Exam 3 Study Guide Doug Smith Chapters 11 13 14 18 1 Calculate Holding Period Return a The total return received from holding an asset or portfolio of assets over a period of time generally expressed as a percentage b Holding Period Return Income End of Period Value Initial Value Initial Value 2 Dividend Payout a A financial ratio that shows how much a company pays out in dividends each year relative to its share price In the absence of any capital gains the dividend yield is the return on investment for a stock b Dividend Yield Annual Dividends per share Price per share 3 Security Intrinsic Value a The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business in terms of both tangible and intangible factors b This value may or may not be the same as the current market value c For example value investors that follow fundamental analysis look at both qualitative business model governance target market factors etc and quantitative ratios financial statement analysis etc 4 Calculate Expected market price per share a The market price per share of stock or the price per share of stock is a current measure of price not an accounting or historical measure of the value of stock like the book value per share which is based on the information from a company s balance sheet b The market price per share is a financial metric that investors use to determine whether or not to purchase a stock c Market Price Per Share Net Income Preferred Dividends Number of Shares of Common Shares Outstanding d The market price per share and the current price at which the stock is being traded are not necessarily the same i The current trading price is based on investor buying and selling behavior ii The market price per share is also called the intrinsic value of a share of stock or the actual value based on the actual variables taken from the company s financial statements 5 Stock Valuation Models a There are the simple to use ones such as the comparables method and there are the more involved methods such as the discounted cash flow model b Valuation methods typically fall into two main categories absolute and relative valuation models i Absolute valuation models attempt to find the intrinsic or true value of an investment based only on fundamentals Focus on such things as dividends cash flow and growth rate for a single company and not worry about any other companies ii relative valuation models operate by comparing the company in question to other similar companies These methods generally involve calculating multiples or ratios such as the price to earnings multiple and comparing them to the multiples of other comparable firms 6 Components of a Balance Sheet Income Statement a The balance sheet contains statements of assets liabilities and shareholders equity Assets represent things of value that a company owns and has in its possession or something that will be received and can be measured objectively i b Income Statement also known as Profit Loss Account is a report of income expenses and the resulting profit or loss earned during an accounting period i 7 Components of Dupont model a In the 1920s the DuPont corporation created an analysis method that fills this need by breaking down ROE into a more complex equation DuPont analysis shows the causes of shifts in the number b There are two variants of DuPont analysis the original three step equation and an extended five step equation The three step equation breaks up ROE into three very important components Taking the ROE equation ROE net income shareholder s equity and multiplying The Three Step DuPont Calculation the equation by sales sales we get ROE net income sales sales shareholders equity We now have ROE broken into two components the first is net profit margin and the second is the equity turnover ratio Now by multiplying in assets assets we end up with the three step DuPont identity ROE net income sales sales assets assets shareholders equity This equation for ROE breaks it into three widely used and studied components ROE net profit margin asset turnover equity multiplier 8 Calculate current ratio a Current ratio is a comparison of current assets to current liabilities calculated by dividing your current assets by your current liabilities Potential creditors use the current ratio to measure a company s liquidity or ability to pay off short term debts 9 Quality of Earnings a The amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory b Quality of earnings is considered poor during times of high inflation Also earnings that are calculated conservatively are considered to have higher quality than those calculated by aggressive accounting policies 10 GAAP IFRS a The common set of accounting principles standards and procedures that companies use to compile their financial statements GAAP are a combination of authoritative standards set by policy boards and simply the commonly accepted ways of recording and reporting accounting information b GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when analyzing companies for investment purposes c A set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements IFRS are issued by the International Accounting Standards Board d The goal with IFRS is to make international comparisons as easy as possible This is difficult because to a large extent each country has its own set of rules 11 Interest Rate Sensitivity a A measure of how much the price of a fixed income asset will fluctuate as a result of changes in the interest rate environment b Generally the longer the maturity of the asset the more sensitive the asset will be to changes in interest rates Changes in interest rates are watched closely by bond and fixed income traders as the resulting price fluctuations will affect the overall yield of the securities c Investors who understand the concept of duration can immunize their fixed income portfolios to changes in short term interest rates 12 Components and Effects of Duration a Duration is an estimated measure of the price sensitivity of a bond to a change in interest rates It can be stated as a percentage or in dollar amounts It can be helpful to shock or analyze what will happen to a