CHAPTER FOURTEENFINANCIAL ANALYSISSlide 3Slide 4Slide 5Slide 6TECHNICAL ANAYSISSlide 8Slide 9Slide 10Slide 11FUNDAMENTAL ANALYSISSlide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 211CHAPTER FOURTEENFINANCIAL ANALYSIS OF COMMON STOCKS2FINANCIAL ANALYSIS•WHAT IS FINANCIAL ANALYSIS?–DEFINITION: the activity of providing inputs to the portfolio management process3FINANCIAL ANALYSIS•PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS–THE ASSOCIATION OF INVESTMENT MANAGEMENT AND RESEARCH (AIMR)•acts as an advocate for the financial analyst profession•it hosts conferencing and workshops–designed to enhance the knowledge base of the memberships•it also publishes the Financial Analysts Journal4FINANCIAL ANALYSIS•REASONS FOR FINANCIAL ANALYSIS–TWO PRIMARY REASONS•to determine certain securities’ characteristics •to attempt to identify mispriced securities5FINANCIAL ANALYSIS•REASON #1: DETERMINING SECURITY CHARACTERISTICS–estimate future sensitivity to major factors–estimate dividend yield6FINANCIAL ANALYSIS•REASON #2: ATTEMPTING TO IDENTIFY MISPRICED SECURITIES–use fundamental analysis–approaches•valuation determines the intrinsic value compared to the current market value•estimate key financial variables such as–EPS next year–income growth next year7TECHNICAL ANAYSIS•DEFINITION: a form of security analysis that attempts to forecast price changes based on historical price and volume trends8TECHNICAL ANAYSIS•Two Groups of Strategies Used:1. Momentum and Contrarian Strategies2. Moving Average and Trading Range BreakoutStrategies9TECHNICAL ANAYSIS1. Momentum and Contrarian Strategies–METHDOLOGY:•examine the returns over a time period just ended to identify–momentum investors who seek out stocks recently rising in price for purchase; falling for sale–contrarians who follow the opposite strategy of most investors»contrarians base their strategy on the overreation theory10TECHNICAL ANAYSIS2. Moving Average and Trading Range Breakout Strategies–MOVING AVERAGE STRATEGY:•calculate a moving average over the last 200 days of closing prices•divide today’s closing price into the moving average (SHORT-TO-LONG RATIO)•if short-to-long ratio is greater than 1, buy•if ratio is less than 1, sell11TECHNICAL ANAYSIS•2. Moving Average and Trading Range Breakout Strategies–TRADING RANGE BREAKOUT STRATEGY:•high and low prices for past 200 trading days are identified•if today’s close is greater than the high = buy!•if today’s close is less than the low = sell!12FUNDAMENTAL ANALYSIS•TOP-DOWN V. BOTTOM UP–TOP-DOWN APPROACH•attempts to forecast in the following order1. economic activity2. industry performance3. firm’s performance13FUNDAMENTAL ANALYSIS•TOP-DOWN V. BOTTOM UP–BOTTOM-UP APPROACH:•attempts to estimate prospects in the following order:1. The firm2. The Industry3. The economy14FUNDAMENTAL ANALYSIS•FINANCIAL STATMENT ANALYSIS–INTEGRAL PART OF FUNDAMENTAL ANALYSIS•it helps the analyst understand a firm’s current condition•where it is headed•what factors affect it•how the factors affect it15FUNDAMENTAL ANALYSIS•FINANCIAL STATMENT ANALYSIS–Review of Accounting Statements•includes a study of the three major statements prepared monthly by most accountants:–the balance sheet–the income statement–the statment of cash flows16FUNDAMENTAL ANALYSIS•FINANCIAL STATMENT ANALYSIS–RATIO ANALYSIS•DEFINITION: a technique used to examine a company’s financial statements•Use of Ratios–as an absolute standard–as a comparative indicator–as a trend over time–in combination with technical analysis17FUNDAMENTAL ANALYSIS•FINANCIAL STATMENT ANALYSIS–RATIO ANALYSIS•Types of Ratios–internal liquidity–operating performance–risk analysis–growth analysis18FUNDAMENTAL ANALYSIS•internal liquidity ratios:–indicate the ability of the firm to meet future short-term financial obligations–some liquidity ratios:•current ratio•quick ratio•cash ratio•receivables turnover19FUNDAMENTAL ANALYSIS•operating performance ratios:–indicate how well the management is operating the business–some examples:•total asset turnover•net fixed asset turnover•equity turnover20FUNDAMENTAL ANALYSIS•risk analysis ratios:–indicates the uncertainty of income flows for the total firm and for the individual sources of capital (debt and stock)–some examples:•debt to equity ratio•long-term debt/total capital ratio21FUNDAMENTAL ANALYSIS•growth analysis ratios:–indicate how fast a firm should grow–it involves analysis using several other ratios•net profit margin•total asset turnover•total