intro to fundamental analysis
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Introduction to Fundamental AnalysisLauri08/11/2012
What is Fundamental Analysis?● Method of valuing securities such as stocks and
bonds● Attempts to find out their intrinsic (true) values● If undervalued → Long (Buy)● If overvalued → Short (Sell)
EXAMPLE 1 : Slot Machine● Jack buys a £1 500 Poker
Machine and takes £1 000 loan at 5% annual interest rate
● He places the machine to a local barber shop and promises to give 20% of the earnings to the shop owner
● The machine starts earning him £300/month
● How much is Jack's business worth? £500? £1000? £1 500?
Some Ratios
● P/E ratio (price-to-earnings ratio)- How long it takes that the investment pays itself back
- Market Price per Share* / Annual Earnings per Share (EPS)***EPS = Net Earnings / Number of Shares**Market Price = Market Capitalisation
● P/B ratio or PBV (price-to-book-value ratio)- How much tangible asset (+ goodwill) you get for the money you invest- Market Price per Share / Book Value per Share***
***Book Value = Value of Total Assets
More Terminology● (Shareholder's) Equity = Assets – Debt● Net Gearing (%) = Net Debt / Equity● EBITDA = Earnings before interest, taxes,
depreciation (e.g.repairs), and amortisation (e.g.patents,copyrights)
● EBIT = Earnings before interest and taxes● Net Income/Profit = Earnings after taxes● Dividend Yield (%)
= Dividend per Share / Market Price per Share● Dividend Payout Ratio(%) = Dividend per
Share / EPS
Some More Ratios● Profit Margin (%) = Net Profit / Net Sales● Return on Equity (ROE) (%)
- Annual increase in shareholder's equity
- ROE = Net Income (After Tax) / Equity- Double ROE → Double P/E
● Return on Assets (ROA) (%)- ROA = Net Income / Total Assets
● PEG Ratio (Price/Earnings-to-growth)- PEG = (P/E) / (Annual EPS Growth)- e.g.company growing 30% a year with P/E=30 → PEG=1
EXAMPLE 2 : More Slot Machines
● What if Jack invests all his earnings to new Poker Machines and places the machines in new barber shops?
● What if we take into account the risk that hooligans break his machine?
Top-Down Stock Selection● World View
- Recognising the trend using e.g. leading indicators (building permits, UMCSI)
● Industry View- Which sectors are going to thrive given the world view?
● Business View- Which stocks within the industry are most suitable based on their ratios and our world view
Rules of Thumb (by Peter Lynch)● Market Cap < £5 billion● PEG ratio < 1.2 (PEG=1 is fair
value)● Earnings Growth > 15%● Gearing (Debt Ratio) < 35%● Institutional ownership < 65%● Pays Dividend● Not a penny stock● Careful with cyclical stocks
(e.g. construction, automobile)
Questions?