Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 14 Stock Analysis and Valuation

Copyright ©2004 Pearson Education, Inc. All rights reserved.

Chapter 14

Stock Analysis and Valuation

Copyright ©2004 Pearson Education, Inc. All rights reserved. 14-2

Chapter Objectives

• Describe how to interpret stock quotations

• Illustrate how to conduct an analysis of a firm

• Describe how to conduct an industry analysis of stocks

• Explain how to value stocks


Stock Quotations

• Price quotations readily available from the Internet, stock brokers or financial newspapers

• Provide information about the price of each stock over the previous day or a recent period


Stock Quotations


Financial Planning Online: Stock Information

• Go to: www.bloomberg.com

• This Web site provides stock quotations for the stocks that you specify. It also provides a summary of financial market conditions and links to information about investments.

http://www.bloomberg.com/




Analysis of the Firm

• Annual report– Balance sheet: a financial statement that

indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time

– Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time



Exhibit 14.2: Balance Sheet for Stewart Corporation (numbers are in millions)



Exhibit 14.3: Income Statement for Stewart Corporation (number are in millions)



• Firm-specific characteristics– Analysis of a firm’s income statement

and balance sheet can reveal the following characteristics:

– Liquidity• Current ratio: the ratio of a firm’s short-term

assets to its short-term liabilities

• Show the firm’s ability to cover expenses



– Financial leverage: a firm’s reliance on debt to support its operations

• Debt ratio: a measure of financial leverage that measures the proportion of total assets financed with debt

• Times interest earned ratio: a measure of financial leverage that measures the ratio of the firm’s earnings before interest and taxes to its total interest payments



– Efficiency• Inventory turnover: a measure of efficiency;

computed as the cost of goods sold divided by average daily inventory

• Average collection period: a measure of efficiency; computed as accounts receivable divided by average daily sales

• Asset turnover ratio: a measure of efficiency; computed as sales divided by average total assets



– Profitability• Operating profit margin: a firm’s operating profit

divided by sales

• Net profit margin: a measure of profitability that measures net profit as a percentage of sales

• Return on assets: a measure of profitability; computed as net profit divided by total assets

• Return on equity: a measure of profitability; computed as net profit divided by stockholder’s equity



Exhibit 14.4:Ratios Used to Analyze Stewart Corporation


Financial Planning Online:Determining Industry Norms

• Go to: http://biz.yahoo.com/research/indgrp

• This Web site provides information on various industry groups and allows you to obtain financial information on firms you specify in any industry.

http://biz.yahoo.com/research/indgrp

http://biz.yahoo.com/research/indgrp



– Information provided by Value Line• Recent stock price

• PE ratio

• Dividend yield

• Rating of the firm

• Beta

• Financial statistics

• Trading volume



Exhibit 14.5: An Example from Value Line Investment Survey



• Go to: http://www.bloomberg.com/bbn/economies.html

• This Web site provides information about economic conditions that can affect the values of investments.

http://www.bloomberg.com/bbn/economies.html







• Focus on Ethics: Accounting fraud– Many firms recently used fraudulent financial

statements

– Motivation for fraud• Manager compensation

• Short-tem focus

– Revenue-inflating techniques• Recognizing revenue before it is earned

• Recognizing revenue from cancelled orders



– The Enron and WorldCom scandals• Over-reported revenue and under-reported

expenses

• Many stockholders lost their entire investment

– Preventing future accounting fraud• Use independent auditor

• New rules from Security and Exchange Commission


Economic Analysis of Stocks

• Involves assessing economic conditions that can affect a firm’s stock price

• Economic growth: a measure of growth in a country’s economy over a particular period– Gross domestic product (GDP):

the total market value of all products and services produced in a country



– Weak economic conditions• Lowers demand and stock prices

• Consumers spend less, further lowering demand

– Fiscal policy effects• Fiscal policy: the means by which the U.S.

government imposes taxes on individuals and corporations and by which it spends its money



• Interest rates– Stocks perform better when interest rates

are low

– Some stocks are more sensitive to interest rates than others

– The Federal Reserve uses monetary policy

to influence interest rates



• Inflation: the increase in the general level of prices of products and services over a specified period– Consumer price index (CPI): a measure of

inflation that represents prices of various consumer products

– Producer price index (PPI): a measure of inflation that represents prices of products used to produce other products



Exhibit 14.6: Sources of Economic Information


Industry Analysis of Stocks

• Stock prices susceptible to industry conditions– Increased demand generally leads to

higher stock prices

– Changes in competition also affect demand, earnings, and stock prices



• Industry indicators– Various publications and online sources for

information on specific industries

– Industry stock index measures how the market value of firms within an industry has changed over time



Exhibit 14.7: Sources of Economic Information


Stock Valuation

• Estimate the market value of a stock before purchasing

• Price of stock based on the demand for the stock versus its supply

• Technical analysis: the valuation of stocks based on historical price patterns


Stock Valuation

• Fundamental analysis: the valuation of stocks based on an examination of fundamental characteristics such as revenue or earnings, or the sensitivity of the firm’s performance to economic conditions


Stock Valuation

• Price-earnings (PE) method: a method of valuing stocks in which a specific firm’s earnings per share are multiplied by the mean industry price-earnings (PE) ratio

Price-Earnings (PE) Ratio = P/E


Stock Valuation

– You can use the PE ratios of stocks to value a firm as follows:

• Look up the PE ratios of stocks in the firm’s industry.

• Multiply the average industry PE ratio times the firm’s earnings per share.

• Compare your estimated value of the firm’s stock to its market value to determine whether the stock is undervalued or overvalued.


Stock Valuation

– Deriving an estimate of earnings• May use last year’s earnings or estimate

expected earnings

• Value Line and other investment services provide such forecasts

– Limitations of the PE method• Forecasting earnings is difficult

• Some firms are involved in multiple industries


Financial Planning Online: Earnings Estimates for Valuing Your Stock

• Go to: http://biz.yahoo.com/research/earncal/today.html

• This Web site provides recent earning per share estimates of a firm that you specify, which you can use when applying the PE method of valuation.

http://biz.yahoo.com/research/earncal/today.html




Stock Valuation

• Price-Revenue (PR) method: a method of valuing stocks in which the revenue per share of a specific firm is multiplied by the mean industry ratio of share price to revenue

– Limitations of the PR method

• Difficulty in deciding which firms to use for comparison

• Revenues don’t indicate how well a firm is managed


Integrating Your Analyses

• Analyzing the firm, the economy and the industry allows assessment of future performance

• Economic, industry, and firm-specific conditions impact a firm’s stock price



Exhibit 14.8:Factors That Increase and Decrease the Stock’s Price


Financial Planning Online: Screening Stocks for Investment Decisions

• Go to: http://screen.yahoo.com/stocks.html

• This Web site provides a list of stocks that meet criteria that you specify for performance over the last year, such as PE ratio and other characteristics.

http://screen.yahoo.com/stocks.html


Stock Market Efficiency

• Efficient stock market: a market in which stock prices fully reflect information that is available to investors– Indicates that investors should be able to

accurately identify undervalued stocks

• Inefficient stock market: a market in which stock prices do not reflect all information that is available to investors


How Stock Valuation Fits within Your Financial Plan

• Key decisions about stock for your financial plan are:– Should you consider buying stock?

– How should you value stocks when determining whether to buy them?

– What methods should you use for investing in stocks?


Integrating Key Concepts

Integrating Key Concepts

• Part 1: Financial Planning Tools

• Part 2: Liquidity Management

• Part 3: Financing

• Part 4: Protecting Your Assets and Income

• Part 5: Investing– In Chapter 13 we learned about investment fundamentals

– In Chapter 14 we learned about stock analysis and valuation

– In Chapter 15 we will cover investing in stocks

– In Chapter 16 we will learn about investing in bonds

– In Chapter 17 we will learn about investing in mutual funds

– In Chapter 18 we will cover asset allocation

• Part 6: Retirement and Estate Planning

Documents

Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 14 Stock Analysis and Valuation