R◦I◦T Financial Management Association

Fundamental Analysis Valuation

What is Fundamental Analysis?

• Discovering the fundamental value of a company; what is a business worth?

• Analyze:– Financial Strength (ex. Financial statements)– Past Performance – Growth Potential– Management– Get the “grand picture” of the company

R◦I◦T F◦M◦A

Efficient Market Hypothesis

• In an active market that includes many well-informed and intelligent investors, securities will be appropriately priced and reflect all available information.

• If a market is efficient, no information or analysis can be expected to result in out performance of an appropriate benchmark.

R◦I◦T F◦M◦A

Efficient Market Hypothesis• Strong Form Efficiency: Share prices reflect all

information and no one can earn excess returns.

• Semi-strong Form Efficiency: Share prices adjust within an arbitrarily small but finite amount of time and in an unbiased fashion to publicly available new information, so that no excess returns can be earned by trading on that information.

• Weak Form Efficiency: Implies that Technical analysis techniques will not be able to consistently produce excess returns, though some forms of fundamental analysismay still provide excess returns.

http://en.wikipedia.org/wiki/Efficient_market_hypothesis R◦I◦T F◦M◦A

Behavioral Finance

•Studies how cognitive or emotional biases, which are individual or collective, create anomalies in market prices and returns that may be inexplicable via EMH alone.

•Example: Stock Market Crash of 1987

R◦I◦T F◦M◦A

Where Do I Begin?

• What does the company do?

• How big is it?

• Company Goals

• Financial Health

• Competitive Landscape

• Economic Conditions

R◦I◦T F◦M◦A

• Who are they?

• Do they make products or sell services?

• Who are they targeting?

R◦I◦T F◦M◦A

What Does the Company Do?

How Big Is The Company?

• Micro-cap: $100 million or less• Small-cap: $100 million to $500 million• Mid-cap: $500 million to $5 billion• Large-cap: $5 billion +

R◦I◦T F◦M◦A

Market Cap = Shares Outstanding x Share Price

Financial Statements

• Income Statement

• Cash Flow Statement

• Balance Sheet

R◦I◦T F◦M◦A

The Income Statement

• The purpose of the income statement is to show managers and investors whether or not the company made or lost money during the period being reported.

What does it look like?

R◦I◦T F◦M◦A

The Cash flow Statement

• A cash flow statement is a financial report that shows incoming and outgoing money during a particular period.

http://en.wikipedia.org/wiki/Cash_flow_statement#Operating_activities

R◦I◦T F◦M◦A

Statement of Retained Earnings

Ending Retained Earnings = Beginning Retained Earnings + Investments - Dividends Paid + Net Income

•Shows the change in retained earnings over time

•The Statement of Retained Earnings uses information from the income statement, and provides information to the balance sheet.

R◦I◦T F◦M◦A

The Balance SheetIt is a snapshot of a companies current financial position

Assets

-Current Assets

-Fixed Assets

Liabilities

-Current Liabilities

-Fixed Liabilities

Equity

http://en.wikipedia.org/wiki/Balance_sheet

R◦I◦T F◦M◦A

R◦I◦T F◦M◦A

Price to Sales Price to Book

Price to Earnings

(P/E)

Gross Profit Margin

Beta Return on Equity

(ROE)

Current Ratio Debt Ratio

Show Me the Numbers!

R◦I◦T F◦M◦A

Price to Sales

Share Price/

Revenue Per ShareP S

•P/S ratio can be used in comparison to other companies

•How much is being paid for per share of sales

•If P/S < 1, it means investors are paying less for each unit of sales

R◦I◦T F◦M◦A

Price to Earnings

Share Price/

Earnings Per ShareP E

•Companies with no growth do not have a P/E ratio

•A high P/E ratio could mean higher growth in the future

R◦I◦T F◦M◦A

Price to Book

Share Price/

Total Assets - Intangible Assets &LiabilitiesP B

•Compares the company’s share price to their book value

•A low P/B ratio could mean:

•Stock undervalued

•Something very wrong…

R◦I◦T F◦M◦A

Gross Profit Margin

•How much do they get to keep?

•Use in comparison to other companies to determine who has the highest Gross Profit Margin

Revnues - Cost of Goods Sold

Revenue

R◦I◦T F◦M◦A

Beta

•A method of measure of risk in comparison to the market

•The market has a Beta equal to 1

•Beta > 1 = riskier than the market

•Beta < 1 = less riskier than the market

•Beta = or close to 0 is no risk in comparison to the market

•Get examples

R◦I◦T F◦M◦A

Return on Equity (ROE)

Useful to comparing the profitability of a firm in regards to its’ competitors.

Net Income

Shareholder's Equity

R◦I◦T F◦M◦A

Debt Ratio

Debt Ratio > 1= company has more debt than assets

Debt Ratio < 1 = company has more assets than debt

*Used as a tool to measure risk of companies

Total Debts

Total Assets

R◦I◦T F◦M◦A

Current Ratio

•Measure of ability to pay short-term liabilities

•Higher ratios means the more capable a company is to paying back short-term debt

Current Assets

Current Liabilities

R◦I◦T F◦M◦A

Is This Company Profitable?

•Gross Margin/Profit/Income, Net Income

•Look at company’s income statement

•Look at historical gross margin

•How much does it sell and how much does the company get to keep?

•More income = more for future business operations, return to investors

•Look for companies to perform better than their competitors!

•Citigroup Annual Income Statement

R◦I◦T F◦M◦A

Stock Performance

•What has the stock price done in the past year? 5 years? All of its history?

•Does it show solid performance or very volatile performance?

•Google Stock Performance

•Yahoo! Stock Performance

R◦I◦T F◦M◦A

Management

•Is management stable?

•Recent change in management?

•Has change in management affected the stock price?

•HP Probe

R◦I◦T F◦M◦A

Competitive Landscape

•How are they performing in regards to competitors?

•Compare to their industry, compare to the overall market

•Compare:

•Share price

•Profit margins

•Financial ratios

•Strategies

•Target markets

Dividends

Defined: Payments made by a company to its shareholders.

Important Dates:

• Declaration Date• Date of Record• Ex-Dividend Date (usually before Date of Record)

• Can be cash, stock, or assets.

R◦I◦T F◦M◦A

Dividends

• The power of dividends. GE 1996 Dividend: $.35

GE 2006 Dividend:$1.00

That’s a 186% increase in dividends over the past 11years!

• Average Annual increase 16.9%

• If this were to continue, a share of GE bought today, would yield a $4.08 dividend ten years from now.

@13%= $3.00 per shareR◦I◦T F◦M◦A

Dividends

Not always a good thing?

•Can indicate lack of growth

•Dividend may be unsustainable

•The effects of cutting a dividend

R◦I◦T F◦M◦A

Stock Splits• Ordinary stock splits occur when a publicly held company

distributes more stock to holders of existing stock.

• 2-for-1: is when a company simply issues one additional share for every one outstanding.

• The company's net assets didn't increase, only the number of outstanding shares.

• Companies issue splits to make the stock more attractive to investors whether it be an ordinary split or a reverse split.

http://invest-faq.com/articles/stock-split.html

R◦I◦T F◦M◦A

Stock Buybacks

• Income Statement

R◦I◦T F◦M◦A

A Nastie Example…for tying the importance of financial statements

together

http://finance.yahoo.com/q?s=tsty

R◦I◦T F◦M◦A

Benchmarking – How do we compare?

The most widely accepted benchmark is the performance of the Standard and

Poor’s 500 Index.

R◦I◦T F◦M◦A

• S&P 500 used to compare stock performance of a single firm against the 500 largest American publicly traded companies– Only useful when the company in

consideration is equivalent in size and stature to the components of this index.

– For example, one would not wish to compare the performance of a BB stock against the $SPX

R◦I◦T F◦M◦A

Benchmarking Continued

Standard and Poor’s Fortune 500 Index up less than 50% in past five years

R◦I◦T F◦M◦A

ANF up 300% in past five years

• Financial ratios used to compare a firm’s financial performance to a competitor’s

• Popular ratios are Profit Margin, Return on Assets, Inventory Turnover, and the Quick Ratio

R◦I◦T F◦M◦A

Other Methods of Benchmarking

Profitability CompanyIndustry

MedianMarket

Median1

Gross Profit Margin 66.70% 35.10% 51.80%

Pre-Tax Profit Margin 19.40% 6.40% 6.30%

Net Profit Margin 12.00% 4.20% 4.80%

Return on Equity 36.7% 18.3% 9.3%

Return on Assets 20.4% 9.4% 1.6%

Return on Invested Capital 27.6% 12.3% 4.2%

R◦I◦T F◦M◦A

Key Ratios, using the Industry as a Benchmark

Valuation CompanyIndustryMedian

MarketMedian1

Price/Sales Ratio 2.10 0.96 2.15

Price/Earnings Ratio 17.37 19.03 18.62

Operations CompanyIndustryMedian

MarketMedian1

Days of Sales Outstanding 11.62 5.36 57.47

Inventory Turnover 2.4 4.7 5.6

Financial CompanyIndustryMedian

MarketMedian1

Current Ratio 1.90 2.18 1.71

Quick Ratio 1.0 0.9 1.2

R◦I◦T F◦M◦A

R◦I◦T F◦M◦A

ANF and the Competitive Landscape

R◦I◦T F◦M◦A

Where to Invest?

R◦I◦T F◦M◦AR◦I◦T F◦M◦A

How Can I Find More Information?

• Yahoo! Finance• MSN Money Central• Hoovers Online through RIT• Mergent Online through RIT• Investext• S&P NetAdvantage through RIT• SmartMoney.com• Annual Reports

R◦I◦T F◦M◦AR◦I◦T F◦M◦A