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Transcript
Capital Markets

To help to finance Companies
1.
2.

Annual Working Capital increases
Annual Capital Expenditures “CAPEX”
= $ 150 Billion
= $ 900 Billion
= $ 1,050 Billion
Source of funds:
1.
Annual Earnings
GAP
2.
Need to Issued New Debt
Or Issue new Shares of Equity
= ($ 800 Billion)
$ 250 Billion
($ 250 Billion)
= $0
1
Assets & Investing

The Assets
Fixed Income


Bonds
Real Estate

Equity


Shares
Units

Derivatives


Options
Futures
•
•
•
The Process
Asset Allocation
Equity/Fixed
60/40
80/20
120/20 ?


Security Selection
Security Analysis

Risk Return Trade-off
2
Projected 10 year cumulative real return
stock return 8%; bond return 4.5%
inflation 3%
80% stock / 20% bond
52%
70% stock / 30% bond
47%
60% stock / 40% bond
42%
50% stock / 50% bond
38%
40% stock / 60% bond
33%
30% stock / 70% bond
29%
20% stock / 80% bond
24%
Stock are riskier than Bonds.
Rule of Thumb for Individuals – 100 minus
your age for Bond allocation
3
Risk and
Prices
andexpected
Coupon Return
Rates
Return
Risk
4
Financial Instruments


Money Market
 Certificates of Deposit
 U.S. Treasury Bills
 Money Market Funds

Bond Market

 U.S Treasury Notes and
Bonds
 U.K. Gilts and Consols
 Municipal Bonds
 Corporate Bonds
Equity Market
 Common Stock
 Preferred Stock
Derivative Market
 Options
 Futures

Other
 Swaps
 Pass-throughs
5
Intermediation and Innovation

Banks
 Commercial Banks
 Investment Banks


Securitization
 GNMA
 CMOs, CDOs
Funds






Mutual
Hedge
Pension
Private Equity
Foreign Exchange
Commodity

Bundling (Un)
 STRIPS

Engineering
 Custom-tailored Risk/Return
 Synthetics – derivative
hedges – mimic something
6
Fixed Securities & Rates

Fixed







CDs – bank time-deposits
Paper – unsecured, trade-able company debt
Acceptances – bank promises
Eurodollars - $ denominated foreign bonds
Repos, Reverse Repos – of treasury debt
Treasuries – bills, notes, bonds
Rates




Prime
Fed Funds
LIBOR
TED Spread : the 3-month Treasury less LIBOR
7
TED Spread
Denominated in basis points (bps). Historically 10 to 50
bps – average 30 bps
A rising TED spread indicates shrinking liquidity –an
indicator of perceived credit risk:
T-bills are considered risk-free
LIBOR reflects the credit risk of lending banks.
Widening TED spread is a sign that lenders believe
default risk on interbank (counterparty) loans is
increasing.]
2007 average
September 2008
10/10/2008
150 – 200 bps
> 300 bps
465 bps
8
a
Pick the Federal Reserve Bank
Chairmen?
c
b
Click Glenn Hubbard
for the parody
d
e
9
10
What’s the problem with the Fed balance
sheet?
Not it’s size. But the quality of the assets.
The largest piece of the pie is pass-thru-securities
(pass thrus from sub-prime mortgages) CDO’s.
No one knows the real value of this balance sheet.
Did the Fed break the law? (Federal Reserve Act
of 1913) by taking less than Federal government
backed securities?
11
Inflation?
Deflation?
The problem is losing dollar strength.
Most people get this wrong. The effects are
similar: prices go up, but the cause is
subtly different. The weakening dollar due
to the extreme moves by the Fed
undermine Americans buying power.
12
The Appeal of Common Stocks
 Residual Owners: stockholders of a firm are the
owners, who are entitled to dividend income and a
prorated share of the firm’s earnings only after all the
firm’s other obligations have been met
 Stocks allow investors to tailor investments to meet
individual needs and preferences.
 Stocks may provide a steady stream of current income
through dividends.
 Stocks may increase in value over time through
capital gains.
13
From Stock Prices to Stock Returns
 Stock Returns: take into account both price changes and
dividend income
 Over past 50 years, stock returns have ranged from +48.28%
in 1954 to -21.45% in 1974
 Stock returns over past 50 years have averaged around 11%
 From 1998 through mid-’03, DJIA averaged 1.7%
14
15
DJIA annual Returns since 2003
2003
8341.63
10453.92
2112.29
25.32%
2004
10453.92
10783.01
329.09
3.15%
2005
10783.01
10717.50
-65.51
-0.61%
2006
10717.50
12463.15
1745.65
16.29%
2007
12463.15
13264.82
801.67
6.43%
2008
13264.82
8776.39
-4488.43
-33.84%
2009
8776.39
10428.05
1651.66
18.82%
2010
10428.05
11577.51
1149.46
11.02%
2011
11577.51
12217.56
640.05
5.53%
2012
12217.56
13104.14
886.58
7.26%
Average
5.95%
Standard Deviation 16.02%
16
Advantages of Stock Ownership

Higher returns than bonds.

Over past 50 years, stocks averaged 11% and high-grade
corporate bonds averaged 6%.

Inflation hedge – stock returns typically exceed the rate of
inflation.

Easy to buy and sell stocks.

Price and market information is easy to find in financial media.

Unit cost per share of stock is lower than for bonds.
17
Disadvantages of Stock Ownership
 Stocks are subject to many different kinds of risk:




Business risk
Financial risk
Market risk
Event risk
 Difficult to predict which stocks will go up in value due
to wide swings in profits and general stock market
performance
 Low current income compared to other
investment alternatives
18
Current Income from Stocks versus Bonds
19
Common Stock Values
 Par Value: the stated, or face, value of a stock
 Mainly an accounting term and not very useful
to investors
 Book Value: the amount of stockholders’ equity
 The difference between the company’s assets minus the
company’s liabilities and preferred stock
 Market Value: the current price of the stock in the
stock market
20
Common Stock Values
 Market Capitalization: the overall current value of the
company in the stock market
 Total number of shares outstanding multiplied by the market
value per share
 Investment Value: the amount that investors believe
the stock should be trading for, or what they think it’s
worth
 Probably the most important measure for a stockholder
21
Dividends

Dividend income is one of the two basic sources of return to
investors.

Dividend income is more predictable than capital gains, so
preferred by investors seeking lower risk.

Dividends are taxed at maximum 15% tax rate, same as capital
gains.

Dividends tend to increase over time as companies’ earnings
grow; increases average 3-5% per year.

Dividends represent the return of part of the profit of the
company to the owners, the stockholders.
22
Key Dates for Dividends
23
Dividends and Earnings Per Share
 Earnings Per Share: the amount of annual earnings
available to common stockholders, stated on a per-share
basis
 Earnings are important to stock price
 Earnings help determine dividend payouts
EPS 
Net profit
 Preferred dividends
after taxes
Number of shares of
common stock outstanding
24
Dividends and Dividend Yield
 Dividend Yield: a measure to relate dividends to share
price on a percentage basis
 Indicates the rate of current income earned on the
investment dollar
 Convenient method to compare income return to other
investment alternatives
Annual dividends received per share
Dividend yield 
Current market price of the stock
25
Dividends and Dividend Payout Ratio
 Dividend Payout Ratio: the portion of earnings per share
(EPS) that a firm pays out as dividends
 Companies are not required to pay dividends
 Some companies have high EPS, but reinvest all money
back into company
Dividends per share
Dividend payout ratio 
Earnings per share
26
Types of Stock
 Blue Chip Stocks: financially strong, high-quality
stocks with long and stable records of earnings and
dividends
 Companies are leaders in their industries
 Relatively lower risk due to financial stability
of company
 Popular with investing public looking for steady growth
potential, perhaps dividend income
 Provide shelter during unsettled markets
 Examples: Wal-Mart, Proctor & Gamble, Microsoft, United
Parcel Service, Pfizer and 3M Company
27
Types of Stock (cont’d)
 Income Stocks: stocks with long and sustained records
of paying higher-than average dividends
 Good for investors looking for relatively safe and high level
of current income
 Dividends tend to increase over time (unlike interest
payments on bonds)
 Some companies pay high dividends because they offer
limited growth potential
 More subject to interest rate risk
 Examples: Verizon, Conagra Foods, Pitney Bowes, R.R.
Donnelley, Bank of America and AmSouth Bancorp
28
Types of Stock (cont’d)
 Income Stocks: stocks with long and sustained records
of paying higher-than average dividends
 Dividends tend to increase over time (unlike interest
payments on bonds)
 Some companies pay high dividends because they offer
limited growth potential
 Examples: Verizon, Conagra Foods, Pitney Bowes, Wrigley
29
Types of Stock (cont’d)
 Growth Stocks: stocks that experience high rates of
growth in operations and earnings
 High rate of growth in earnings > market
 Higher price appreciation (due to increasing earnings)
 Riskier investment because price will fall if earnings growth
cannot be maintained
 Typically pay little or no dividends
 Examples: Lowe’s, Harley-Davidson, Starbucks, Apple
30
Types of Stock (cont’d)
 Cyclical Stocks: stocks whose earnings and overall
market performance are closely linked to the general
state of the economy
 Stock price tends to move with the business cycle
 Tend to do well when economy is growing, poorly in
slowing economy
 Best for investors willing to move in and out of market as
economy changes
 Examples: Caterpillar, Maytag Corp.
31
Types of Stock (cont’d)
 Defensive Stocks: stocks that tend to hold their value,
and even do well, when the economy starts to falter
 Stock price remains stable or increases when general
economy is slowing
 Products are staples that people use in good times and bad
times, such as electricity, beverages, foods
and drugs
 Best for aggressive investors looking for “parking place”
during slow economy
 Examples: Proctor & Gamble, WD-40, Walmart
32
Market Capitalization
 Small-Cap Stocks: under $1 billion
 Mid-Cap Stocks: $1 billion to $4 or
$5 billion
 Large-Cap Stocks: more than $4 or
$5 billion
33
Types of Stock
 Small-Cap Stocks: small companies with market
capitalizations less than $1 billion
 Provide opportunity for above-average returns
(or losses)
 Short financial track record
 Erratic earnings
 Not widely-traded; liquidity is issue
34
Types of Stock (cont’d)
 Mid-Cap Stocks: medium-sized companies with
market capitalizations between $1 billion and $4 or $5
billion
 Provide opportunity for greater capital appreciation
than Large-Cap stocks, but less price volatility than SmallCap stocks
 Long-term track records for profits and stock valuation
 “Baby Blues” offer same characteristics of Blue Chip stocks
except size
 Examples: Wendy’s, Barnes & Noble, Petsmart, Cheesecake
Factory
35
Types of Stock (cont’d)
 Large-Cap Stocks: large companies with market
capitalizations over $4 or $5 billion
 Number of companies is smaller, but account for 80% to
90% of the total market value of all U.S. equities
 Bigger is not necessarily better
 Tend to lag behind small-cap and mid-cap stocks, but
typically have less volatility
 Examples: AT&T, General Motors, Microsoft
36
Investing in Foreign Stocks
 Globalization of financial markets is growing
 U.S. equity market is less than 50% of world
equity markets
 Six countries make up 80% of world equity market
 U.S. market remains largest and one of best
performing equity markets
 Much of performance of non-U.S. markets is due to changes
in currency exchange rates
37
Stock Investment Strategies
 Buy-and-Hold
 Investors buy high-quality stocks and hold them for
extended time periods
 Goal may be current income and/or
capital gains
 Investors often add to existing stocks over time
 Very conservative approach; value-oriented
38
Stock Investment Strategies (cont’d)
 Current Income
 Investors buy stocks that have high dividend yields
 Safety of principal and stability of income are
primary goals
 May be preferable to bonds because dividends levels tend to
increase over time
 Often used to provide to supplement other income, such as
in retirement
39
Stock Investment Strategies (cont’d)
 Quality Long-Term Growth
 Investors buy high-quality growth stocks, mid-cap stocks
and tech stocks
 Capital gains are primary goal
 Higher level of risk due to emphasis on capital gains
 Significant trading of stocks may occur over time
 Diversification is used to spread risk
 “Total Return Approach” is version that emphasizes both
capital gains and high income
40
Stock Investment Strategies (cont’d)
 Aggressive Stock Management
 Investors buy high-quality growth stocks, blue chip stocks,
mid-cap stocks, tech stocks and cyclical stocks
 Capital gains are primary goal
 High level of risk due to emphasis on capital gains
 Investors aggressively trade in and out of stocks, often
holding for short periods
 Timing the market is key element
 Time consuming to manage
41
Stock Investment Strategies (cont’d)
 Speculation and Short-Term Trading
 Also called “day trading”
 Investors buy speculative stocks, small-cap stocks and tech
stocks
 Capital gains are primary goal
 Highest level of risk due to emphasis on capital gains in
short time period
 Investors aggressively trade in and out of stocks, often
holding for extremely short periods
 Looking for “big score” on unknown stock
 Time consuming & high trading costs
42
What is Security Analysis?
 “The process of gathering and organizing information and
then using it to determine the intrinsic value of a share of
common stock.”
43
What is Intrinsic Value?
 Intrinsic Value
 The underlying or inherent value of a stock, as determined
through fundamental analysis
 A prudent investor will only buy a stock if its market price
does not exceed what the investor thinks the stock is worth.
 Intrinsic value depends upon several factors:



Estimates of future cash flows
Discount rate
Amount of risk
44
“Top Down” Approach to
Traditional Security Analysis
 Step 1: Economic Analysis
 State of overall economy
 Step 2: Industry Analysis
 Outlook for specific industry
 Level of competition in industry
 Step 3: Fundamental Analysis
 Financial condition of specific company
 Historical behavior of specific company’s stock
45
Efficient Market Hypothesis
 Efficient Market: the concept that the market is so
efficient in processing new information that securities
trade very close to or at their correct values at all times
 Efficient market advocates believe:
 Securities are rarely substantially mispriced in
the marketplace
 No security analysis is capable of finding mispriced
securities more frequently than using random chance
46
Who Needs Security Analysis
in an Efficient Market?
 Fundamental analysis is still important because:
 All of the people doing fundamental analysis is the reason
the market is efficient
 Financial markets may not be perfectly efficient
 Pricing errors are inevitable
7-47
47
Industry Analysis
 Evaluate the competitive position of a particular industry in
relation to
other industries
 Looking for new opportunities &
growth potential
 Identify companies within the industry that look promising
 Looking for strong market positions, pricing leadership,
economies of scale, etc.
48
Issues that Affect an Industry
 What is the nature of the industry?
 Is the industry regulated?
 What role does labor play in the industry?
 How important are technological developments?
 Which economic forces have the most impact on the
industry (e.g., interest rates, foreign trade)?
 What are the important financial and operating
considerations (e.g., access to capital)?
49
Growth Cycle Stages
and Investments

Growth Cycle reflects the vitality of an industry or a company
over time.

Initial development: industry is new and risks are
very high

Rapid expansion: product acceptance is growing and investors
become very interested

Mature growth: expansion comes from growth in the economy
and returns are more predictable

Stability or decline: demand for product is
investors avoid this stage
diminishing and
50
Fundamental Analysis
 Evaluate the financial condition and operating results of
a specific company




Competitive position
Composition and growth in sales
Profit margins and dynamics of earnings
Asset mix (i.e. cash balance, inventory, accounts receivable,
fixed assets)
 Financing mix ( i.e. debt, stock)
 The value of a stock is influenced by the financial
performance of the company that issued the stock.
51
Where Do We Start?
 Interpreting Financial Statements
 Using Financial Ratios
 Fundamental analysis is often the most demanding and
most time-consuming phase of stock selection.
52
Major Groups of Financial Ratios





Liquidity Ratios: the company’s ability to meet day-to-day
operating expenses and satisfy short-term obligations as they
become due
Activity Ratios: how well the company is managing
its assets
Leverage Ratios: amount of debt used by the company
Profitability Ratios: measures how successful the company is at
creating profits
Common Stock Ratios: converts key financial information into
per-share basis to simplify
financial analysis
53
Common Stock Ratios

Price/Equity Ratio: shows how the stock market is pricing the
company’s common stock
 One of most widely used ratios in common stock selection
 Often used in stock valuation models
P/E 
Market price of common stock
EPS
Net profit after taxes  Preferred dividends
EPS 
Number of common shares outstanding


Higher ratio: more expensive
Lower ratio: less expensive
54
Common Stock Ratios (cont'd)

What is the P/E ratio for a company with profits of $139.7
million, 61,815,000 outstanding shares of common stock and a
current market price of $41.50 per share?
$139,700,000
EPS 
or $2.26
61,815,000 shares
$41.50
Price/Earnings ratio 
or 18.4
$2.26
Copyright © 2005 Pearson
7-55
55
Common Stock Ratios (cont'd)
 Price/Earnings Growth Ratio (PEG): compares
company’s P/E ratio to the rate of growth
in earnings
Stock’s P/E ratio
PEG ratio=
3- to 5-year growth rate in earnings
 Ratio > 1: stock may be fully valued
 PEG = 1: stock price in line with
earnings growth
 Ratio < 1: stock may be undervalued
Copyright © 2005 Pearson
7-56
56
Common Stock Ratios (cont'd)
 Payout Ratio: how much of its earnings a company
pays out to stockholders in the form
of dividends
 Traditional payout ratios have been 40% to 60%
 Recent trends have been lower payout ratios, with more tax
efficient stock buyback programs used frequently
 High payout ratios may be difficult to maintain and the stock
market does not like cuts in dividends
Dividends per share
Payout ratio 
Earnings per share
57
Common Stock Ratios (cont'd)
 Book Value per Share: difference between assets and
liabilities (equity) per share
Book value per share 
Common stockholders’ equity
Number of common shares outstanding
 A company should be worth more than its
book value.
58
Common Stock Ratios (cont'd)
 Price-to-Book Ratio: compares stock price to book
value to see how aggressively the stock is being priced
Market price of common stock
Price-to-book-value 
Book value per share
 Higher ratio: stock is fully-priced or overpriced
 Lower ratio: stock may be fairly priced
or underpriced
59