Fundamental Analysis Valuation by liwenting


Financial Management Association

Fundamental Analysis Valuation
       What is Fundamental Analysis?
• Discovering the fundamental value of a
  company; what is a business worth?
• Analyze:
  – Financial Strength (ex. Financial statements)
  – Past Performance
  – Growth Potential
  – Management
  – Get the “grand picture” of the company

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          Efficient Market Hypothesis
• In an active market that includes many well-informed
  and intelligent investors, securities will be
  appropriately priced and reflect all available

• If a market is efficient, no information or analysis can
  be expected to result in out performance of an
  appropriate benchmark.

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                  Efficient Market Hypothesis
• Strong Form Efficiency: Share prices reflect all information
  and no one can earn excess returns.

• Semi-strong Form Efficiency: Share prices adjust within an
  arbitrarily small but finite amount of time and in an unbiased
  fashion to publicly available new information, so that no
  excess returns can be earned by trading on that information.

• Weak Form Efficiency: Implies that Technical analysis
  techniques will not be able to consistently produce excess
  returns, though some forms of fundamental analysismay still
  provide excess returns.
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                    Behavioral Finance
•Studies how cognitive or emotional biases, which are individual
 or collective, create anomalies in market prices and returns that may
 be inexplicable via EMH alone.

•Example: Stock Market Crash of 1987

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              Where Do I Begin?
•   What does the company do?
•   How big is it?
•   Company Goals
•   Financial Health
•   Competitive Landscape
•   Economic Conditions

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        What Does the Company Do?

• Who are they?
• Do they make products or sell services?
• Who are they targeting?

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             How Big Is The Company?
•   Micro-cap: $100 million or less
•   Small-cap: $100 million to $500 million
•   Mid-cap: $500 million to $5 billion
•   Large-cap: $5 billion +

    Market Cap = Shares Outstanding x Share Price

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         Financial Statements

• Income Statement
• Cash Flow Statement
• Balance Sheet

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              The Income Statement

• The purpose of the income statement is
  to show managers and investors
  whether or not the company made or
  lost money during the period being

  What does it look like?

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             The Cash flow Statement

• A cash flow statement is a financial
  report that shows incoming and
  outgoing money during a particular

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                    Statement of Retained Earnings
          •Shows the change in retained earnings over time
          •The Statement of Retained Earnings uses information from the
          income statement, and provides information to the balance sheet.

Ending Retained Earnings = Beginning Retained Earnings + Investments - Dividends Paid + Net Income

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                     The Balance Sheet
  It is a snapshot of a companies current financial position

Assets                                      Liabilities
-Current Assets                             -Current Liabilities
-Fixed Assets                               -Fixed Liabilities


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       Show Me the Numbers!

 Price to Sales       Price to Book

Price to Earnings   Gross Profit Margin
       Beta          Return on Equity
 Current Ratio         Debt Ratio

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                              Price to Sales

                   Share Price
          P/S 
                Revenue Per Share
•P/S ratio can be used in comparison to other
•How much is being paid for per share of sales
•If P/S < 1, it means investors are paying less for
each unit of sales

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                          Price to Earnings

                    Share Price
           P/E 
                 Earnings Per Share
•Companies with no growth do not have a P/E ratio
•A high P/E ratio could mean higher growth in the future

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                               Price to Book

                                 Share Price
          P/B 
                Total Assets - Intangible Assets &Liabilities

•Compares the company’s share price to their
book value
•A low P/B ratio could mean:
    •Stock undervalued
    •Something very wrong…

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                       Gross Profit Margin

           Revnues - Cost of Goods Sold
•How much do they get to keep?
•Use in comparison to other companies to determine who has the highest
Gross Profit Margin

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•A method of measure of risk in comparison to the market
•The market has a Beta equal to 1
•Beta > 1 = riskier than the market
•Beta < 1 = less riskier than the market
•Beta = or close to 0 is no risk in comparison to the market

•Get examples

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                        Return on Equity (ROE)

                          Net Income
                      Shareholder's Equity
Useful to comparing the profitability of a firm in regards to its’ competitors.

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                               Debt Ratio

                         Total Debts
                         Total Assets
Debt Ratio > 1= company has more debt than
Debt Ratio < 1 = company has more assets than

*Used as a tool to measure risk of companies

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                                Current Ratio

                      Current Assets
                     Current Liabilities
•Measure of ability to pay short-term liabilities
•Higher ratios means the more capable a company is to
paying back short-term debt

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                 Is This Company Profitable?

•Gross Margin/Profit/Income, Net Income
•Look at company’s income statement
•Look at historical gross margin
•How much does it sell and how much does the company get to keep?
•More income = more for future business operations, return to investors
•Look for companies to perform better than their competitors!

•Citigroup Annual Income Statement

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                         Stock Performance

•What has the stock price done in the past year? 5 years? All of its history?
•Does it show solid performance or very volatile performance?
•Google Stock Performance
•Yahoo! Stock Performance

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•Is management stable?
•Recent change in management?
•Has change in management affected the stock
•HP Probe

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                        Competitive Landscape

•How are they performing in regards to competitors?
•Compare to their industry, compare to the overall market
    •Share price
    •Profit margins
    •Financial ratios
    •Target markets

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Payments made by a company to its shareholders.

Important Dates:

• Declaration Date
• Date of Record
• Ex-Dividend Date (usually before Date of Record)

• Can be cash, stock, or assets.
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• The power of dividends.
   GE 1996 Dividend: $.35
   GE 2006 Dividend:$1.00

   That’s a 186% increase in dividends over the past

• Average Annual increase 16.9%
• If this were to continue, a share of GE bought today,
would yield a $4.08 dividend ten years from now.

 @13%= $3.00 per share
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            Not always a good thing?

•Can indicate lack of growth

•Dividend may be unsustainable

•The effects of cutting a dividend

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                                    Stock Splits
• Ordinary stock splits occur when a publicly held company
  distributes more stock to holders of existing stock.

•    2-for-1: is when a company simply issues one additional
    share for every one outstanding.

• The company's net assets didn't increase, only the
  number of outstanding shares.

• Companies issue splits to make the stock more attractive
  to investors whether it be an ordinary split or a reverse

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           Stock Buybacks

• Income Statement

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           A Nastie Example
…for tying the importance of financial statements


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Benchmarking – How do we
  The most widely accepted benchmark
 is the performance of the Standard and
             Poor’s 500 Index.

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           Benchmarking Continued
• S&P 500 used to compare stock
  performance of a single firm against the
  500 largest American publicly traded
  – Only useful when the company in
    consideration is equivalent in size and stature
    to the components of this index.
  – For example, one would not wish to compare
    the performance of a BB stock against the

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                 ANF up 300% in past five

Standard and Poor’s Fortune 500 Index up
less than 50% in past five years

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         Other Methods of Benchmarking
• Financial ratios used to compare a firm’s
  financial performance to a competitor’s
• Popular ratios are Profit Margin, Return on
  Assets, Inventory Turnover, and the Quick

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Key Ratios, using the Industry as a Benchmark
                                       Industry    Market
Profitability                Company
                                          Median     Median1

Gross Profit Margin          66.70%    35.10%      51.80%

Pre-Tax Profit Margin        19.40%    6.40%       6.30%

Net Profit Margin            12.00%    4.20%       4.80%

Return on Equity             36.7%     18.3%       9.3%

Return on Assets             20.4%     9.4%        1.6%

Return on Invested Capital   27.6%     12.3%       4.2%

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                                      Industry   Market
  Valuation                Company
                                      Median     Median1
  Price/Sales Ratio        2.10       0.96       2.15
  Price/Earnings Ratio     17.37      19.03      18.62

                                                   Industry Market
Operations                             Company
                                                   Median Median1
Days of Sales Outstanding              11.62       5.36    57.47
Inventory Turnover                     2.4         4.7     5.6

                                      Industry Market
             Financial      Company
                                      Median Median1
             Current Ratio 1.90       2.18       1.71
             Quick Ratio    1.0       0.9        1.2

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ANF and the Competitive Landscape

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Where to Invest?

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        How Can I Find More Information?
•   Yahoo! Finance
•   MSN Money Central
•   Hoovers Online through RIT
•   Mergent Online through RIT
•   Investext
•   S&P NetAdvantage through RIT
•   Annual Reports

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