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CHAPTER FOURTEEN

CHAPTER FOURTEEN. FINANCIAL ANALYSIS OF COMMON STOCKS. FINANCIAL ANALYSIS. REASONS FOR FINANCIAL ANALYSIS TWO PRIMARY REASONS to determine certain securities’ characteristics to attempt to identify mispriced securities. FINANCIAL ANALYSIS.

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CHAPTER FOURTEEN

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  1. CHAPTER FOURTEEN FINANCIAL ANALYSIS OF COMMON STOCKS 1

  2. FINANCIAL ANALYSIS • REASONS FOR FINANCIAL ANALYSIS • TWO PRIMARY REASONS • to determine certain securities’ characteristics • to attempt to identify mispriced securities

  3. FINANCIAL ANALYSIS • REASON #1: DETERMINING SECURITY CHARACTERISTICS • estimate future sensitivity to major factors • estimate dividend yield

  4. FINANCIAL ANALYSIS • REASON #2: ATTEMPTING TO IDENTIFY MISPRICED SECURITIES • use fundamental analysis • approaches • valuation determines the intrinsic value compared to the current market value • estimate key financial variables such as • EPS next year • income growth next year

  5. FUNDAMENTAL ANALYSIS • TOP-DOWN V. BOTTOM UP • TOP-DOWN APPROACH • attempts to forecast in the following order 1. economic activity 2. industry performance 3. firm’s performance

  6. FUNDAMENTAL ANALYSIS Economic Analysis

  7. FUNDAMENTAL ANALYSIS • FINANCIAL STATEMENT ANALYSIS • INTEGRAL PART OF FUNDAMENTAL ANALYSIS • it helps the analyst understand a firm’s current condition • where it is headed • what factors affect it • how the factors affect it

  8. FUNDAMENTAL ANALYSIS • FINANCIAL STATEMENT ANALYSIS • Review of Accounting Statements • includes a study of the three major statements prepared monthly by most accountants: • the balance sheet • the income statement • the statement of cash flows

  9. FUNDAMENTAL ANALYSIS • FINANCIAL STATEMENT ANALYSIS • RATIO ANALYSIS • DEFINITION: a technique used to examine a company’s financial statements • Use of Ratios • as an absolute standard • as a comparative indicator • as a trend over time

  10. FUNDAMENTAL ANALYSIS • FINANCIAL STATEMENT ANALYSIS • RATIO ANALYSIS • Types of Ratios • internal liquidity • operating performance • risk analysis • growth analysis • profitability • market ratios

  11. FUNDAMENTAL ANALYSIS • internal liquidity ratios: • indicate the ability of the firm to meet future short-term financial obligations • some liquidity ratios: • current ratio • quick ratio • cash ratio • receivables turnover

  12. FUNDAMENTAL ANALYSIS • operating performance ratios: • indicate how well the management is operating the business • some examples: • total asset turnover • net fixed asset turnover • equity turnover

  13. FUNDAMENTAL ANALYSIS • risk analysis ratios: • indicates the uncertainty of income flows for the total firm and for the individual sources of capital (debt and stock) • some examples: • debt to equity ratio • long-term debt/total capital ratio

  14. FUNDAMENTAL ANALYSIS • growth analysis ratios: • indicate how fast a firm should grow • it involves analysis using several other ratios • net profit margin • total asset turnover • total assets/equity

  15. FUNDAMENTAL ANALYSIS Profitability Ratios • Gross Margin • Gross profit / Sales • Operating Margin • Operating income / Sales • ROA • Net income / Total assets • ROE • Net income / Owner’s equity

  16. FUNDAMENTAL ANALYSIS Per Share Calculations • Book Value Per Share (BVPS) • Total equity / # shares outstanding • Earnings Per Share (EPS) • Net income / # shares outstanding • Cash Flow Per Share (CFPS) • Operating cash flow / # shares outstanding

  17. FUNDAMENTAL ANALYSIS Market Value Ratios • Price / Book (or Market / Book) • Stock price / BVPS • Price / Earnings (P/E) • Stock price / EPS • Price / Cash flow (P/CF) • Stock price / CFPS

  18. Sources of Information • Annual reports • Wall Street Journal • Value Line • Standard & Poor’s • Research Insight

  19. Sources of Information • Internet • NYSE (www.nyse.com) • Nasdaq (www.nasdaq.com) • Text (www.mhhe.com/cj) • CNNfn.com • CNBC.com • Yahoo.com • Zacks.com • Smartmoney.com • Multex.com • MSNBC.com • Quicken.com

  20. Sources of Information • SEC • EDGAR • 10K & 10Q reports

  21. TECHNICAL ANALYSIS • DEFINITION: a form of security analysis that attempts to forecast price changes based on historical price and volume trends

  22. TECHNICAL ANALYSIS • Two Groups of Strategies Used: 1. Momentum and Contrarian Strategies 2. Moving Average and Trading Range Breakout Strategies

  23. Technical Analysis • Support and resistance areas • Support level / Bottom feeders • Resistance level / Topping out / profit taking • Breakouts

  24. TECHNICAL ANALYSIS 1. Momentum and Contrarian Strategies • METHDOLOGY: • examine the returns over a time period just ended to identify • momentum investors who seek out stocks recently rising in price for purchase; falling for sale • contrarians who follow the opposite strategy of most investors • contrarians base their strategy on the overreaction theory

  25. TECHNICAL ANALYSIS 2. Moving Average and Trading Range Breakout Strategies • MOVING AVERAGE STRATEGY: • calculate a moving average over the last 200 days of closing prices • divide today’s closing price into the moving average (SHORT-TO-LONG RATIO) • if short-to-long ratio is greater than 1, buy • if ratio is less than 1, sell

  26. TECHNICAL ANALYSIS • 2. Moving Average and Trading Range Breakout Strategies • TRADING RANGE BREAKOUT STRATEGY: • high and low prices for past 200 trading days are identified • if today’s close is greater than the high = buy! • if today’s close is less than the low = sell!

  27. TECHNICAL ANALYSIS Reading the tea leaves… • Advance / decline line: Closing Arms or Trin • Relative strength • Moving averages • Candlestick chart • Chart formations: head-and-shoulders

  28. Trin = Declining volume / Declines Advancing volume / Advances Examples • Closing Arms: Trin Values > 1 considered bearish

  29. Examples • Advance/Decline Line Calculation Issues Issues Weekday Advancing Declining Difference Cumulative THU 1,162 1,888 -726 -726 FRI 2,275 1,198 1,077 351 MON 1,203 1,849 -646 -295 TUE 1,187 1,878 -691 -986 WED 1,739 1,311 428 -558 THU 2,193 910 1,283 725 FRI 2,178 974 1,204 1,929 MON 1,540 1,525 15 1,944 TUE 1,660 1,540 120 2,064

  30. Examples • Relative strength: Charts performance relative to industry or market Value Line Timeliness* Price performance/Average performance of V-L Stocks

  31. 11 + 12 + 14 = 12.33 3 Moving Average 12 + 14 + 13 = 13.00 3

  32. Moving Average Graph

  33. Candlestick Making

  34. Head and Shoulders Formation

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