V. STOCKS I. Fundamental Analysis (Continued)

V. STOCKS

I. Fundamental Analysis (Continued)

b. Components of the Income Statementi. Total Revenue = gross receipts, total received from

operationsii. Cost of Revenue = cost of goods sold, direct costs for

components of the productiii. Gross Profit = revenues less cost of revenuesiv. Operating Expense = costs related to production of

product or servicesv. Operating Income or Loss = profits generated by sales,

net of cost of goods sold and operating expensevi. Earnings Before Interest, Taxes, Depreciation, and

Amortization = income generated by operations before accounting adjustments

vii. Operating Free Cash Flow = calculated by subtracting all cash expenses from all sources of operating revenue


2. Balance Sheeta. A “snapshot” of corporate assets and

liabilities at a particular timeb. Components of the Balance Sheet

i. Current Assets – items owned by a corporation that can be readily turned into cash

ii. Current Liabilities – short term debtiii. Common Stock & Retained Earnings –

accumulated profits allocated to shareholdersiv. Treasury Stock – a negative number indicates a

stock buy back – increases per share earnings and potentially stock price


3. Statement of Cash Flowsa. Measures cash generated or consumed by a

corporationb. Components

i. Cash flows provided by or used in operations – shows whether core operations are generating or consuming cash

ii. Cash flows provided by or used in capital expenditures – shows whether a firm is investing in its business

iii. Cash flows provided by or used in financing – can show a company’s ability to raise capital or whether capital is being used by financing activities (stock buy backs, paying off debt)

iv. Change in cash and cash equivalents – total effect – whether the corporation is generating or consuming cash (firm’s liquidity)


Sample Statements: e10vq , e10vq

http://www.sec.gov/Archives/edgar/data/1159167/000095013508005241/b71181ice10vq.htm


4. Basic Ratiosi. Earnings per Share = total earnings

outstanding shares

Tracks profitability regardless of firm size

ii. Price/Earnings Ratio (P/E Ratio) =current share priceearnings per share

Provides a rough estimate of market opinion of current and future corporate operations


iii. Return on Assets = earnings assets

Measures efficiency of use of firm assets

iv. Return on Equity = earnings common

stock equity

Measures efficiency of the use of shareholder capital


v. Return on Invested Capital (ROIC) = EBITD common and preferred stock equity & long term debt

Measures efficiency of the use of the entire corporate capital structure

vi. Debt/Equity Ratio = total debt market capitalization

Measures the leverage in a company and thus its vulnerability to interest rate changes


vii. Current Ratio = Current Assets Current Liabilities

A measure of liquidity, whether a company has sufficient assets to pay current debts


5. Issues Regarding Outstanding Sharesa. Float – the number of shares outstanding

(available for purchase)b. Stock repurchase (buy back) program –

where a company purchases its own shares on the open market – reduces float (reduces supply of shares), decreasing number of shares outstanding, increasing earnings per share, and increasing share price


6. Choosing Stocks Based Upon Fundamentals

a. Stock Market Selection Methodsi. Dogs of the Dow – buy highest yielding Dow

stocks at the beginning of the year, selling best of stocks after 12 months

ii. Relative Strength from Investors Business Daily – compares stocks with the overall market Investors.com: HELP


iii. S&P Star Quality Rankings – stocks are ranked by anticipated performance based upon fundamentals http://www2.standardandpoors.com/spf/pdf/index/SP_Citigroup_Global_STARS_Methodology_Web.pdf?vregion=us&vlang=en

iv. Value Line Value Line - The Most Trusted Name in Investment Research


b. Diversification – Selecting stocks that respond to the market in different ways – stocks should not all be positively correlated (prices moving in the same direction), in the same industry, or with the same market cap

i. Large Cap = market capitalization in excess of $5,000,000,000

ii. Midcap = market capitalization from $1,000,000,000 to $5,000,000,000

iii. Small Cap = market capitalization of less than 1,000,000,000


c. Growth versus Value Stocksi. Growth Stock – High P/E ratio, earnings

expected to grow at an above average rate

ii. Value Stocks – Low P/E ratio, searching for “bargains” – stocks that are out of favor or in industries out of favor with investors but with good fundamentals

iii. Value Trap – Low P/E ratio stock that is a bad investment – P/E is low for a reason


d. Cyclical Stocks – Rise and fall with the economy in general – ex. Transports

e. Defensive Stocks – Product demand exists in all phases of the business cycle – consumer staples, drugs, etc.

f. Domestic versus International – If markets are performing poorly in one country, stocks from another country could be performing well


g. Data Sourcesi. Financial press and Internet sites – provide readily

available information, but may not be in depth or timely

ii. Professional research – can have greater “depth,” can reveal more obscure information, but can be biased and expensive

iii. Companies – can provide fairly detailed information, but biased towards the company

iv. SEC filings – very detailed and thorough, must be accurate, but difficult to read and not timely


7. Other Approachesa. “Buy what you know” – Purchase shares

of companies that you do business with and are impressed by

b. Consensus information – Agreement among analysts or researchers regarding whether a stock is a good value

J. Technical Analysis

1. 50 Day Moving Average – provides guidance regarding long term stock price movement trends (200 day = very long term)

a. Positive Momentum – Above the moving average

b. Negative Momentum – Below the moving average AVAV: Technical Analysis for AEROVIRONMENT, INC. - Yahoo! Finance

2. 5 - 20 Day Moving Average – Shows very short term trend

J. Technical Analysis (Continued)

3. Support – Stock “Bottom,” price below which shares have historically not traded

4. Resistance – Stock “Top,” the price that the stock tends to “bounce off of,” a stop to further price advances

5. Volume – Shares traded per day, indicates whether a price movement is “real” (ex. – stock trading higher on high volume shows interest in stock during price advances, stock price increasing on low volume is “drifting”


6. Bollinger Bands – One standard deviation above and below the stock price, based upon 20 day moving average – a measure of stock price volatility http://us.rd.yahoo.com/finance/chart/overlay/bollinger/*http:/finance.yahoo.com/q/ta?s=CSX&t=1y&l=on&z=m&q=l&p=b&a=&c=

a. Sharp price changes tend to occur after the bands tighten, indicating a “break out” from a less volatile pattern

b. Prices moving outside the bands indicate a continuing trendc. Trend reversal is indicated by bottoms or tops outside the

band, followed by bottoms and tops inside the bandd. A move originating at one band tends to move all the way to

the other band


7. Stock Chart Types – In all types, y axis indicates price, x axis is time

a. Lineb. Bar (High, Low, Close)c. Candlesticks – White = stock up, Black =

stock downd. Point and figure

8. Chart Scalinga. Arithmetic – Even scale of price movementsb. Logarithmic – Scale by percentage change,

works best for highly volatile stocks

K. Reading Corporate Annual Reports

1. Highlights – Contains basic information presented in a manner favorable to the corporation

a. Highlights statistics of which the firm is most proud

b. Generally includes total sales and net income

http://www.fanniemae.com/ir/pdf/annualreport/2007/2007_annual_report.pdf

K. Reading Corporate Annual Reports (Continued)

2. Letter to Shareholders – Review of the year just past and potential highlights of the year to come

a. Is a statement of management’s intentionsb. Can be checked with previous years’

statements to develop a sense of management’s credibility

3. Review of Operations – Provides an overview of a company’s products, services, facilities, and future direction


4. Financial Statementsa. Report of the Independent Auditor – Can be at

either the beginning or the end of the financial statements http://library.corporate-ir.net/library/11/112/112348/items/276539/TYC_AR.pdf (p. 98)

i. “Clean” or unqualified opinion – statements present fairly the corporation’s financial position

ii. “Qualified” or “Modified” opinion – specific problems exist which must be addressed before the auditor can claim a fair and accurate presentation of the corporation’s financial position (page 122) http://www.ford.com/doc/2007_ar.pdf


iii. Disclaimer of Opinion – A true opinion is not possible because of inability to fairly value assets, liabilities, etc.

iv. Adverse Opinion – The firm’s financial statements are inacurate.

5. Report by Management – certification of accuracy of report pursuant to Sarbanes – Oxley


6. Balance Sheeta. Current Assets

i. Cash and Cash Equivalents – Cash and marketable securities with less than 3 months maturity when purchased

ii. Accounts and Notes Receivable – Customer balances owed to the company

iii. Inventories – Finished goods, work in process, and raw materials – LCM is most conservative, but can also be carried at FIFO & LIFO – LIFO cushion is used in an inflationary environment, undervalued inventory reduces assets

iv. Prepaid Expenses – Payments in advance for rent, insurance, subscriptions, utilities, etc. – listed as an asset that depreciates over time

K. Reading Corporate Annual Reports (Continued)b. Net Fixed Assets – Includes plant,

property, and equipment – also known as capital or long term assets – carried at cost with accumulated depreciation, except for land, which does not depreciate

c. Other Assetsi. Miscellaneous – Life insurance policies on

key executives, notes receivable after more than one year, long term prepaid expenses, and minority stock ownership in other companies

V. STOCKS I. Fundamental Analysis (Continued)

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Transcript of V. STOCKS I. Fundamental Analysis (Continued)