copyright ©2004 pearson education, inc. all rights reserved. chapter 14 stock analysis and...
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Copyright ©2004 Pearson Education, Inc. All rights reserved.
Chapter 14
Stock Analysis and Valuation
Copyright ©2004 Pearson Education, Inc. All rights reserved. 14-2
Chapter Objectives
• Describe how to interpret stock quotations
• Illustrate how to conduct an analysis of a firm
• Describe how to conduct an industry analysis of stocks
• Explain how to value stocks
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Stock Quotations
• Price quotations readily available from the Internet, stock brokers or financial newspapers
• Provide information about the price of each stock over the previous day or a recent period
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Financial Planning Online: Stock Information
• Go to: www.bloomberg.com
• This Web site provides stock quotations for the stocks that you specify. It also provides a summary of financial market conditions and links to information about investments.
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Analysis of the Firm
• Annual report– Balance sheet: a financial statement that
indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time
– Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time
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Analysis of the Firm
Exhibit 14.2: Balance Sheet for Stewart Corporation (numbers are in millions)
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Analysis of the Firm
Exhibit 14.3: Income Statement for Stewart Corporation (number are in millions)
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Analysis of the Firm
• Firm-specific characteristics– Analysis of a firm’s income statement
and balance sheet can reveal the following characteristics:
– Liquidity• Current ratio: the ratio of a firm’s short-term
assets to its short-term liabilities
• Show the firm’s ability to cover expenses
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Analysis of the Firm
– Financial leverage: a firm’s reliance on debt to support its operations
• Debt ratio: a measure of financial leverage that measures the proportion of total assets financed with debt
• Times interest earned ratio: a measure of financial leverage that measures the ratio of the firm’s earnings before interest and taxes to its total interest payments
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Analysis of the Firm
– Efficiency• Inventory turnover: a measure of efficiency;
computed as the cost of goods sold divided by average daily inventory
• Average collection period: a measure of efficiency; computed as accounts receivable divided by average daily sales
• Asset turnover ratio: a measure of efficiency; computed as sales divided by average total assets
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Analysis of the Firm
– Profitability• Operating profit margin: a firm’s operating profit
divided by sales
• Net profit margin: a measure of profitability that measures net profit as a percentage of sales
• Return on assets: a measure of profitability; computed as net profit divided by total assets
• Return on equity: a measure of profitability; computed as net profit divided by stockholder’s equity
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Analysis of the Firm
Exhibit 14.4:Ratios Used to Analyze Stewart Corporation
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Financial Planning Online:Determining Industry Norms
• Go to: http://biz.yahoo.com/research/indgrp
• This Web site provides information on various industry groups and allows you to obtain financial information on firms you specify in any industry.
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Analysis of the Firm
– Information provided by Value Line• Recent stock price
• PE ratio
• Dividend yield
• Rating of the firm
• Beta
• Financial statistics
• Trading volume
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Analysis of the Firm
Exhibit 14.5: An Example from Value Line Investment Survey
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Analysis of the Firm
• Go to: http://www.bloomberg.com/bbn/economies.html
• This Web site provides information about economic conditions that can affect the values of investments.
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Analysis of the Firm
• Focus on Ethics: Accounting fraud– Many firms recently used fraudulent financial
statements
– Motivation for fraud• Manager compensation
• Short-tem focus
– Revenue-inflating techniques• Recognizing revenue before it is earned
• Recognizing revenue from cancelled orders
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Analysis of the Firm
– The Enron and WorldCom scandals• Over-reported revenue and under-reported
expenses
• Many stockholders lost their entire investment
– Preventing future accounting fraud• Use independent auditor
• New rules from Security and Exchange Commission
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Economic Analysis of Stocks
• Involves assessing economic conditions that can affect a firm’s stock price
• Economic growth: a measure of growth in a country’s economy over a particular period– Gross domestic product (GDP):
the total market value of all products and services produced in a country
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Economic Analysis of Stocks
– Weak economic conditions• Lowers demand and stock prices
• Consumers spend less, further lowering demand
– Fiscal policy effects• Fiscal policy: the means by which the U.S.
government imposes taxes on individuals and corporations and by which it spends its money
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Economic Analysis of Stocks
• Interest rates– Stocks perform better when interest rates
are low
– Some stocks are more sensitive to interest rates than others
– The Federal Reserve uses monetary policy
to influence interest rates
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Economic Analysis of Stocks
• Inflation: the increase in the general level of prices of products and services over a specified period– Consumer price index (CPI): a measure of
inflation that represents prices of various consumer products
– Producer price index (PPI): a measure of inflation that represents prices of products used to produce other products
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Economic Analysis of Stocks
Exhibit 14.6: Sources of Economic Information
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Industry Analysis of Stocks
• Stock prices susceptible to industry conditions– Increased demand generally leads to
higher stock prices
– Changes in competition also affect demand, earnings, and stock prices
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Industry Analysis of Stocks
• Industry indicators– Various publications and online sources for
information on specific industries
– Industry stock index measures how the market value of firms within an industry has changed over time
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Industry Analysis of Stocks
Exhibit 14.7: Sources of Economic Information
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Stock Valuation
• Estimate the market value of a stock before purchasing
• Price of stock based on the demand for the stock versus its supply
• Technical analysis: the valuation of stocks based on historical price patterns
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Stock Valuation
• Fundamental analysis: the valuation of stocks based on an examination of fundamental characteristics such as revenue or earnings, or the sensitivity of the firm’s performance to economic conditions
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Stock Valuation
• Price-earnings (PE) method: a method of valuing stocks in which a specific firm’s earnings per share are multiplied by the mean industry price-earnings (PE) ratio
Price-Earnings (PE) Ratio = P/E
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Stock Valuation
– You can use the PE ratios of stocks to value a firm as follows:
• Look up the PE ratios of stocks in the firm’s industry.
• Multiply the average industry PE ratio times the firm’s earnings per share.
• Compare your estimated value of the firm’s stock to its market value to determine whether the stock is undervalued or overvalued.
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Stock Valuation
– Deriving an estimate of earnings• May use last year’s earnings or estimate
expected earnings
• Value Line and other investment services provide such forecasts
– Limitations of the PE method• Forecasting earnings is difficult
• Some firms are involved in multiple industries
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Financial Planning Online: Earnings Estimates for Valuing Your Stock
• Go to: http://biz.yahoo.com/research/earncal/today.html
• This Web site provides recent earning per share estimates of a firm that you specify, which you can use when applying the PE method of valuation.
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Stock Valuation
• Price-Revenue (PR) method: a method of valuing stocks in which the revenue per share of a specific firm is multiplied by the mean industry ratio of share price to revenue
– Limitations of the PR method
• Difficulty in deciding which firms to use for comparison
• Revenues don’t indicate how well a firm is managed
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Integrating Your Analyses
• Analyzing the firm, the economy and the industry allows assessment of future performance
• Economic, industry, and firm-specific conditions impact a firm’s stock price
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Analysis of the Firm
Exhibit 14.8:Factors That Increase and Decrease the Stock’s Price
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Financial Planning Online: Screening Stocks for Investment Decisions
• Go to: http://screen.yahoo.com/stocks.html
• This Web site provides a list of stocks that meet criteria that you specify for performance over the last year, such as PE ratio and other characteristics.
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Stock Market Efficiency
• Efficient stock market: a market in which stock prices fully reflect information that is available to investors– Indicates that investors should be able to
accurately identify undervalued stocks
• Inefficient stock market: a market in which stock prices do not reflect all information that is available to investors
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How Stock Valuation Fits within Your Financial Plan
• Key decisions about stock for your financial plan are:– Should you consider buying stock?
– How should you value stocks when determining whether to buy them?
– What methods should you use for investing in stocks?
Integrating Key Concepts
• Part 1: Financial Planning Tools
• Part 2: Liquidity Management
• Part 3: Financing
• Part 4: Protecting Your Assets and Income
• Part 5: Investing– In Chapter 13 we learned about investment fundamentals
– In Chapter 14 we learned about stock analysis and valuation
– In Chapter 15 we will cover investing in stocks
– In Chapter 16 we will learn about investing in bonds
– In Chapter 17 we will learn about investing in mutual funds
– In Chapter 18 we will cover asset allocation
• Part 6: Retirement and Estate Planning