Fundamental and technical analysis of companies before investing

Fundamental and technical analysis of companies before investing

1. Fundamental Analysis
•Macroeconomics Analysis
•Industry Analysis
•Equity Valuation Model
(Dividend Discount Model-DDM)
•Financial Statement Analysis

2. Macroeconomics Analysis
•Global Economy Analysis
–affects export, price competition and profits
–exchange rate: purchasing power and earnings
•Domestic Economy
–The ability to forecast the macroeconomy can translate
into great investment performance
–outperform other analysts to earn extra profits
Many variables can affect economy

3. –Gross Domestic Product (GDP):
measures the economy’s total output of goods and services
–Employment rate:
measures the extent that the economy is operating at full capacity
–Inflation
measures the general level of prices increase Phillip’s curve
–Interest Rate
high interest rate reduces PV of cashflows, thus stock values
–Budget Deficit
large deficit means more borrowing, which
implies higher interest rate.
–Sentiment
consumers and producers confidence

4. Business Cycles
•business cycles: pattern of recession and recovery
•peak: the end of expansion and start of recession
•trough: the bottom of the recession
•stock returns are decreasing when at peak and
increasing at trough
•cyclical industries: do well in expansionary periods but
poorly in recession, e.g., durable goods such as automobile
and wash machines
•defensive industries: little sensitive to business cycles,
such food

5. Industry Analysis
•Select a goodindustry to invest. It is difficult for
a firm to do well in a troubled industry
•Standard Industry Classification (SIC) code
•Value line Investment Survey -reports 1700 firms in
90 industries
•Two factors that determine the sensitivity of a
firm’s earnings to business conditions:
business risk,
financial risk

6. Business risk
•Sales sensitivity to business condition
some industries are robust (food) while others are
not (movie)
•operating leverage: thedivision between fixed and
variable costs.
–firms with greater amounts of variable cost relative to the
fixed cost are subject less to business fluctuations, thus
profits are more stable
Financial Risk
•the degree in using financial leverage (the amount
of interest payment)
•leverage firm is more sensitive to business cycles

7. Industry cycles
Start-up Build-up Maturity Decline
Start-up: increasing growth
Build-up/consolidation: stabilized growth
maturity: slower growth
Decline: shrinking growth

8. Equity Valuation Model
•Dividend Discount Model (DDM)
V
0= (D
1+P
1)/(1+k)
= D
1/(1+k) + D
2/(1+k)
2
...+ D
n/(1+k)
n
•constant growth assumption
V
0= D1/(1+k) + D
1(1+g)/(1+k)
2
+D
1(1+g)
2
/(1+k)
3
+ ...
= D1/(k-g)
or k = expected return
= D
1/P
0+ g

9. Multistage Growth Model
•Growth profile may not be constant such as:
Expected Growth
Time
g
1
g
2
n
V=D
0(1+g
1)/(1+k)+...+D
0(1+g
1)
n
/(1+k)
n
+ D
0(1+g
1)
n
(1+g
2)/(1+k)
n+1
+ ... and so on

10. Illustration of two-stage Growth
Model
•A stock pays $1 dividend now and its g
1=30% for
6 yrs. Thereafter, its g
2=6%, its k=15%
•yr 1: $1(1+0.3) =1.13
yr 2: 1(1+0.3)
2
=1.69
yr 3: 1(1+0.3)
3
=2.20
yr 4: 1(1+0.3)
4
=2.86
.
yr 7: 1(1+0.3)
6
(1+6%)=5.12
yr 8: 1(1+0.3)
6
(1+6%)
2
=5.42
.

11. Market Value (equity)
Market value is the present value of its future dividends
Time PV(Dt) Growth rate
0 34.0 -
1 37.8 11.17%
2 41.78 10.52
3 45.85 9.74
At time 1:
FV(Dividends) = 34.00(1.15) -1.3= 37.8
At time 2:
FV(dividends) = 37.80(1.15) -1.69=41.78
Expected return at time 0 (15%)
= Yr end dividend/current price + growth rate
= 1.3/34 + 11.17%

12. P/E Ratio Behaviors
•Price = No growth value/share
P
0= E
1/k + PVGO
or
•P
0/E
1= [1+ PVGO]/k
E
1/k
Time
P/E
average

13. Pitfalls in P/E Analysis
•Denomination of P/E ratio is the accounting
earnings (arbitrary rules or historical cost
will distort the earnings figures)
•Earning should be based on economic
earnings (i.e., net of economic deprecation)
•Earnings are future figures vs P/E ratio
(which uses past accounting earnings)

14. Earnings Forecast
•Models for forecasting:
E
i,t = g
i+ E
i,t-4 +a
i(E
i,t-1-E
i,
t-5)
where g: growth factor
a: adjustment factor
E: Earnings
•Time Series Analysis
ARMA model
Exponential smoothing
•professional institution forecast
•Performance Evaluation MSE or others

15. Financial Statement Analysis
•Preparation of Source/Use Fund Statement
•Ratio Analysis
–Performance Analysis
–Du Pont Analysis

16. Use/source of Fund Statement
•Sources Uses
C. Paper $ 5.8Cash $ 0.4
A/P 17.8A/R 16.2
Div/P 1.4Inv 34.8
S/T debt 4.6Prep. Ex 0.4
S/T Lease3.8Lease82.8
L/T Debt20.6Others3.6
L/T Lease25.0Tax1.0
C/S 3.2
P/I Cap 0.6
NI 54.4Div.46.6
Depreciation 48.6
Total 185.8 185.8

17. Analysis of Use/Source
•Sales growth=3.5%
•Uses-major component
A/R =8.72%; Inventory = 18.73%; Lease = 44.6%
Dividend = 25.1%
•Sources
A/P = 9.5%; L/T debt = 11.1%; L/T lease = 13.4%
Operation profits = 55.4%
(NI+depreciation)
•Why issue shares?
•S/T-/LT capital increases so much?

18. Ratio Analysis
•Assets SalesProfit
•Liquidity Ratio
•Risk Ratio
•Du Pond Analysis
ROE=Net Income(NI)/Equity (E)
= NI Pretax Prof EBIT Sale TA
P.Prof EBIT Sales TA E
TB IB GPM TAT EM
Pretax profit =EBIT -Interest
TB = Tax burden
IB = interest burden