Practical Investment Management by Robert.A.Strong slides ch07

8/14/2019 Practical Investment Management by Robert.A.Strong slides ch07

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CHAPTER SEVEN

Practical Investment Management

Robert A. Strong

A

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FUNDAMENTAL STOCK ANALYSIS


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South-Western / Thomson Learning 2004 7 - 2

Outline

Valuation Philosophies

Investors Understanding of Risk Premiums The Time Value of Money

The Importance of Cash Flows

The Tax Factor

EIC Analysis

Value vs. Growth Investing The Value Approach to Investing

The Growth Approach to Investing How Price Relates to Value

Value Stocks and Growth Stocks:

How to Tell by Looking


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The Price-to-Book Ratio The Price-Earnings Ratio Differences between Industries

Outline


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Outline

Some Analytical Factors Growth Rates

The Dividend Discount Model

The Importance of Hitting the Earnings Estimate

The Multistage DDM Caveats about the DDM

False Growth

A Firms Cash Flows

Small-Cap, Mid-Cap, and Large-Cap Stocks Ratio Analysis

Cooking the Books


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Fundamental analysts believe

securities are priced according to

fundamental economic data.

Technical analysts think investor behavior

and supply and demand factors play the

most important role.


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Investors understanding of risk premiums:

Investors are almost always risk-averse.

The time value of money:

Everyone agrees on this basic principle.

The importance of cash flows:Most investment research deals with

predicting future corporate earnings.

The tax factor:The tax code is complicated and not all

investments are taxed equally.


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Economy, Industry and Company (EIC)

analysis:

The analyst first considers conditions in

the overall economy(market risk),

then determines which industries are themost attractive in light of the economic

conditions (using Porters competitive

strategy analysis framework, for example),

and finally identifies the most attractive

companies within the attractive

industries.




Insert Figure 7-1 here.



Value vs. Growth Investing

A value investorbelieves that securities

should be purchased only when the

underlying fundamentals (macroeconomicinformation, industry news, and a firms

financial statements) justify the purchase.

Value investors believe in a regression

to the mean.

The Value Approach to Investing



Regression to the Mean

Most of the time a

securitys long-term return is

consistent with its

risk.

Over the long run, a security

cannot survive with a cumulativereturn that is negative.C

umu

lativ e

Return

Time in the Long Term

0

+

-

xxx

x

x

x

xxx

xx

x

xx

xUndervalued stock:

Buy

Overvalued stock: Sell




Growth investors seek steadily growing

companies. There are two factions:

Information traders are in a hurry; theybelieve information differentials in the

marketplace can be profitably exploited.

True growth investors are more willing to

wait, but they share the belief that goodinvestment managers can earn above-

average returns for their clients.

The Growth Approach to Investing




In the early days of the market, before the

Great Crash of 1929, price played a minor

role: A stock with good long-term

prospects is always a good investment.

How Price Relates to Value

The modern perspective is that

value isinextricably intertwined

with price.$8




No precise definition exists.

Classification by Morningstar Mutual Funds:

Value Stocks and Growth Stocks:

How to Tell by Looking

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Practical Investment Management by Robert.A.Strong slides ch07