LOS
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.
-----------------
Prescribed reading
“Equity: Concepts and Techniques”
Ch. 6, pp. 256–273, International Investments, 5th edition, Bruno Solnik and Dennis McLeavey (Addison Wesley, 2003)
“Industry Analysis”
Ch. 13, pp. 466–468, Investment Analysis and Portfolio Management, 8th edition, Frank K. Reilly and Keith C. Brown (South-Western, 2006)
For points to refresh on Industry analyis based on 7th edition of Reilly and Brown please visit
http://nrao-sapm-handbook.blogspot.com/2007/12/r-b-ch14-points-to-refresh.html
Showing posts with label Equity investment analysis. Show all posts
Showing posts with label Equity investment analysis. Show all posts
Monday, March 17, 2008
Thursday, March 13, 2008
Reading 59: Company Analysis and Stock Valuation
Prescribed reading
“Company Analysis and Stock Valuation”
Ch. 14, pp. 513–516 and 533–548, Investment Analysis and Portfolio Management, 8th edition, Frank K. Reilly and Keith C. Brown (South-Western, 2006)
Visit for points to refresh of this chapter from 7th edition
http://nrao-sapm-handbook.blogspot.com/2007/12/r-b-ch15-points-to-refresh.html
“Company Analysis and Stock Valuation”
Ch. 14, pp. 513–516 and 533–548, Investment Analysis and Portfolio Management, 8th edition, Frank K. Reilly and Keith C. Brown (South-Western, 2006)
Visit for points to refresh of this chapter from 7th edition
http://nrao-sapm-handbook.blogspot.com/2007/12/r-b-ch15-points-to-refresh.html
Types of Stocks
59.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;
Company Analysis and Stock Valuation
By evaluating financial performance variable we can identify good companies. But good companies are not necessarily good investments. For finding a good investment, we have to compare the intrinsic value of a stock to its market value.
Stock of a great company may be overpriced and in such as a case the stock of a growth company may not be growth stock.
Growth Companies
Growth companies have historically been defined as companies that consistently experience above-average increases in sales and earnings. Financial theorists define in more specific terms a growth company as one with management and opportunities that yield rates of return greater than the firm’s required rate of return. So in the definition of financial theorists growth company has a return on investment that is greater than the required rate of return based on its risk measure.
Growth Stocks
Growth stocks are not necessarily shares in growth companies.
A growth stock has a higher rate of return than other stocks with similar risk. Growth stocks give a higher return in comparison to the risk adjusted return that is expected from stocks with similar risk measure.
Superior risk-adjusted rate of return occurs because in the market they are undervalued at that point of time compared to other stocks
Defensive Companies and Stocks
Defensive companies’ future earnings are more likely to withstand an economic downturn. They have low business risk and not excessive financial risk
Defensive stocks are stocks with low or negative systematic risk (beta values). While defensive companies' stocks can be defensive stocks, they are defensive stocks only when their beta value is significantly less than one. So the analyst have to calculate beta value of a stock before declaring any stock as defensive stock.
Cyclical Companies and Stocks
Cyclical companies are those whose sales and earnings will be heavily influenced by aggregate business activity.
Cyclical stocks are those that will experience changes in their rates of return greater than changes in overall market rates of return. In this case beta value of stocks are significantly higher than one.
Speculative Companies and Stocks
Speculative companies are those whose assets involve great risk but those that also have a possibility of great gain.
Speculative stocks possess a high probability of low or negative rates of return and a low probability of normal or high rates of return. When markets are at historical peaks or stocks are way above their intrinsic values, many stocks may become speculative.
Value versus Growth Investing
In the debate about growth and value investing, both growth and value stocks are have higher risk adjusted returns compared to other stocks.
IN this context, growth stocks will have positive earnings surprises and above-average risk adjusted rates of return because the stocks are undervalued relative the growth of earnings and dividends expected from them.
Value stocks appear to be undervalued for reasons besides earnings growth potential. The growth potential in earnings and dividends is not spectacular in these stocks, and the undervaluation will be because of apprehension that the sales and earnings may decline relative to average companies.
On the basis of quantitative criteria, value stocks (population or all the companies from value stocks are identified) usually have low P/E ratio or low ratios of price to book value. Growth stocks (population or all the companies from which growth stocks are identified) usually have high P/E ratios and high price to book value ratios.
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;
Company Analysis and Stock Valuation
By evaluating financial performance variable we can identify good companies. But good companies are not necessarily good investments. For finding a good investment, we have to compare the intrinsic value of a stock to its market value.
Stock of a great company may be overpriced and in such as a case the stock of a growth company may not be growth stock.
Growth Companies
Growth companies have historically been defined as companies that consistently experience above-average increases in sales and earnings. Financial theorists define in more specific terms a growth company as one with management and opportunities that yield rates of return greater than the firm’s required rate of return. So in the definition of financial theorists growth company has a return on investment that is greater than the required rate of return based on its risk measure.
Growth Stocks
Growth stocks are not necessarily shares in growth companies.
A growth stock has a higher rate of return than other stocks with similar risk. Growth stocks give a higher return in comparison to the risk adjusted return that is expected from stocks with similar risk measure.
Superior risk-adjusted rate of return occurs because in the market they are undervalued at that point of time compared to other stocks
Defensive Companies and Stocks
Defensive companies’ future earnings are more likely to withstand an economic downturn. They have low business risk and not excessive financial risk
Defensive stocks are stocks with low or negative systematic risk (beta values). While defensive companies' stocks can be defensive stocks, they are defensive stocks only when their beta value is significantly less than one. So the analyst have to calculate beta value of a stock before declaring any stock as defensive stock.
Cyclical Companies and Stocks
Cyclical companies are those whose sales and earnings will be heavily influenced by aggregate business activity.
Cyclical stocks are those that will experience changes in their rates of return greater than changes in overall market rates of return. In this case beta value of stocks are significantly higher than one.
Speculative Companies and Stocks
Speculative companies are those whose assets involve great risk but those that also have a possibility of great gain.
Speculative stocks possess a high probability of low or negative rates of return and a low probability of normal or high rates of return. When markets are at historical peaks or stocks are way above their intrinsic values, many stocks may become speculative.
Value versus Growth Investing
In the debate about growth and value investing, both growth and value stocks are have higher risk adjusted returns compared to other stocks.
IN this context, growth stocks will have positive earnings surprises and above-average risk adjusted rates of return because the stocks are undervalued relative the growth of earnings and dividends expected from them.
Value stocks appear to be undervalued for reasons besides earnings growth potential. The growth potential in earnings and dividends is not spectacular in these stocks, and the undervaluation will be because of apprehension that the sales and earnings may decline relative to average companies.
On the basis of quantitative criteria, value stocks (population or all the companies from value stocks are identified) usually have low P/E ratio or low ratios of price to book value. Growth stocks (population or all the companies from which growth stocks are identified) usually have high P/E ratios and high price to book value ratios.
Reading 60: An Introduction to Security Valuation: Part II
Prescribed reading
“An Introduction to Security Valuation: Part II”
Ch. 11, Investment Analysis and Portfolio Management, 8th edition, Frank K. Reilly and Keith C. Brown (South-Western, 2006)
LOS
60a. state the various forms of investment returns;
Visit - for refresher points on this chapter
http://nrao-sapm-handbook.blogspot.com/2007/12/r-b-ch11-points-to-refresh.html
“An Introduction to Security Valuation: Part II”
Ch. 11, Investment Analysis and Portfolio Management, 8th edition, Frank K. Reilly and Keith C. Brown (South-Western, 2006)
LOS
60a. state the various forms of investment returns;
Visit - for refresher points on this chapter
http://nrao-sapm-handbook.blogspot.com/2007/12/r-b-ch11-points-to-refresh.html
Earnings Multiplier Model from 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;
DDM model in terms of price (when the market is in equilibrium - each stock's is equal to its value determined by DDM model)
P = D1/k-g
Dividing both sides by E1 (Expected Earnings per share)
P/E1 = (D1/E1)/k-g
so the equilibrium P/E1 ratio is determined by D1/E1, k and g and the DDM model can be used to develop the earnings multiplier model also.
the factors in the DDM that affect a stock’s price-to-earnings (P/E) ratio;
DDM model in terms of price (when the market is in equilibrium - each stock's is equal to its value determined by DDM model)
P = D1/k-g
Dividing both sides by E1 (Expected Earnings per share)
P/E1 = (D1/E1)/k-g
so the equilibrium P/E1 ratio is determined by D1/E1, k and g and the DDM model can be used to develop the earnings multiplier model also.
Reading 61: Introduction to Price Multiple
Prescribed reading:
John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003)
LOS
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.
John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003)
LOS
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.
Price to Cash Flow Valuation Multiple
The use of this ratio is also becoming popular.
According to Reilly and Brown, the growth in popularity of this relative valuation technique can be traced to concern over the propensity of some firms to manipulate earnings per share. Cash flow values are generally less prone to manipulation.
Discounted cash flow techniques use only cash flow as the basis for valuation.
According to Reilly and Brown, the growth in popularity of this relative valuation technique can be traced to concern over the propensity of some firms to manipulate earnings per share. Cash flow values are generally less prone to manipulation.
Discounted cash flow techniques use only cash flow as the basis for valuation.
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