the economy and securities analysis - business finance

7/29/2019 The Economy and Securities Analysis - Business Finance

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Laws of Demand and Supply Fundamental to an understanding ofeconomics are the basic concepts of

demand and supply.Law of Demand The law of demand states

that there is an inverse relationship between

the price of a good and the amount buyers

are willing to purchase of such a good.

Law of Supply The law of supply states that

there is a direct relationship between the

price of a good and the amount offered forsale.


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Economic Factors The decision toinvest in the securities of a particularcompany is based internal factors and

external factors. Internal Factors are those within the

control of the company.

External Factors are factors thatgenerally considered beyond thecontrol of a company.


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GNP and GDP there are several indicatorsthat are used to measure the economicactivity in a country. Two of the more

popular ones are GNP and GDP. Gross National Product (GNP) represents

the total value of goods and services

produced by Philippine nationals in a givenyear, regardless of whether such goodsand services are produced within oroutside the Philippines.


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Gross Domestic Product (GDP) representsthe output of goods and services producedwithin the geographic borders of the

Philippines in any given year, regardless ofwhether such goods and services areproduced by Filipinos or foreign nationals.

Nominal values are expressed in currentpesos while real values are values thathave been adjusted for the effects ofinflation.


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Philippine Consumer Price Index (PCPI) The PCPI is an indicator of the general levelof prices by measuring changes in the

prices of a fixed basket of selectedconsumer goods and services, using somespecified year as the base year.

Inflation is an economic conditioncharacterized by a continuing rise in thegeneral level of prices of goods andservices.


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Deflation is the opposite of inflationand is therefore a period of decliningprices of goods and services.

From another viewpoint, inflationreduces the purchasing power ofmoney while deflation increases the

relative value of money.


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Money Supply This is the amount ofmoney that exists in the economy atany given time. It consists of:

M1 Also referred to as narrow moneyand includes currency in circulation and

demand deposits.

M2 Also called broad money and

consists of M1 plus time deposits andsavings account in the banking system.


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M3 The broadest measure of moneysupply and consists of M1 and M2 plus the

assets and liabilities of financial institutions.

Also called Domestic Liquidity.

M4 Also called liquidity money. Theseinclude M3 plus transferable

deposits, treasury bills and deposits held in

foreign currency deposits. Almost all short-term, highly liquid assets will be included

in this measure.


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The government has three majormeans of controlling money supply:

Establishing reserve requirements for

banks and other depository institutions.Buying and selling government securities

in the open market.

Setting the interest rate of which the

Bangko Sentral ng Pilipinas (BSP) will loanfunds to banks and other depository

institutions.


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Increasing money supply is called anexpansionary monetary policy and is

achieved by reducing reserve

requirements, buying government

securities in the open market, andlowering discount rates to banks.

In contrast, decreasing money supply is

called restrictive money supply and isaccomplished by increasing bank reserve

requirements, selling government

securities in the open market, and raising

the discount rate to banks.


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Interest Rates In the broadest sense,interest is the price of money and is theresult of a choice between spending

the money today or postponingspending until the later date.

The Bangko Sentral ng Pilipinas (BSP) is

the premier financial institution of thegovernment.


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The Bureau of Treasury (BTr) also playsan important role in the determinationof interest rates as they decide what

bids to accept or reject duringauctions of T-Bills and T-Notes.

The weighted average interest rates

(WAIR) for the different tenors are thenused by banks, financing companies,issuers of debt securities and otherfinancial institutions as benchmarks for

their lending and borrowing rates.


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The Business Cycle Over time, theeconomy goes through alternatingperiods of prosperity and depression

called the business cycle. The business cycle has four (4) phases:

expansion, peak, recession, and

trough.


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Peak

Recession

Trough

Expansion


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In the expansion phase, there is an upturnin business activity where industrialproduction, investments, property values,

consumer demand and GNP are increasingwhile underemployment is decreasing.

As the cycle moves into the peak, the

economy starts to overheat. Eventually,there is overproduction and build-up ofexcessive amounts of inventory beyondpresent levels of demand.


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Following the peak is a period ofcontraction or recession. Productionstarts to go down together with interest

rates, prices, and investments. Underemployment begins to rise when

recession bottoms out and production

levels go off. At this point, there isnowhere to go but up.


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Financial Statements are the mainsource of financial information formajor investment decisions.

There are four corporate financialstatements that are most importantand available to the investing public:the Statement of Financial Position,

Income Statement, AccumulatedRetained Earnings Statement, and theStatement of Cash Flows.


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The Statement of Financial Position,which is recently called Balance Sheet,represents the financial condition of a

corporation as of a particular date. Itshows what the corporation owns,what is owes, and what its net worth is.

The balance sheet formula is:

Assets = Liabilities + Stockholders Equity


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ASSETS

Current Assets:

Cash

Marketable SecuritiesAccounts Receivable

Inventories

Supplies

Total

Non-Current Assets:

Land/Buildings

Machinery/Equipment

Total

TOTAL ASSETS

LIABILITIES & STOCKHOLDERS EQUITY

Current Liabilities:

Accounts Payable

Notes PayableAccrued Expenses/Taxes

Total

Long-Term Liabilities:

Mortgage Bonds

Bank Loans

Total

Stockholders Equity:

Capital Stock

Capital Surplus

Retained Earnings

Total

TOTAL LIABILITIES & STOCKHOLDERS EQUITY

BETANIA INCORPORATED

Statement of Financial PositionDecember 31, 2011

P 500,000

2,500,0002,450,000

7,420,000

130,000

25,000,000

12,000,000

P 13,000,000

37,000,000P 50,000,000

P 1,540,000

1,360,000210,000

5,000,000

3,000,000

30,000,0003,000,000

5,890,000

P 3,110,000

8,000,000

38,890,000

P 50,000,000


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ASSETS

Current Assets:

Cash

Marketable Securities

Accounts Receivable

Inventories

Supplies

Total

Non-Current Assets:

Land/Buildings

Machinery/Equipment

TotalTOTAL ASSETS

P 500,000

2,500,000

2,450,000

7,420,000

130,000

25,000,000

12,000,000

P 13,000,000

37,000,000

P 50,000,000


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LIABILITIES & STOCKHOLDERS EQUITY

Current Liabilities:

Accounts Payable

Notes Payable

Accrued Expenses/Taxes

Total

Long-Term Liabilities:

Mortgage Bonds

Bank Loans

Total

Stockholders Equity:

Capital StockCapital Surplus

Retained Earnings

Total

TOTAL LIABILITIES & STOCKHOLDERS EQUITY

P 1,540,000

1,360,000

210,000

5,000,000

3,000,000

30,000,000

3,000,000

5,890,000

P 3,110,000

8,000,000

38,890,000

P 50,000,000


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The Income Statement is also referredto as Profit and Loss Statement andStatement of Operations.

It summarizes the results of thecorporations operation for a givenperiod of time (usually a year).


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Income StatementFor the Year Ended December 31, 2011

Net Sales

Less: Cost of Good Sold

Gross ProfitLess: Selling & Administrative Expenses

Operating Income

Add: Other Income

Earnings Before Interest and Taxes (EBIT)

Less: Interest Expense

Earnings Before Taxes (EBT)Less: Taxes

NET INCOME

P 12,500,000

5,200,000

P 7,300,0003,350,000

3,950,000

40,000

3,990,000

880,000

3,110,0001,026,300

P 2,083,700


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This is a statement which shows howthe firm used it profits; whether theywere retained in the company or paid-

out to stockholders as dividends.


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Accumulated Retained Earnings StatementFor the Year Ended December 31, 2011

Retained Earnings, Beginning

Add: Net Income

Less: Cash Dividends

Retained Earnings, End

P 5,306,300

2,083,700

1,500,000P 5,890,000( )


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This statement is a summary of cashprovided by and used in operating,investing, and financing activities of

the corporation and the aggregateeffect of these activities on the cashbalance.


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Statement of Cash Flows

For the Year Ended December 31, 2011

Cash Flows from Operating Activities:

Net IncomeAdd: Depreciation Expense

Increase/Decrease in Operating Assets:

Marketable Securities

Accounts Receivable

Inventories

Supplies

Increase/Decrease in Operating Liabilities:

Accounts Payable

Notes Payable

Accrued Expenses/Taxes

Net Cash Provided by Operating Activities

Cash Flows from Financing Activities:

Decrease in Dividends Payable

Increase in Loans Payable

Net Cash Used in Financing Activities

Net Increase in Cash

Cash Balance, January 1Cash Balance, December 31

( )

( )

( )

( )

P 570,000

400,000

3,250,000

3,700

360,000

240,000

30,000

1,500,000

500,000

P 2,083,7001,250,000

2,283,700

150,000

1,200,000

1,000,000

200,000

300,000P 500,000

( )

( )


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This analysis involves the use of traditionaleconomic and business concepts in theexamination of economic and company

variables that leads to an estimation of thevalue of an investment.

The examination of these variables is called

the valuation process of which there aretwo approaches: the top-down approachand the bottom-up approach.


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Top-down approach begins with anassessment of the economy and thefinancial markets. This followed by an

analysis of different industries and howthey are affected (favorably oradversely) by prevailing economic

and market conditions.


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Bottom-up approach is moreconcerned with the analysis, selection,and pricing of securities. This entails a

detailed examination of companiesand an appraisal of the value of theirsecurities (whether they are

underpriced, overpriced or fairlypriced).


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One of the most important tools thatfundamental analysis use in theassessment of corporate performance

is called financial ratio analysis, whichis the study of meaningful relationshipsbetween various accounts appearing

in the financial statements of acompany.


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There are four broad categories ofratios used in financial ratio analysis:profitability (earnings), activity

(efficiency), liquidity (short-termsolvency), and leverage (level andcoverage of long-term debt).


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Profitability (Earnings) Ratios Theseratios reflect the results of thecompanys profit seeking activities.

Gross Profit Margin (GPM) The GPMindicates the basic cost structure of the

company. An analysis over time of a

companys GPM compared to industry

standards will reveal its relative cost-pricestructure.

Operating Profit Margin (OPM) This ratio

compares operating profits to net sales.


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Net Profit Margin (NPM)This ratio uses thesame concept as the OPM, but considers

other income, interest expenses and tax

payments.

Return on Common Equity (RCE)The RCE

measures the return on investment by

common stockholders. When the RCE is

consistently higher than the cost ofcapital, it is considered a good

investment.


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Earnings Per Share (EPS) a favoriteamong fundamental analysis because

the EPS, when correlated with the market

price of shares, gives an indicator of

whether such shares are fairly priced or

not.

Price/Earnings Ratio (PE)also referred to

as the corporations earnings multiple. Ahigh P/E indicates that investors are

paying a high market price for todays

earnings.


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Dividend Payout Ratio (DP)measures thepercentage of net income paid to

common stockholders as cash dividends.

Dividend Yield The dividend yield for

common stock expresses the rate of

return that the dividend represents on the

stocks current market price.


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Activity (Efficiency) Ratios Theseratios are a gauge of the companysability to effectively manage its assets.

Inventory Turnover This ratio is thenumber of times per year a corporation

turns over its inventory. It is a measure of

the companys ability to market its

product and manage its inventory.

Days in Inventory The approximate

number of days it takes to convert

inventory into sales.


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Receivables Turnover a measure of acompanys efficiency in collecting

receivables and in managing credit. A

low receivables turnover means that the

company is not efficient in collecting fromits customers and this can put a lot of

strain on the companys cash position.

Average Collection Period Theapproximate number of days it takes to

collect receivables.


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Liquidity Ratios These ratios measurea corporations solvency or its ability tomeet short-term obligations.

Net Working Capital the differencebetween the current assets and current

liabilities. It gives an indication of how

much liquid assets would be available for

operations if the company were to payoff all its short-term obligations.

Current Ratio this ratio indicates the

corporations ability to pay its current

liabilities using its current assets.


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Quick Ratio a more stringent measure ofsolvency and includes only the

companys more liquid assets. Inventories

are excluded from the computation

because it takes some time to convertthem into sales and eventually into cash.

This is also called Acid Test Ratio.

Cash Ratio the most severe test of thecorporations short-term debt paying

ability and includes only Cash and

Marketable Securities to cover current

liabilities.


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Coverage Ratios These ratiosmeasure a companys financialleverage (level of debt) and risk. They

also measure the protection to thecompanys long-term creditors andinvestors.

Debt-to-Equity Ratio (DE) a boardpicture of a companys capital structure

and basically presents the relationship of

what is owed and what is owned.


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Times Interest Earned - Also called InterestCoverage Ratio and is a measure of

protection to creditors. An interest cover

of 1x means that the company has just

enough earnings to make interestpayments on loans and bonds.

Book Value Per Share (BV) approximate

residual value per share that is availablefor distribution to common stockholders if

the corporation is to be liquidated.


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involves theexaminationof pastmarketdata,suchas

pricesandthevolumetrading,whichleads

toanestimateoffutureprice.Itisbasedon the belief that the values of securities

are primarily the result of supply and

demand forces in the market, and not ofearningsand/ordividends.


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They also believe that supply anddemand are affected by numerousfactors, rational and irrational. This

means that prices are influenced notonly by fundamental variables but alsoby psychology and sentiment ofbuyers and sellers.

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