Workshop 4

• Security Analysis


  Part of formulating a successful long-range investment program
• Security analysis


  Process of gathering information, organizing it into a logical framework, and then using the information to determine the intrinsic value of common stock
• Intrinsic value


  A measure of the underlying worth of a share of stock
• A prudent investor will only buy a stock if its market price does not exceed what the investor thinks the stock is worth
• Intrinsic value


  • Estimates of the stock's future cash flows
  • The discount rate
  • The risk associated with future performance
• The Top-Down Approach to Security Analysis

  • Step 1: Economic Analysis
  • Step 2: Industry Analysis
  • Step 3: Fundamental Analysis
• Economic Analysis


  Assess the general state of the economy and its potential effects on businesses
• Industry Analysis


  • Overall outlook for specific industry within which a company operates
  • Level of competition in that industry
• Fundamental Analysis


  • Financial condition and operating results of a company
  • Company analysis helps investors formulate expectations about the company's future performance
• Economic Analysis


  The study of the underlying condition of the economy and the impact it might have on the behavior of share prices
• The figure shows that during recessions (indicated by the vertical gray bars) the stock market tends to fall, though the stock market usually begins to rebound before the recession ends
• Business cycle


  A series of alternating contractions and expansions which reflects changes in the total economic activity over time
• Gross domestic product (GDP)


  Market value of all goods and services produced in a country over a given period
• Industrial production


  An indicator of the output produced by industrial companies
• Normally, GDP and index of industrial production move up and down with the business cycle
• Key Economic Factors


  • Government Fiscal Policy
  • Monetary Policy
  • Other Factors
• Government Fiscal Policy


  • Taxes
  • Government Spending
  • Debt management
• Monetary Policy


  • Money supply
  • Interest rates
• Other Factors


  • Inflation
  • Consumer spending
  • Business Investments
  • Foreign trade and foreign exchange rates
• Sources that provide summary of economic outlook

  • Wall Street Journal
  • Financial Times
  • The Economist
  • Business Week
  • Periodic reports from major brokerage houses
• Use the economic outlook information to


  • Determine areas for further analysis
  • Evaluate specific industries or companies
• The Market as a Leading Indicator


  • Changes in stock prices usually occur before the actual forecasted changes become apparent in the economy
  • The current trend of stock prices is frequently used to help predict the course of the economy itself
• Industry Analysis


  Understanding the outlook and risks inherent in an industry gives valuable insight about the outlook for and risks inherent in individual companies, and their securities, that makeup that industry
• Key Issues


  • Developing an Industry Outlook
• Industry Analysis


  • Step 1: establish the competitive position of a particular industry in relation to other industries
  • Step 2: Identify companies within the industry that hold particular promise
• Examples of NAICS Industry Codes

  • 12.7 Industry Analysis
• Key Issues


  • What is the nature of the industry?
  • Is the industry regulated?
  • What role does labor play in the industry?
  • How important are technological developments?
  • Which economic forces are especially important to the industry?
  • What are the important financial and operating considerations?
• The Industry Growth Cycle

  • Initial Development
  • Rapid Expansion
  • Mature Growth
  • Stability or Decline
• Figures related to Industry Analysis

  • Figure 12.12 Industry Life Cycle
  • Figure 12.10 Stylized Depiction of Business Cycle
  • Figure 12.9 Industry Cyclicality
  • Figure 12.11 Sector Rotation
• Industry Structure and Performance

  • Threat of entry
  • Rivalry between existing competitors
  • Pressure from substitute products
  • Bargaining power of buyers
  • Bargaining power of suppliers
• Sources for Industry information


  • S&P Industry Surveys
  • Brokerage house reports
  • Articles in the popular financial media
  • Morningstar, Value Line, Mergent
  • Yahoo.com, zacks.com, businessweek.com, bigcharts.com
• Developing an Industry Outlook

  • Assess the expected industry response to forecasted economic developments
  • Demand for product
  • Industry sales
  • Research & Development
  • What are the prospects for industry growth?
  • Take a closer look at any firm(s) that stand out
• Fundamental analysis


  The study of a firm's financial statements and other information for the purpose of determining a stock's intrinsic value
• The Concept


  • The value of a stock is influenced by the performance of the company that issued the stock
  • Company analysis: a historical analysis of the financial strength of the firm, using financial statements of the firm
• • The competitive position of the company
  • The types of assets owned and growth rate of sales
  • Profit margins and dynamics of earnings
  • Composition and liquidity of assets (asset mix)
  • Capital structure (financing mix)
• Time consuming and demanding phase, so investors may rely on published reports and financial websites as well
• Balance Sheet


  Statement of what a company owns and what it owes at one specific time
• Assets


  What the company owns (i.e., cash, inventory, accounts receivable, equipment, buildings, land)
• Liabilities


  What the company owes (i.e. bills, debt)
• Stockholders' equity


  Difference between assets and liabilities; claim held by the firm's stockholders