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CHAPTER FOURTEEN

CHAPTER FOURTEEN. FINANCIAL ANALYSIS OF COMMON STOCKS. FINANCIAL ANALYSIS. WHAT IS FINANCIAL ANALYSIS? DEFINITION: the activity of providing inputs to the portfolio management process. FINANCIAL ANALYSIS. PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS

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CHAPTER FOURTEEN

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  1. CHAPTER FOURTEEN FINANCIAL ANALYSIS OF COMMON STOCKS

  2. FINANCIAL ANALYSIS • WHAT IS FINANCIAL ANALYSIS? • DEFINITION: the activity of providing inputs to the portfolio management process

  3. FINANCIAL ANALYSIS • PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS • THE ASSOCIATION OF INVESTMENT MANAGEMENT AND RESEARCH (AIMR) • acts as an advocate for the financial analyst profession • it hosts conferencing and workshops • designed to enhance the knowledge base of the memberships • it also publishes the Financial Analysts Journal

  4. FINANCIAL ANALYSIS • PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS • THE ASSOCIATION OF INVESTMENT MANAGEMENT AND RESEARCH (AIMR) • acts as an advocate for the financial analyst profession • it host conferencing and workshops • designed to enhance the knowledge base of the memberships • it also publishes the Financial Analysts Journal

  5. FINANCIAL ANALYSIS • REASONS FOR FINANCIAL ANALYSIS • TWO PRIMARY REASONS • to determine certain securities’ characteristics • to attempt to identify mispriced securities

  6. FINANCIAL ANALYSIS • REASON #1: DETERMNING SECURITY CHARACTERISTICS • estimate future sensitivity to major factors • estimate dividend yield

  7. FINANCIAL ANALYSIS • REASON #2: ATTEMPTING TO IDENTIFY MISPRICED SECURITIES • use fundamental analysis • approaches • valuation determines the intrinsic value compared to the current market value • estimate key financial variables such as • EPS next year • income growth next year

  8. TECHNICAL ANAYSIS • DEFINITION: a form of security analysis that attempts to forecast price changes based on historical price and volume trends

  9. TECHNICAL ANAYSIS • Two Groups of Strategies Used: 1. Momentum and Contrarian Strategies 2. Moving Average and Trading Range Breakout Strategies

  10. TECHNICAL ANAYSIS 1. Momentum and Contrarian Strategies • METHDOLOGY: • examine the returns over a time period just ended to identify • momentum investors who seek out stocks recently rising in price for purchase; falling for sale • contrarians who follow the opposite strategy of most investors • contrarians base their strategy on the overreation theory

  11. TECHNICAL ANAYSIS 2. Moving Average and Trading Range Breakout Strategies • MOVING AVERAGE STRATEGY: • calculate a moving average over the last 200 days of closing prices • divdied today’s closing price into the moving average (SHORT-TO-LONG RATIO) • if short-to-long ratio is greater than 1, buy • if ratio is less than 1, sell

  12. TECHNICAL ANAYSIS • 2. Moving Average and Trading Range Breakout Strategies • TRADING RANGE BREAKOUT STRATEGY: • high and low prices for past 200 trading days are identified • if today’s close is greater than the high = buy! • if today’s close is less than the low = sell!

  13. FUNDAMENTAL ANALYSIS • TOP-DOWN V. BOTTOM UP • TOP-DOWN APPROACH • attempts to forecast in the following order 1. economic activity 2. industry performance 3. firm’s performance

  14. FUNDAMENTAL ANALYSIS • TOP-DOWN V. BOTTOM UP • BOTTOM-UP APPROACH: • attempts to estimate prospects in the following order: 1. The firm 2. The Industry 3. The economy

  15. FUNDAMENTAL ANALYSIS • FINANCIAL STATMENT ANALYSIS • INTEGRAL PART OF FUNDAMENTAL ANALYSIS • it helps the analyst understand a firm’s current condition • where it is headed • what factors affect it • how the factors affect it

  16. FUNDAMENTAL ANALYSIS • FINANCIAL STATMENT ANALYSIS • Review of Accounting Statements • includes a study of the three major statements prepared monthly by most accountants: • the balance sheet • the income statement • the statment of cash flows

  17. FUNDAMENTAL ANALYSIS • FINANCIAL STATMENT ANALYSIS • RATIO ANALYSIS • DEFINITION: a technique used to examine a company’s financial statements • Use of Ratios • as an absolute standard • as a comparative indicator • as a trend over time • in combination with technical analysis

  18. FUNDAMENTAL ANALYSIS • FINANCIAL STATMENT ANALYSIS • RATIO ANALYSIS • Types of Ratios • internal liquidity • operating performance • risk analysis • growth analysis

  19. FUNDAMENTAL ANALYSIS • internal liquidity ratios: • indicate the ability of the firm to meet future short-term financial obligations • some liquidity ratios: • current ratio • quick ratio • cash ratio • receivables turnover

  20. FUNDAMENTAL ANALYSIS • operating performance ratios: • indicate how well the management is operating the business • some examples: • total asset turnover • net fixed asset turnover • equity turnover

  21. FUNDAMENTAL ANALYSIS • risk analysis ratios: • indicates the uncertainty of income flows for the total firm and for the individual sources of capital (debt and stock) • some examples: • debt to equity ratio • long-term debt/total capital ratio

  22. FUNDAMENTAL ANALYSIS • growth analysis ratios: • indicate how fast a firm should grow • it involves analysis using several other ratios • net profit margin • total asset turnover • total assets/equity

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