Macroeconomics and Industry

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Macroeconomics and Industry Powered By Docstoc
					     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           PV(Dt)         Growth rate
0              34.0           -
1              37.8           11.17%
2              41.78          10.52
3              45.85            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             Uses
 C. Paper    $ 5.8    Cash $ 0.4
 A/P          17.8    A/R     16.2
 Div/P          1.4   Inv     34.8
 S/T debt       4.6   Prep. Ex 0.4
 S/T Lease      3.8   Lease 82.8
 L/T Debt     20.6    Others   3.6
 L/T Lease    25.0    Tax      1.0
 C/S            3.2
 P/I Cap        0.6
 NI            54.4   Div.    46.6
 Depreciation 48.6
 Total       185.8           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

				
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