1. IV(A.1) Recommendations and representations should have a reasonable basis
Required conduct
(1) Be diligent and thorough in investigations, when making recommendations, or when undertaking investment actions for others.
(2) Have a reasonable and adequate basis, supported by appropriate research, for recommendations and investments.
(3) Avoid material misrepresentation in any research report or investment recommendations.
(4) Maintain files and records to support the reasonableness of recommendations and investment decisions.
Members must make reasonable and diligent efforts to ensure any research report is accurate. Members should not use any information from a source he or she has reason to suspect is not accurate.
2. IV(A.2) research Reports
Required conduct
(1) Include all relevant factors in research reports.
(2) Distinguish between facts and opinions in research reports.
(3) Indicate the basic characteristics of the investment for any research reports containing an investment recommendation.
Research report encompasses all means of communicating an investment recommendation. These includes:
(1) Traditional research reports on the market, a class of investments, asset allocation, or a specific secuirity in paper form.
(2) IN-person or telephone recommendations.
(3) Media broadcasts
(4) Computer transmissions (e.g., the Internet)
Capsule recommendations (such as a “buy” or “sell” lists) must be supported by background reports or data that are available to interested members.
(5) A supervisory analyst should check research reports to assure compliance with these standards.
3. IV(A.3) Maintaining Independence 0and Objectivity
Required conduct
Every member should avoid situations that might cause, or be perceived to cause, a loss of independence and objectivity in recommending investments or taking investment action.
Analysts and portfolio managers violate this standard if they:
(1) Take an allocation of shares in oversubscribed IPOs for their personal account.
(2) Accept expensive gifts or entertainment from corporations (corporations that are not clients)
(3) Allow their firm’s business relationships with a company to affect a research review or investment decision.
(4) Allow compensation schedules to affect judgment.
4. IV(B.1) fiduciary Duties
The member has the responsibility to understand and comply with his or her fiduciary duties. This standard relates primarily to those who have discretionary authority in managing clients’ assets, or have other relationships of special trust. It is especially important in cases of managing trust and pension funds.
To satisfy this standard, members have an affirmative obligation to determine what their fiduciary duties are:
a. Required Conduct of Fiduciaries in General
(1) The duties of fiduciaries are to be found in :
(2) The general duties of fiduciaries are:
(a) Loyalty
(b) Care
(c) Prudence
(d) Impartiality
(e) Discretion
(3) Members with control over client assets should
b. Required Conduct of Trustees
(1) the Prudent Man Rule requires that every investment undertaken for a trust, standing alone, must be made prudently, i.e., with the prime directive of preserving the value of the corpus of the trust and secondarily, providing a safe return on the capital invested.
More recently, states have moved towards a Prudent Investor rule.
(a) Under the Prudent Man Rule, certain asset classes might be interpreted to be inherently imprudent (e.g., options), whereas no asset class is considered inherently imprudent under the Prudent Investor Rule. The riskiness of assets must be considered within a portfolio context in P.I.R.
(b) Under the P.M.R., the standard of prudence is applied to each asset held in trust, standing alone. Under the P.I.R. the standard of prudence is applied to the overall portfolio. The prime directive is to achieve a return/risk objective that is reasonable, without exceeding a level of overall portfolio risk that an investment professional would deem suitable to the trust under the prevailing circumstances. Employing overly conservative strategies may be subjected to less criticism under the traditional P.M.R. Under the P.I.R., overly conservative investment strategies may not be justified if they result in generating significantly inferior returns.
(c) The P.I.R. requires that trust investments be reasonably diversified.
(d) Under Traditional P.M.R. trustees were usually not permitted to delegate the authority to make investments. Under P.I.R. trustees may delegate the authority to make investment decisions to qualified investment managers, as long as those managers are selected prudently.
(e) Paying above average commissions for research or other services provided by a broker is permitted if the fiduciary comes to a bona fide conclusion that the services rendered are worth the extra cost.
(f) The modern P.I.R. standards generally impose a professional standard of care and prudence (Prudent Expert Standard).
(g) Other fiduciary duties that must be followed under U.S. law are:
(1) All of the beneficiaries of a trust should be treated equally.
(2) Best efforts must be applied to maximizing after-tax returns.
(3) Legal requirements, such as the filing of periodic financial statements and tax returns required by law, must be known and satisfied.
c. Required conduct for Managing Private Retirement Plans Governed by ERISA
Under ERISA, fiduciaries of retirement plans have the following affirmative duties:
(1) Loyalty: Loyalty, under ERISA, require them to act solely in the interest of the plan participants and beneficiaries with the exclusive purpose of: (a) Providing plan benefits. (b) Defraying reasonable plan expenses.
(2) Care: Care requires them to use all of the skills of a professional in carrying out their responsibilities. Thus ERISA applies a Prudent Expert standard.
(3) Prudence: Prudence requires them to take no risks that are likely to endanger the ability of the plan to provide promised benefits and earn a reasonable return commensurate with the risk taken.
(4) Know and Carry out their Responsibilities as Defined by the Plan’s Trust Documents
(5) ERISA prohibits fiduciaries from
(a) Self-Dealing
(b) Permitting conflicts of interest
(c) Receiving “Kickbacks”
(d) Dealing with Parties in Interest.
d. Legal Rights and Beneficiaries and participants under ERISA
Under ERISA, plan participants and beneficiaries who believe that their retirement trust is not being operated solely for their best interests may bring civil action again the plan fiduciaries. If victorious, they have the right to recover both the losses the court decides they have suffered as a result of breaches of duty by the plan fiduciaries and their attorney(s) fees.
e. Required Conduct for Fiduciaries Associated with Public Pension Plans
f. Required Conduct for Fiduciaries of Charitable Organizations and Endowments
(1) In the U.S. fiduciary duties of fiduciaries of charitable organizations and endowments are primarily contained in the Uniform Management of Institutional Funds Act (UMIFA), which embodies most of the same standards as those found in the Prudent Man and Prudent Investor Standards.
UMIFA does impose some unique affirmative duties on institutional fiduciaries. These are:
(a) Fiduciaries must formulate policies for the investment program of the organization’s assets. Such policies should be based on:
(1) the amount of funds needed on a long- and short term basis, to carry out the work of the institution.
(2) The current and probable future resources of the organization.
(3) The expected return on its assets.
(4) Probable future economic trends.
(b) to follow spending and investment policies adopted by the institution.
g. Required Conduct for Money Managers
(1) Money managers can look to the Investment Advisors Act of 1940 for some behavioral guidance. This act prohibits investment advisors from
(2) Some general principles that should guide a money manager are
(a) be honest and loyal to the client, acting always in the clients best interest.
(b) Use care and independent professional judgment in investment matters.
(c) Have a reasonable basis for investment decisions.
(d) Avoid conflicts of interest or make full disclosure of facts and circumstances that could be construed as a conflict of interest.
(e) Make sure investment actions and advice are suitable for the client.
(f) Obtain the best executions’ on trades for clients. Make sure that commissions and other expenses are reasonable for the service rendered.
(g) Avoid misrepresentations of all kinds, particularly with respect to performance presentations.
h. Required Conduct for Brokers and Dealers
In particular, brokers and dealers:
(1) Should not churn customer accounts.
(2) Should not accept funds when their firms are insolvent
(3) Should not engage in fraudulent, deceptive or manipulative practices.
(4) Should not exploit their customers’ trust or ignorance
(5) Should deal fairly with their clients.
i. Required Conduct for Security Analysts
Research analyst must:
(1) Do the best job they can for their employers and their employers’ clients.
(2) Se independent judgment.
(3) Have an adequate basis for their recommendations
(4) Deal fairly with clients and fellow professionals.
j. Other Issues Regarding the Required Conduct of Fiduciaries
(1) Social Investing: Social investing is permitted under most fiduciary laws and guidelines only if:
(a) The portfolio’s return and risk are not compromised.
(b) Diversification is still adequate
(c) Excessive costs are not incurred.
(2) Relationship Investing
(3) Proxy voting
The U.S. Dept of Labor has set forth specific regulations for proxy voting of shares held by qualified retirement plans governed by ERISA.
(a) The investment manager has the fiduciary responsibility of voting proxies arising form the retirement plans under his or her control, unless the plan documents designate some other person)s) as the responsible Party(s)
(4) Soft Dollars
When an investment manager pays for goods or services that benefit the manager by channeling security transactions through specific brokers who are paid commissions for those transactions, the funds paid are called “soft dollars.” When managers use their own funds to pay for goods and services, such payments are called “hard dollars.”
(a) The primary rule is that brokerage belongs to the client. Fiduciaries must not use client funds for their own benefit. However transactions involving soft dollars are permitted under the following circumstances:
(1) the goods or services purchased help the manager make a better investment decision.
(b) ERISA imposes a sole benefit test of loyalty for the management of pension plans.
5. IV(B.2) Portfolio Investment Recommendations and Actions
a. required conduct
Members shall:
(1) Inquire as to client’s financial situation, investment experience, and investment objectives before any investment recommendations or action are made. Update this information at least once a year.
(2) Before making a recommendation or taking investment action, determine the appropriateness and suitability of the action by considering:
(a) The client’s needs and circumstances
(b) The basic characteristics of the investment
(c) The client’s investment experience and objectives.
(3) Distiniguish between facts and opinions in presenting investment recommendations.
(4) Disclose to clients and prospects the basic format and general principles by which securities are selected and portfolios are constructed. Promptly disclose to clients and prospects any changes that might significantly affect this process.
(5) Obtain written authorization from the client to make changes.
Saturday, November 15, 2008
D. Standard IV: Relationships with and Responsibilities to Clients and Prospects - Part II
6. IV(B.3) Fair Treatment of clients
Required conduct
Deal fairly with clients regarding:
(1) Dissemination of recommendations
(2) Dissemination of changes of prior opinions
(3) Taking investment action.
Every effort should me made to communicate investment ideas to clients, for which the ideas are suitable and who have a known interest in them, as simultaneously as possible within reasonable limits defined by communications technology.
7. IV(b.4)Priority of Transactions
Required conduct
This standard applies to all members and access persons (defined as persons who have advanced knowledge pertaining to upcoming research recommendations, changes in opinions about securities, and/or pending investment actions to be taken either by the firm itself, or on behalf of clients).
There is nothing unethical about access persons investing for their own benefit. The personal investments of access persons and investment professionals must be undertaken within the confines of the following restrictions.
(1) Interests of clients, the employer, and the integrity of the professional must be put ahead of the access person’s or member’s own personal interests.
(2) Care must be taken that personal investments do not create conflicts of interest or impair the investment professional’s ability to be objective and render independent professional judgments about securities.
(3) All applicable laws, regulations, and compliance procedures must be followed.
(4) The investment professional should not receive a personal benefit from investment actions taken on behalf of a client (except for the usual and customary compensation for the service rendered).
Compliance Procedures
8. IV(B.5) Confidentiality
Required conduct
Preserve the confidentiality of client and employer information, unless it concerns illegal activities. The best approach is never to disclose information received from a client or employer, except to authorized persons on a “need to know” basis.
9. IV(B.6) Prohibition against misrepresentations
Required conduct
A member may not misrepresent:
(1) The performance of his or her (or the employer’s) services or investment performance.
(2) Their qualifications or the qualifications of their firm.
(3) Their academic and professional standards.
Members should ensure that misrepresentation does not occur in oral presentations, advertising, electronic communication, or written materials.
No guarantees should be given regarding the outcome or the probable return on an investment.
10. IV (B.7) Disclose conflicts of interest to clients and prospects
Required conduct
Members must disclose to clients and prospects any potential conflict of interest. Disclosure of any matter that could reasonably be expected to impair objectivity allows clients to judge motives and possible biases for themselves.
11. IV(B.8) Disclose referral fees
Required conduct
The existence of referral fees, their nature, and their amount should be disclosed in writing to any prospective client, as soon as the client is referred to a member.
Compliance Procedures
Required conduct
Deal fairly with clients regarding:
(1) Dissemination of recommendations
(2) Dissemination of changes of prior opinions
(3) Taking investment action.
Every effort should me made to communicate investment ideas to clients, for which the ideas are suitable and who have a known interest in them, as simultaneously as possible within reasonable limits defined by communications technology.
7. IV(b.4)Priority of Transactions
Required conduct
This standard applies to all members and access persons (defined as persons who have advanced knowledge pertaining to upcoming research recommendations, changes in opinions about securities, and/or pending investment actions to be taken either by the firm itself, or on behalf of clients).
There is nothing unethical about access persons investing for their own benefit. The personal investments of access persons and investment professionals must be undertaken within the confines of the following restrictions.
(1) Interests of clients, the employer, and the integrity of the professional must be put ahead of the access person’s or member’s own personal interests.
(2) Care must be taken that personal investments do not create conflicts of interest or impair the investment professional’s ability to be objective and render independent professional judgments about securities.
(3) All applicable laws, regulations, and compliance procedures must be followed.
(4) The investment professional should not receive a personal benefit from investment actions taken on behalf of a client (except for the usual and customary compensation for the service rendered).
Compliance Procedures
8. IV(B.5) Confidentiality
Required conduct
Preserve the confidentiality of client and employer information, unless it concerns illegal activities. The best approach is never to disclose information received from a client or employer, except to authorized persons on a “need to know” basis.
9. IV(B.6) Prohibition against misrepresentations
Required conduct
A member may not misrepresent:
(1) The performance of his or her (or the employer’s) services or investment performance.
(2) Their qualifications or the qualifications of their firm.
(3) Their academic and professional standards.
Members should ensure that misrepresentation does not occur in oral presentations, advertising, electronic communication, or written materials.
No guarantees should be given regarding the outcome or the probable return on an investment.
10. IV (B.7) Disclose conflicts of interest to clients and prospects
Required conduct
Members must disclose to clients and prospects any potential conflict of interest. Disclosure of any matter that could reasonably be expected to impair objectivity allows clients to judge motives and possible biases for themselves.
11. IV(B.8) Disclose referral fees
Required conduct
The existence of referral fees, their nature, and their amount should be disclosed in writing to any prospective client, as soon as the client is referred to a member.
Compliance Procedures
Friday, November 14, 2008
Relationships with and Responsibilities to the Investing Public
Ethical and Professional Standards
Standard V: Relationships with and Responsibilities to the Investing Public
1. V(A) Do not use material nonpublic information
Members shall not make any investment action (trade the security, or make a recommendation regarding the security), or communicate the information, when in the possession of material nonpublic information related to the value of a security if such action would breach a duty, the information was misappropriated, or if it relates to a tender offer. If such material nonpublic information is received, an effort should be made to get the company about whom the information relates to make a public disclosure of the information, except if the information was received because of a special or confidential relationship with the company (as in the case of “constructive” insider), and the information is to be kept in confidence.
a. Definitions of Material Nonpublic Information
(1) Traditional theory
(a) Information must be material. Information is material if:
(1) It pertains to a tender offer.
(2) It would significantly change the total mix of information about a company, its affairs, or its securities; i.e., a reasonable investor would want to know it before making an investment decision, or, if known it would probably have an impact on the price of a security.
(3) It is a specific fact, rather than an opinion.
(b) The information must be Nonpublic. Information becomes public as soon as the company discloses it in a way calculated to make it available to the general investing public. Corporate disclosure made to a “room full of analysts” does not constitute disclosure under the law.
(c) The source Must be an insider: Someone who knows the information because he or she is in a position to receive confidential information about a company’s affairs and who has a fiduciary duty not to disclose it.
Tippees, such as analysts who receive material nonpublic information, may legally use it, unless they are brought into the fold of confidentiality or then know that the information was mis-appropriated or obtained illegally. They are brought into the fold of confidentiality when they are given the information for a legitimate business purpose.
Note that a fiduciary duty exists as a matter of law; it cannot be imposed simply by telling someone to “keep this information confidential.”
(2) Misappropriation Theory
Under the misappropriation theory, individuals commit securities fraud if they obtain material nonpublic information from another to whom they owe a duty of trust and confidence, and then communicate that information or use it as the basis of a trade or recommendation, even if they owe no fiduciary duty to the issuer of the involved issuer. They also commit fraud if they obtain material nonpublic information illegally.
The concept is that material nonpublic information is “property.” If anyone who has access to this information uses it for their own personal benefit, or give it to others, they misappropriate company property. This is a form of theft, which is punishable by criminal and civil actions.
b. The Mosaic theory
Taking several immaterial and/or publicly available stand-alone facts from various sources and putting them together to form a complete and significant picture of a corporate situation is called the mosaic theory. This is the analyst’s job and is completely legal.
c. Required conduct
(1) Members shall not take any investment action or communicate information about a security or company, when in the possession of material nonpublic information related to the value of the security if such action would breach a duty owed to the company, the information was misappropriated, or if it relates to a tender offer.
(2) When acting as a consultant or any other role in which the member becomes a “temporary insider” keep information received confidential and do not use it for investment purposes or communicate it to others.
d. Legal Ramifications of Using or Communicating Inside or Misappropriated Information
Penalties include:
(1) Fines up to $1,000,000 for individuals ($2,500,000 for firms)
(2) Disgorgement of up to three times any illicit profits (or losses avoided) from trading (or recommending) securities based on inside or misappropriated information.
(3) Jail terms of up to 10 years.
(4) Civil suit for damages suffered by the counterparties to any illegal trades.
(5) Sanction by regulating bodies, primarily the SEC.
e. Compliance Procedures
(1) Do not seek out material nonpublic information.
2. V(B) Performance Presentation
Members may not misrepresent their investment performance record, either in terms of the presentation or the measurement of those results. When communicating data about the performance history of accounts or composites (group of accounts), either of the individual investment manager or of a firm, the member must give a fair and complete presentation. It is unethical to misrepresent past investment performance or the investment performance that a client can reasonably expect to obtain in the future.
a. Reasons Why Performance Presentation Standards are Necessary
Historically, investors have faced many difficulties in obtaining fair performance results that were comparable among various investment management firms.
Therefore, AIMR developed the AIMR Performance presentation Standards and Global Investment Performance Standards in the hope that a set of globally accepted common standards will enable performance results among various investment firms to become truly comparable.
b. Required conduct
(1) Members may not misrepresent
(2) When communicating data about the performance history of individual accounts, composites (groups of accounts), an individual investment manager, or an entire firm, the member must give a fair and complete presentation.
c. Compliance Procedures
(1) Compliance with the AIMR Performance Presentation Standards and/or the Global Investment Performance Standards is the best way to comply with this standard.
Standard V: Relationships with and Responsibilities to the Investing Public
1. V(A) Do not use material nonpublic information
Members shall not make any investment action (trade the security, or make a recommendation regarding the security), or communicate the information, when in the possession of material nonpublic information related to the value of a security if such action would breach a duty, the information was misappropriated, or if it relates to a tender offer. If such material nonpublic information is received, an effort should be made to get the company about whom the information relates to make a public disclosure of the information, except if the information was received because of a special or confidential relationship with the company (as in the case of “constructive” insider), and the information is to be kept in confidence.
a. Definitions of Material Nonpublic Information
(1) Traditional theory
(a) Information must be material. Information is material if:
(1) It pertains to a tender offer.
(2) It would significantly change the total mix of information about a company, its affairs, or its securities; i.e., a reasonable investor would want to know it before making an investment decision, or, if known it would probably have an impact on the price of a security.
(3) It is a specific fact, rather than an opinion.
(b) The information must be Nonpublic. Information becomes public as soon as the company discloses it in a way calculated to make it available to the general investing public. Corporate disclosure made to a “room full of analysts” does not constitute disclosure under the law.
(c) The source Must be an insider: Someone who knows the information because he or she is in a position to receive confidential information about a company’s affairs and who has a fiduciary duty not to disclose it.
Tippees, such as analysts who receive material nonpublic information, may legally use it, unless they are brought into the fold of confidentiality or then know that the information was mis-appropriated or obtained illegally. They are brought into the fold of confidentiality when they are given the information for a legitimate business purpose.
Note that a fiduciary duty exists as a matter of law; it cannot be imposed simply by telling someone to “keep this information confidential.”
(2) Misappropriation Theory
Under the misappropriation theory, individuals commit securities fraud if they obtain material nonpublic information from another to whom they owe a duty of trust and confidence, and then communicate that information or use it as the basis of a trade or recommendation, even if they owe no fiduciary duty to the issuer of the involved issuer. They also commit fraud if they obtain material nonpublic information illegally.
The concept is that material nonpublic information is “property.” If anyone who has access to this information uses it for their own personal benefit, or give it to others, they misappropriate company property. This is a form of theft, which is punishable by criminal and civil actions.
b. The Mosaic theory
Taking several immaterial and/or publicly available stand-alone facts from various sources and putting them together to form a complete and significant picture of a corporate situation is called the mosaic theory. This is the analyst’s job and is completely legal.
c. Required conduct
(1) Members shall not take any investment action or communicate information about a security or company, when in the possession of material nonpublic information related to the value of the security if such action would breach a duty owed to the company, the information was misappropriated, or if it relates to a tender offer.
(2) When acting as a consultant or any other role in which the member becomes a “temporary insider” keep information received confidential and do not use it for investment purposes or communicate it to others.
d. Legal Ramifications of Using or Communicating Inside or Misappropriated Information
Penalties include:
(1) Fines up to $1,000,000 for individuals ($2,500,000 for firms)
(2) Disgorgement of up to three times any illicit profits (or losses avoided) from trading (or recommending) securities based on inside or misappropriated information.
(3) Jail terms of up to 10 years.
(4) Civil suit for damages suffered by the counterparties to any illegal trades.
(5) Sanction by regulating bodies, primarily the SEC.
e. Compliance Procedures
(1) Do not seek out material nonpublic information.
2. V(B) Performance Presentation
Members may not misrepresent their investment performance record, either in terms of the presentation or the measurement of those results. When communicating data about the performance history of accounts or composites (group of accounts), either of the individual investment manager or of a firm, the member must give a fair and complete presentation. It is unethical to misrepresent past investment performance or the investment performance that a client can reasonably expect to obtain in the future.
a. Reasons Why Performance Presentation Standards are Necessary
Historically, investors have faced many difficulties in obtaining fair performance results that were comparable among various investment management firms.
Therefore, AIMR developed the AIMR Performance presentation Standards and Global Investment Performance Standards in the hope that a set of globally accepted common standards will enable performance results among various investment firms to become truly comparable.
b. Required conduct
(1) Members may not misrepresent
(2) When communicating data about the performance history of individual accounts, composites (groups of accounts), an individual investment manager, or an entire firm, the member must give a fair and complete presentation.
c. Compliance Procedures
(1) Compliance with the AIMR Performance Presentation Standards and/or the Global Investment Performance Standards is the best way to comply with this standard.
Ethical and Professional Standards - Corporate Governance
VI. Corporate Governance
A. Introduction
B. Fiduciaries Responsible for Voting Proxies
C. Proxy Voting Standards for Fiduciaries
D. Recommended elements in a proper Proxy Voting Policy
1. Designate a competent individual or policy making body as being responsible for implementing and monitoring a proxy voting policy. This person or body should:
2. Set up administrative procedures that:
E. Laws and Regulations Regarding the Voting of Proxies by Fiduciaries
A. Introduction
B. Fiduciaries Responsible for Voting Proxies
C. Proxy Voting Standards for Fiduciaries
D. Recommended elements in a proper Proxy Voting Policy
1. Designate a competent individual or policy making body as being responsible for implementing and monitoring a proxy voting policy. This person or body should:
2. Set up administrative procedures that:
E. Laws and Regulations Regarding the Voting of Proxies by Fiduciaries
Monday, March 17, 2008
Reading 58: Equity: Concepts and Techniques
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
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
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.
Subscribe to:
Posts (Atom)
