Security Valuation and Selection

1. Security Valuationand Selection Chapter 17

2. Fundamental Analysis versus Technical Analysis • Fundamental analysis • the practice of evaluating the information contained in financial statements, industry reports, and economic factors to determine the intrinsic value of a firm

3. Fundamental Analysis versus Technical Analysis • Intrinsic value • the “true” or economic, value of a firm

4. Fundamental Analysis versus Technical Analysis • Fundamentalist • analysts who utilize analysis in an attempt to forecast future stock price movements

5. Fundamental Analysis versus Technical Analysis • Technical analysis • examination of supply and demand for securities to determine trends in price movements of stocks or financial instruments

6. Fundamental Analysis versus Technical Analysis • Technicians • the term given to analysts who examine stocks and financial markets using technical analysis

7. Economic Analysis • Forecasting business cycles • to determine when to expect changes in the business cycle, or the direction in which aggregate economic activity is moving

8. Economic Analysis • Business cycle • the movement in aggregate economic activity as measured by the gross domestic product (GDP)

9. Economic Analysis • Expansion • increasing economic activity

10. Economic Analysis • Contraction • decreasing economic activity

11. Economic Analysis • Gross Domestic Product (GDP) • a measure of all of the goods and services produced in the economy during a specified time period

12. Economic Analysis • Recession • two consecutive quarters of economic contraction, or decline, in the GDP

13. Economic Analysis

14. Economic Analysis • Economic indicators • Leading economic indicators • economic measures that tend to move prior to, or precede, movements in the business cycle

15. Economic Analysis • Economic indicators • Lagging economic indicators • economic measures that tend to move after, or follow, movements in the general economy (business cycles)

16. Economic Analysis • Economic indicators • Coincident indicators • economic measures that tend to mirror, or move at the same time as, business cycles

17. Business Cycles

18. Business Cycles - Monetary Policy and Fiscal Policy • Monetary Policy • the means by which the Federal Reserve influences economic conditions by managing the nation’s money supply

19. Business Cycles - Monetary Policy and Fiscal Policy • Fiscal Policy • Government spending, which is primarily supported by the government’s ability to tax individuals and businesses

20. Business Cycles - Monetary Policy and Fiscal Policy • Deficit spending • situation that occurs when the government spends more than it collects in taxes

21. Industry Analysis • Cyclical industries • industries that tend to be directly related to business cycles such that they perform best during expansions and worst during contractions

22. Industry Analysis • Defensive, or countercyclical, industries • industries that tend to perform best when the economy is in a contraction or recession, but are generally the poorest performers in expanding economies

23. Industry Analysis • Industry life cycle • the various phases of an industry with respect to its growth in sales and its competitive conditions

24. Industry Life Cycle Industry Sales Mature Expansion (Growth) Introductory Life-Cycle Stages

25. Evaluating the Firm’s Financial Position • Financial statement analysis • comparison to other similar firms • forecast direction for future • predict earnings and dividends • risk evaluation

26. Stock Valuation Techniques • Dividend discount models (DDM) • a model that utilizes the discounted cash flow principle to value common stock • value is represented by the present value of the dividends expected to be received from investing in the stock

27. Stock Valuation Techniques • Dividend discount models (DDM)

28. Stock Valuation Techniques • Valuation using P/E ratios • ratio computed by dividing the current market price per share, P0, by the earnings per share, EPS0

29. Stock Valuation Techniques • Evaluation using the economic value added (EVA) approach • method used to evaluate if the earnings generated by a firm are sufficient to compensate the suppliers of funds - both the bondholders and the stockholders

30. Stock Valuation Techniques • Evaluation using the economic value added (EVA) approach

31. Economic Value Added (EVA) • Changing the capital structure can change value because the WACC is affected • Increasing the efficiency of the firm through reductions in operating expenses or increases in revenue will increase operating income and thus increase value

32. Technical Analysis • Charting - using charts and graphs • Bar chart • a graph that indicates the high, low, and closing price movements for a stock during a specified period

33. Technical Analysis • Charting - using charts and graphs • Trend line • a line that indicates the direction of the stock price movements • it is drawn so that it touches either the high prices or the low prices for some of the trading days

34. Technical Analysis • Charting - using charts and graphs • Trend line penetration • the point at which the trading line crosses the trend line

35. Technical Analysis

36. Technical Analysis • Measures and indicators used by technical analysts • The Dow Theory • a technique used to predict reversals in market patterns by examining the movements of the Dow Jones Industrial Average and the Dow Jones Transportation Average

37. Technical Analysis • Measures and indicators used by technical analysts • Moving averages • stock price averages for a fixed time frame, say 100 days, computed for a particular period of time

38. Technical Analysis • Measures and indicators used by technical analysts • Technical indicators • measures used by technical analysts to forecast future movements in stock prices

39. Technical Analysis • Measures and indicators used by technical analysts • Market breadth indicators • measure the trading volume and the range of trading that takes place in the market

40. Technical Analysis • Measures and indicators used by technical analysts • Advance/decline line • a graph that depicts the results computing the difference between the number of advancing stocks and the number of declining stocks over some time period

41. Technical Analysis • Measures and indicators used by technical analysts • Sentiment indicators • technical indicators that are used to monitor the “mood” or psychology of the market

42. Stock Selection Criteria • Growth stocks • stocks of firms that have many positive net present value opportunities • in general, these firms exhibit sales and earnings growth that significantly exceed the industry averages

43. $1.99 Stock Selection Criteria • Value stocks • stocks of firms that are mispriced, especially those that are undervalued

44. Investment Selection in Efficient Markets • Abnormal returns • returns that exceed the returns earned by investments with similar risks • Weak form efficiency • current market prices reflect all historical information, including any information that might be provided by examining past price movements and trading volume data

45. Investment Selection in Efficient Markets • Semistrong form efficiency • current market prices reflect all publicly available information, including information contained in historical data and information contained in current financial statements • Strong form efficiency • current market prices reflect all information, whether it is public or private

46. Investment Selection in Efficient Markets • Even if we accept that abnormal returns cannot be earned on a consistent basis, we still need to evaluate the investments we select to ensure the risk position is appropriate and that our investment goals are being met

47. End of Chapter 17 Security Valuationand Selection