investing fa13 itb 2
TRANSCRIPT
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InvestingIntroduction to Business
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Covered Today
Primer on investing
Qualitative analyses
Quantitative analyses
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Why Invest?
Companies
Mobilize assets
Counteract inflation
Individuals
Save for retirement
Build wealth
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Choosing Investment Vehicles
Qualitative Analyses
Economic climate
Industry traits Company traits
Quantitative Analyses
Profitability ratios
Leverage ratios
Efficiency ratios
Solvency ratios
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Qualitative Analyses
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Economic Climate
Business Cycle
State of Credit
Consumer Confidence
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Business cycle
*drastically oversimplied
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Cyclicality
Correlation of stock performance with market
activity
Cyclical companies follow the market (Blue) Non-cyclical companies remain constant (Red)
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State of Credit
Expense associated with borrowing money
Determines money supply
In the US, based on the prime rate set by the
federal reserve
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Consumer Confidence
Attempts to predict consumer spending and saving
Difficult to measure
Indices:
Consumer Confidence Index (Conference board)
Consumer Sentiment Index (Mich. – Reuters)
Consumer Comfort Index (Bloomberg)
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Business Traits
Industry Landscape
Product Differentiation
Management
Patents
Suppliers and Customer Channels
International Exposure
Brand Strength
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Quantitative Analyses
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Efficient Market Hypothesis
‘The market always has perfect information, therefore
securities always trade at correct prices’
It is impossible to outperform the market
Stocks may deviate from that correct price on
occasion, but since these movements are random
you cannot consistently beat the market
Instead of picking stocks, invest in an index fund
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Value Investing
Directly contradicts the Efficient Market Hypothesis
A strategy of selecting stocks that trade for less
than their intrinsic values
Value investors believe that the market overreacts
to good and bad news
Stock price fluctuations that do not correspond to
company fundamentals provide opportunities tovalue investors
Similar to discount shopping
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Why Use Ratios?
Eliminate Scale
Allow comparison across time
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Profitability
Evaluate the profitability of a company
Example Ratio:
Return on Equity
P/E
EPS
ROE = (Net Income/Shareholders’ Equity)
Price to Earnings = (Stock Price/Earnings per Share)
EPS = (Net Income / Shares Outstanding)
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ROE
Return on Equity = Net Income
Stockholders Equity
This ratio is used to determine the return on capitalinitially invested by the owners of the firm
Generally a relationship of at least 10 % is desirable
for providing dividends and funds for future growth
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EPS
EPS = Net Income / # Shares Outstanding
Shows how much of the companies profit would be
allocated to each outstanding share
Higher EPS numbers are generally more attractive
to investors than lower EPS numbers
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P/E
P/E = Share Price
Earnings Per Share
A valuation ratio of a company’s current share price compared to its
per share earnings
Expresses how much an investor is willing to pay for a dollar of
earnings
P/E ratios reflect investor sentiments regarding future earnings
growth, high P/E ratios are indicative of bullish investors who believe
the company will experience rapid earnings growth in the future and
therefore investors pay a premium
Benchmark for P/E is between 16-18 but varies within different
industries
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Leverage
Evaluate how the company is financed
Example Ratio
Debt to Equity
D/E = (Total Liabilities/Shareholders’ Equity)
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Debt/Equity
Debt to Equity = Total Liabilities
Total Stockholders Equity
Shows the proportion of debt and equity financing for acompany
Too high debt levels indicate higher risk because acompany has to pay interest on its debt
Values depend on industry, but D/E is generally around 2
Auto companies (capital intensive) High D/E
Service companies Low D/E
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Efficiency
How efficiently is the company operating
Example Ratio
Inventory Turnover Ratio
Net Profit Margin
Asset Turnover Ratio
IT = (Cost of Goods Sold/Average Inventory)
Net Profit Margin = (Net Income/Revenue)
Asset Turnover = (Revenue/ Average Total Assets)
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Inventory Turnover Ratio
Inventory Turnover = Cost of Goods Sold
Average Inventory
Average Inventory = ((Last Year’s Inventory + Current Year’sInventory) / 2)
Shows how efficiently inventory is converted to soldproduct
A low ratio indicates low sales and high inventory,whereas a very high ratio can mean strong sales ortoo little inventory
Benchmark depends on industry
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Net Profit Margin
Net Profit Margin = Net Income
Total Revenue
Shows how efficiently every dollar of revenue isconverted into profit for the company
Higher profit margins are more attractive toinvestors
Benchmark depends on industry
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Asset Turnover Ratio
Asset Turnover = Sales
Average Total Assets
How efficiently a company uses its assets to
generate sales
Generally, the higher asset turnover the better
Benchmark depends on industry
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Solvency
The ability of the company to repay its debts
Example Ratio
Current Ratio
Quick Ratio
Current Ratio = (Current Assets/Current Liabilities)
Quick Ratio = ((Cash + Securities + Accounts
Receivable) / Current Liabilities)
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Current Ratio
Current Ratio = Current Assets
Current Liabilities
This ratio is used to see if, in an emergency, acompany can pay off its immediate debts by sellingits liquid assets
Generally a ratio of 2 to 1 is considered an indicatorof good financial position
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Quick Ratio
Quick Ratio = Cash + Securities + Accounts Receivable
Current Liabilities
Stricter measure of solvency
How is this different from current ratio?
This ratio uses only the most liquid assets.
Liquid assets include: Cash, Securities, Accounts Receivable.
Inventory is not included (some companies have difficulty turning
it into cash)
Healthy companies will have a ratio of approximately 1
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Additional Metrics
Price to Book = (Stock Price/Book Value of Assets)
Price to Revenue = (Stock Price/Revenue per Share)
PEG = (Price/Earnings) / Annual EPS Growth
A ratio that helps to explain a company’s P/E ratio
PEG is a ratio that is used to determine a stock’s
value while taking into account earnings growth As with P/E, a lower PEG ratio means that the stock
is more undervalued
Benchmark is approximately 1
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Beta
Beta = volatility of a stocks’ movements
Beta = 1; the stock is as volatile as the overall stock
market on a whole (average volatility) Beta > 1; the stock is more volatile then the market
as a whole (ex: Tiffany’s)
Beta < 1; the stock is less volatile then the markets
as a whole (ex: Walmart)
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Additional Investing Advice
Invest in What You Know
The average person doesn’t have the time to explore
unknown industries with proper analysis
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Summary
1. Evaluate the state of the economy at large
2. Choose an industry and evaluate its state
3. Compare companies within the industry
Qualitative metrics
Management, Product Differentiation, etc.
Quantitative metrics Profitability, Leverage, Efficiency, Solvency
4. Buy or Sell