STUDY SESSION 14 ANALYSIS OF EQUITY INVESTMENTS:

Industry and Company Analysis

This study session focuses on industry and company analysis and describes the
tools used in forming an opinion about investing in a particular stock or group
of stocks.

This study session begins with the essential tools of equity valuation: the
discounted cash flow technique and the relative valuation approach. These
techniques provide the means to estimate reasonable price for a stock. The
readings on industry analysis are an important element in the valuation process,
providing the top–down context crucial to estimating a company’s potential.
Also addressed is estimating a company’s earnings per share by forecasting
sales and profit margins.

The last reading in this study session focuses on price multiples, one of the
most familiar and widely used tools in estimating the value of a company, and
introduces the application of four commonly used price multiples to valuation.

LEARNING OUTCOMES

Reading 56: An Introduction to Security Valuation: Part I

The candidate should be able to explain the top-down approach, and its
underlying logic, to the security valuation process.


Reading 57: Industry Analysis

The candidate should be able to describe how structural economic changes
(e.g., demographics, technology, politics, and regulation) may affect
industries.

Reading 58: Equity: Concepts and Techniques

The candidate should be able to:
a. classify business cycle stages and identify attractive investment opportunities for
each stage;
b. discuss, with respect to global industry analysis, the key elements related to
return expectations;
c. describe the industry life cycle and identify an industry’s stage in its life cycle;
d. discuss the specific advantages of both the concentration ratio and the
Herfindahl index;
e. discuss, with respect to global industry analysis, the elements related to risk, and
describe the basic forces that determine industry competition.

Reading 59: Company Analysis and Stock Valuation

The candidate should be able to:
a. differentiate between 1) a growth company and a growth stock, 2) a defensive
company and a defensive stock, 3) a cyclical company and a cyclical stock,
4) a speculative company and a speculative stock, and 5) a value stock and a
growth stock;
b. describe and estimate the expected earnings per share (EPS) and earnings
multiplier for a company and use the multiple to make an investment decision
regarding the company.

Reading 60: An Introduction to Security Valuation: Part II

The candidate should be able to:
a. state the various forms of investment returns;
b. calculate and interpret the value both of a preferred stock and a common stock
using the dividend discount model (DDM);
c. show how to use the DDM to develop an earnings multiplier model, and explain
the factors in the DDM that affect a stock’s price-to-earnings (P/E) ratio;
d. explain the components of an investor’s required rate of return (i.e., the real riskfree
rate, the expected rate of inflation, and a risk premium) and discuss the risk
factors to be assessed in determining a country risk premium for use in estimating
the required return for foreign securities;
e. estimate the implied dividend growth rate, given the components of the required
return on equity and incorporating the earnings retention rate and current stock
price;
f. describe a process for developing estimated inputs to be used in the DDM,
including the required rate of return and expected growth rate of dividends.

Reading 61: Introduction to Price Multiples

The candidate should be able to:
a. discuss the rationales for, and the possible drawbacks to, the use of price to
earnings (P/E), price to book value (P/BV), price to sales (P/S), and price to cash
flow (P/CF) in equity valuation;
b. calculate and interpret P/E, P/BV, P/S, and P/CF.