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
Dr. Jitendra Mahakud 8
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
Dr. Jitendra Mahakud 9
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
Dr. Jitendra Mahakud 10
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
Dr. Jitendra Mahakud 11
12. Company Analysis
Industry competitive
environment
SWOT analysis
Present value of cash flows
Relative valuation ratio
techniques
Dr. Jitendra Mahakud 12
13. Firm Competitive Strategies
Current rivalry
Threat of new entrants
Potential substitutes
Bargaining power of suppliers
Bargaining power of buyers
Dr. Jitendra Mahakud 13
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
Dr. Jitendra Mahakud 14
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
Dr. Jitendra Mahakud 15
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
Dr. Jitendra Mahakud 16
17. SWOT Analysis
Examination of a firm’s:
Strengths
Weaknesses
Opportunities
Threats
Dr. Jitendra Mahakud 17
18. SWOT Analysis
Examination of a firm’s:
Strengths INTERNAL ANALYSIS
Weaknesses
Opportunities
Threats
Dr. Jitendra Mahakud 18
19. SWOT Analysis
Examination of a firm’s:
Strengths
Weaknesses
Opportunities
EXTERNAL ANALYSIS
Threats
Dr. Jitendra Mahakud 19
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
Dr. Jitendra Mahakud 20
21. Tenets of Warren Buffet
Business Tenets
Management Tenets
Financial Tenets
Market Tenets
Dr. Jitendra Mahakud 21
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?
Dr. Jitendra Mahakud 22
23. Management Tenets
Is management rational?
Is management candid with its
shareholders?
Dr. Jitendra Mahakud 23
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
Dr. Jitendra Mahakud 24
25. Market Tenets
What is the value of the business?
Can the business be purchased at a
significant discount to its fundamental
intrinsic value?
Dr. Jitendra Mahakud 25
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
Dr. Jitendra 26
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?
Dr. Jitendra Mahakud 27
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
Dr. Jitendra Mahakud 28
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
Dr.
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
Dr. Jitendra Mahakud 30
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
Rk
G
rk Dr. Jitendra Mahakud 31
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
Dr. Jitendra Mahakud 32
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
Dr. Jitendra Mahakud 33
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
Dr. Jitendra Mahakud 35
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
Dr. Jitendra Mahakud 36