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Security Analysis Fundamental Analysis

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					          Security Analysis




• An examination and evaluation of the
  various factors affecting the value of a
  security.




        Framework of Analysis

• Fundamental Analysis
• Approach to Fundamental Analysis
  – Domestic and global economic analysis
  – Industry analysis
  – Company analysis
• Why use the top-down approach




                                             1
    Global Economic Considerations

• Performance in countries and regions is
  highly variable
• Political risk
• Exchange rate risk
    – Sales
    – Profits
    – Stock returns




         Key Economic Variables

•   Gross domestic product
•   Unemployment rates
•   Interest rates & inflation
•   International measures
•   Consumer sentiment




           Government Policy
• Fiscal Policy - government spending and
  taxing actions
    – Direct policy
    – Slowly implemented




                                            2
   Government Policy (cont’d)
• Monetary Policy - manipulation of the
  money supply to influence economic
  activity
  – Initial & feedback effects
• Tools of monetary policy
  – Open market operations
  – Discount rate
  – Reserve requirements




             Demand Shocks

• Demand shock - an event that affects
  demand for goods and services in the
  economy
  – Tax rate cut
  – Increases in government spending




                                          3
              Supply Shocks
• Supply shock - an event that influences
  production capacity or production costs
  – Commodity price changes
  – Educational level of economic participants




             Business Cycles
• Business Cycle
  – Peak
  – Trough
• Industry relationship to business cycles
  – Cyclical
  – Defensive




             Cyclical Indicators:
                  Leading
Leading Indicators - tend to rise and fall in
  advance of the economy
Examples
  – Avg. weekly hours of production workers
  – Stock Prices




                                                 4
           Cyclical Indicators:
              Coincident
Coincident Indicators - indicators that tend to
 change directly with the economy
Examples
  – Industrial production
  – Manufacturing and trade sales




           Cyclical Indicators:
                Lagging
Lagging Indicators - indicators that tend to
  follow the lag economic performance
Examples
  – Ratio of trade inventories to sales
  – Ratio of consumer installment credit
    outstanding to personal income




           Industry Analysis
• Sensitivity to business cycles
• Factors affecting sensitivity of earnings to
  business cycles
  – Sensitivity of sales of the firm’s product to the
    business cycles
  – Operating leverage
  – Financial leverage
• Industry life cycles




                                                        5
          Industry Life Cycles
Stage                  Sales Growth
Start-up               Rapid & Increasing
Consolidation          Stable
Maturity               Slowing
Relative Decline       minimal or Negative




      ANALYSIS AND PLANNING OF
      CORPORATE PERFORMANCE
• Management makes strategic decisions on the
  future direction and growth of the company.
• Management is interested in knowing where the
  company is now and where it wants to be.
• Management is also interested in knowing how,
  i.e. strategies and policies the company should
  use so that it can get to where it wants to be.
• The finance manager assess the company’s
  current position and advises on the financial
  implications of the various options available to
  the company and the most profitable option.




    WHAT IS FINANCIAL ANALYSIS

• This is the evaluation and interpretation of
  financial and related non-financial data to
  assist in investment and financial decision-
  making in relation to a given company.
• Management uses financial analysis to assess
  the performance of the company
• Potential Investors use financial analysis to
  evaluate the profitability of their planned
  investment in the company.
• Bankers and Debt holders use financial analysis
  to evaluate the creditworthiness or the ability




                                                     6
     DATA FOR FINANCIAL ANALYSIS

• Annual Reports: income statements, balance
  sheet, cash flow statements, notes to the
  financial statements and management
  (accounts) forecast
• External Information on share prices from GSE
  and analysts forecast of performance and EPS
• Macro-economic data such Gross Domestic
  Product, inflation and interest rate and taxation
  provide guides to the direction of the economy.
  They are also useful in assessing the recent
  performance and future prospects of the firm




      LEVELS OF SECURITY ANALYSIS

• Security analysis is conducted at three levels:
• Domestic & Global Economy Level Analysis:
  This is to know the trend and direction of the
  economy and its effect on the industry and the
  firm’s performance
• Industry Level Analysis: This is to understand
  the nature and operations of the industry and to
  assess the direction, competition and
  regulations within the industry that impact on the
  firm.
• Firm Level Analysis: This helps to understand
  the nature of the current and future operations of
  the firm and its position within the industry that
  has bearing on current and future performances




        INFORMATION INPUT
•    THE ECONOMY
1.   Production and Income
2.   Employment
3.   Consumption
4.   Investment activities
5.   Interest rates
6.   Inflation
7.   Taxation
8.   Stock Prices




                                                       7
        INFORMATION INPUT
•    THE INDUSTRY
1.   Nature of competition
2.   Market share of each firm
3.   Regulatory conditions
4.   Sensitivity of demand to economic conditions
5.   Nature, sources and cost of inputs
6.   Behaviour of suppliers and customers
7.   Impact of seasonal factors- weather,etc
8.   Impact of technology




        INFORMATION INPUT
•    THE FIRM
1.   Financial statement data
2.   Sources and availability of finances
3.   Position within the industry
4.   Rate of growth in sales, cost and profit
5.   Product divisions and sub-divisions
6.   Sources and availability of inputs
7.   Trends in demand and production
8.   Management and their competence
9.   Extraordinary events occurring in the firm




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