Download Fundamental Analysis

Fundamental Analysis
• Macroeconomics Analysis
• Industry Analysis
• Equity Valuation Model
(Dividend Discount Model- DDM)
• Financial Statement Analysis
Macroeconomics Analysis
• Global Economy Analysis
– affects export, price competition and profits
– exchange rate: purchasing power and earnings
• Domestic Economy
– The ability to forecast the macroeconomy can translate
into great investment performance
– outperform other analysts to earn extra profits
Many variables can affect economy
–Gross Domestic Product (GDP):
measures the economy’s total output of goods and services
– Employment rate:
measures the extent that the economy is operating at full capacity
– Inflation
measures the general level of prices increase Phillip’s curve
– Interest Rate
high interest rate reduces PV of cashflows, thus stock values
– Budget Deficit
large deficit means more borrowing, which
implies higher interest rate.
– Sentiment
consumers and producers confidence
Business Cycles
•
•
•
•
business cycles: pattern of recession and recovery
peak: the end of expansion and start of recession
trough: the bottom of the recession
stock returns are decreasing when at peak and
increasing at trough
• cyclical industries: do well in expansionary periods but
poorly in recession, e.g., durable goods such as automobile
and wash machines
• defensive industries: little sensitive to business cycles,
such food
Industry Analysis
• Select a good industry to invest. It is difficult for
a firm to do well in a troubled industry
• Standard Industry Classification (SIC) code
• Value line Investment Survey - reports 1700 firms in
90 industries
• Two factors that determine the sensitivity of a
firm’s earnings to business conditions:
business risk,
financial risk
Business risk
• Sales sensitivity to business condition
some industries are robust (food) while others are
not (movie)
• operating leverage: the division between fixed and
variable costs.
– firms with greater amounts of variable cost relative to the
fixed cost are subject less to business fluctuations, thus
profits are more stable
Financial Risk
• the degree in using financial leverage (the amount
of interest payment)
• leverage firm is more sensitive to business cycles
Industry cycles
Start-up Build-up Maturity Decline
Start-up: increasing growth
Build-up/consolidation: stabilized growth
maturity: slower growth
Decline: shrinking growth
Equity Valuation Model
• Dividend Discount Model (DDM)
V0= (D1+P1)/(1+k)
= D1/(1+k) + D2/(1+k)2
...+ Dn/(1+k)n
• constant growth assumption
V0 = D1/(1+k) + D1(1+g)/(1+k)2
+D1(1+g)2/(1+k)3 + ...
= D1/(k-g)
or k = expected return
= D1/P0 + g
Multistage Growth Model
• Growth profile may not be constant such as:
Expected Growth
g1
g2
n
Time
V=D0(1+g1)/(1+k)+...+D0(1+g1)n/(1+k)n
+ D0(1+g1)n(1+g2)/(1+k)n+1+ ... and so on
Illustration of two-stage Growth
Model
• A stock pays $1 dividend now and its g1=30% for
6 yrs. Thereafter, its g2=6%, its k=15%
• yr 1: $1(1+0.3) =1.13
yr 2: 1(1+0.3)2=1.69
yr 3: 1(1+0.3)3=2.20
yr 4: 1(1+0.3)4 =2.86
.
yr 7: 1(1+0.3)6(1+6%) =5.12
yr 8: 1(1+0.3)6(1+6%)2 =5.42
.
Market Value (equity)
Market value is the present value of its future dividends
Time
0
1
2
3
PV(Dt)
34.0
37.8
41.78
45.85
Growth rate
11.17%
10.52
9.74
At time 1:
FV(Dividends) = 34.00(1.15) - 1.3= 37.8
At time 2:
FV(dividends) = 37.80(1.15) - 1.69=41.78
Expected return at time 0 (15%)
= Yr end dividend/current price + growth rate
= 1.3/34 + 11.17%
P/E Ratio Behaviors
• Price = No growth value/share
P0 = E1/k + PVGO
or
• P0/E1= [1+ PVGO]/k
E1/k
P/E
average
Time
Pitfalls in P/E Analysis
• Denomination of P/E ratio is the accounting
earnings (arbitrary rules or historical cost
will distort the earnings figures)
• Earning should be based on economic
earnings (i.e., net of economic deprecation)
• Earnings are future figures vs P/E ratio
(which uses past accounting earnings)
Earnings Forecast
• Models for forecasting:
Ei,t = gi + Ei,t-4 +ai(Ei,t-1-Ei,t-5)
where g: growth factor
a: adjustment factor
E: Earnings
• Time Series Analysis
ARMA model
Exponential smoothing
• professional institution forecast
• Performance Evaluation MSE or others
Financial Statement Analysis
• Preparation of Source/Use Fund Statement
• Ratio Analysis
– Performance Analysis
– Du Pont Analysis
Use/source of Fund Statement
• Sources
C. Paper
$ 5.8
A/P
17.8
Div/P
1.4
S/T debt
4.6
S/T Lease
3.8
L/T Debt
20.6
L/T Lease
25.0
C/S
3.2
P/I Cap
0.6
NI
54.4
Depreciation 48.6
Total
185.8
Uses
Cash $ 0.4
A/R
16.2
Inv
34.8
Prep. Ex 0.4
Lease 82.8
Others
3.6
Tax 1.0
Div.
46.6
185.8
Analysis of Use/Source
• Sales growth=3.5%
• Uses- major component
A/R =8.72%; Inventory = 18.73%; Lease = 44.6%
Dividend = 25.1%
• Sources
A/P = 9.5%; L/T debt = 11.1%; L/T lease = 13.4%
Operation profits = 55.4%
(NI+depreciation)
• Why issue shares?
• S/T-/LT capital increases so much?
Ratio Analysis
• Assets
Sales
Profit
• Liquidity Ratio
• Risk Ratio
• Du Pond Analysis
ROE=Net Income(NI)/Equity (E)
= NI
Pretax Prof EBIT Sale TA
P.Prof
EBIT
Sales TA E
TB
IB
GPM TAT EM
Pretax profit =EBIT - Interest
TB = Tax burden
IB = interest burden