fins1612 w5 lecture

8/18/2019 FINS1612 W5 Lecture

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Taxation

• Pre-dividend imputation (prior to 1987)

–

Dividends were taxed twice—first at company level (as profits) and thenat the investors mar!inal rate

• Dividend imputation (since 1987)

– "emoved the dou#le taxation of dividends

–

$nvestors receive fran%in! credit for the tax a company pays on afran%ed dividend


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• &apital !ains tax on shares purchased

– Prior to 19'9'198 tax free

– 19'9'198*1'9'1999• +axpayers mar!inal tax rate applied if held less than 1* months

• +axpayers mar!inal tax rate applied to indexed capital !ain if held

over 1* months

– ,ince *1'9'1999

• . discounted !ain if held at least 1* months/ or

• indexed capital !ain or . discounted !ain if purchased

19'9'198*1'9'1999

Taxation


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Financial performance indicators

• Potential investors are concerned with the future level of a companys

performance

• &ompanys performance affects #oth the profita#ility of the company and the

varia#ility of the cash flows

• $ndicators of company performance

– &apital structure

– 0iuidity

– De#t servicin!

– Profita#ility

– ,hare price

– "is%


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Capital structure

• Proportion of company assets (fundin!) o#tained throu!h de#t and euity

– 2sually measured #y de#t to euity ratio (D'3)

• 4i!her de#t levels increase financial ris%/ i5e5 firm may not #e a#le to

meet interest payments

– 6lso measured #y proprietorship ratio which is the ratio of shareholders

funds to total assets

•

$ndicates firms lon!er term financial via#ility'sta#ility/ a hi!her ratioindicates less reliance on external fundin!



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Liquidity

• +he a#ility of a company to meet its short-term financial o#li!ations

• easured #y current ratio

– ails to consider the not very liuid nature of certain current assets

such as inventory


year)onewithin(due slia#ilitiecurrent year)onewithin(maturin! assetscurrent

ratio&urrent

=


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Liquidity (cont.)• easured #y liuid ratio

• +he hi!her the current and liuid ratios the #etter the liuidity position of a

firm


overdraft#an%-slia#ilitiecurrenthand)on(stoc%inventory-assetscurrent ratio0i1uid =


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Debt servicing

• 6#ility to meet de#t-related o#li!ations i5e5 interest and repayment of de#t

• easured #y de#t to !ross cash flow ratio

–$ndicates num#er of years of cash flow reuired to repay total firm de#t

• easured #y interest covera!e ratio


interestandchar!esleasefinance

taxandinterestchar!es7leasefinance#eforeearnin!s cover $nterest =


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Profitability

• :ide variation in the measurement of profita#ility

– 3arnin!s #efore interest and tax (3;$+) to total funds ratio

– 3arnin!s per share (3P,)


)#orrowin!sandfundsers


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Profitability (cont.)

• :ide variation in the measurement of profita#ility (cont5)

– 3;$+ to lon!-term funds ratio


de#t)term-shortlessfundstotal(i5e5fundsterm-lon!

3;$+

ratiofundsterm-lon!to3;$+ =


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Profitability (cont.)

• :ide variation in the measurement of profita#ility (cont5)

– "eturn on euity (net income'euity)

– 4i!her ratios indicate !reater profita#ility


funds)ers


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!are price• "epresents investors view of the present value of future net cash flows of a

firm

• ,hare price performance indicators

– Price to earnin!s ratio (P'3)

• ,hare price divided #y earnin!s per share

• 6 hi!her P'3 indicates more !rowth in future net cash flows

– ,hare price to net tan!i#le assets ratio (P'=+6)• easures the theoretical premium or discount at which a firms

share price is tradin! relative to its =+6



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• 3valuate and apply #ottom-up and top-down approaches to fundamental

analysis

• Descri#e and apply technical analysis techniues

• 3xamine the role of pro!ram tradin!

• 3xplain the theoretical concepts and implications of the random wal% and

efficient mar%et hypotheses when forecastin! share price movements

Learning ob"ectives


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!are price

1>

? ,hare price is determined #y supply and demand of a companys

shares

? 3xpectation of #ad company performance causes investors to sell

their shares increasin! supply and reducin! the price

? 3xpectation of !ood company performance increases demand and

leads to an increase in share price

:hat causes the shifts in demand and

supply of a companys securities on thesecondary mar%et@


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• +hree approaches to answerin! this uestion

–

15 undamental analysisA top-down

– *5 undamental analysisA #ottom-up

– >5 +echnical analysis

!are price


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Fundamental analysis

1

? &onsiders macro and micro factors that impact upon cash flows andfuture share prices of various industry sectors and firms

? acro factors include interest rates economic !rowth #usiness

investment

? icro factors are firm-specific and relate to mana!ementsimpact on company performance


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Top#do$n approac!

1B

? &onsiders macro factors

? 3conomic !rowth of international economies

? 3xchan!e rates

? $nterest rates

? Domestic economy

? Crowth rate

? ;alance of payments

? $nflation

? :a!e and productivity !rowth

? Covernment responses to chan!es in the a#ove factors


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%conomic gro$t!

17

?+he hi!her the !rowth rate in the rest of the world the !reater thedemand for 6ustralian exports

? ,ectors #enefittin! from international !rowth determined #y source of

the !rowth

? Crowth can #e driven #yA

? increased consumer demand

? increased #usiness investment in euipment


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Flip side of gro$t!

18

? Cenerally !reater domestic !rowth leads to increased profita#ility of

firms

? ;ut hi!h !rowth can lead to any of the followin! factors that can

reduce firm profita#ilityA

? Deterioration in #alance of payments

? $ncrease in inflationary pressures

? Pressure on wa!es

? Depreciation of the exchan!e rate

? "ise in interest rates


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Currency

19

? 6ffect the domestic currency profit of exporters that uote their

products in forei!n currency prices? 6 stren!thenin! 6ustralian dollar (62D) ma%es these firms worse

off #ecause the 62D value of their exports is lower

? +he stren!th of the 62D over the past few years has led to calls

for assistance from the manufacturin! industry for example

? 3xchan!e rates also affect firms indirectly

? 35!5 devaluation of currency increases cost of imports there#y

increasin! inflation


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&nterest rates

*

? 4ave #oth a direct and indirect impact on a firms value

? Direct effect on profita#ility

? "epresents the cost of de#t finance for #orrowers and the

return for finance providers

? $ndirect effect on profita#ility

? "ise in interest rates may indicate a slowin! of economicactivity

? uture reduction in profita#ility

? 6 stron! relationship exists #etween interest rates and exchan!e

rates


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&nflation

**

? 3ffect of inflation on firms real profit

? +ax treatment of inflation

? a%es historical-#ased depreciation allowances inappropriate

? &om#ined with hi!her replacement costs leads to an

overstatement of after-tax profit

? $nventory

? $nflated sellin! price of inventory creates an illusion of inventory

profits


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'ottom#up approac!

*>

? ollowin! identification of the #est economies and industry sectors for

investment usin! the top-down approach the #ottom-up approach

can #e used to identify the #est companies within these

? ;ottom-up approach considers micro factors usin! ratios and other

measures of a firms financial characteristics and performance

? &onsiders factors such asA

? 6ccountin! ratios that assess a companys capital structure

liuidity de#t servicin! profita#ility share price and ris% (see

&hapter B) o#servin! the trend and ma%in! comparisons with

firms in the same industry

? 6dditional information on %ey mana!ement chan!es corporate

!overnance and strate!ic direction


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Comparing companies

*E


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Tec!nical analysis

*

? 3xplains and forecasts share price movements #ased on past price

#ehaviour

? 6ssumes mar%ets are dominated at certain times #y mass

psycholo!y from which re!ular patterns emer!e

? +wo main forecastin! models

? ovin! avera!es (6)

? &hartin!


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oving averages

*B

? ,mooth out a series facilitatin! the identification of trends in the series

? &alculation of 6? 6ssumin! a five-day movin! avera!e the 6 is calculated #y

ta%in! the avera!e of the price series for the precedin! five days

? +radin! rules

? ;uy when the price series cuts the 6 from #elow

? ;uy when the 6 series is risin! stron!ly and the price series cuts

or touches the 6 from a#ove for only a few o#servations

? ,ell when the 6 flattens or declines and the price series cuts the6 from a#ove

? ,ell when the 6 is in decline and the price series cuts or touches

the 6 from #elow for only a few o#servations


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C!arting

*7

? $nvesti!atin! patterns in price charts

? ,everal techniues

? +rend lines

? ,upport and resistance lines

? &ontinuation patterns

? "eversal patterns


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Trend lines

*8

+rends are re!ular movements in share prices

+wo types of trends

15 2ptrend line—connectin! the lower points of risin! price series

*5 Downtrend line—connectin! the hi!her points of fallin! price

series

"eturn line—line drawn parallel to a trend line to create a trend

channel

&ritical issue is to determine when the trend line is !oin!

to chan!e


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upport and resistance lines

*9

? ,upport levels—where there is sufficient demand to halt further pricefalls

? "esistance levels—where there is sufficient supply to halt further

price increases

? ,tron! levels—historical support and resistance

? :ea% levels—support and resistance #ased on more recent activity


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Continuation patterns

>

,ideways share tradin! that does not normally si!nal a chan!e in trend

+wo types

15 +rian!les—composed of a series of price fluctuations each

smaller than its predecessor

,ymmetrical trian!le (no chan!e in trend)/ ascendin! trian!le(uptrend)/ descendin! trian!le (downtrend)

*5 Pennants and fla!s—formed durin! a sharp rise in prices (the

pole)/ then tradin! volume reduces and increases suddenly to

ta%e prices sharply hi!her


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eversal patterns

>1

Fccur after a maGor mar%et move

"esult in a head and shoulders pattern

+hree successive rallies and reactions the second rally #ein!

stron!er than the first and third rallies

i5 0eft shoulder—formed #y volume-stron! rally on uptrend

followed #y reduced-volume reaction

ii5 4ead—second rally increases price #efore reaction moves

price #ac% to previous low

iii5 "i!ht shoulder—final rally mar%ed #y reduced volume

indicatin! price wea%ness


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*alidity of tec!nical analysis

>*

? 3ven where techniues have no apparent underlyin! validity if theyare followed #y enou!h participants they may impact on share price

#ehaviour at times

? ore li%ely to forecast successfully when share prices move out of a

ran!e explained #y economic and financial fundamentals

fins1612 w5 lecture

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