RIT 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 ITFMA

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 ITFMA

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 ITFMA

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 ITFMA

Where Do I Begin?

What does the company do? How big is it? Company Goals Financial Health Competitive Landscape Economic Conditions

R ITFMA

What Does the Company Do?

Who are they? Do they make products or sell services? Who are they targeting?

R ITFMA

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 +

Market Cap = Shares Outstanding x Share Price

R ITFMA

Financial Statements

Income Statement Cash Flow Statement Balance Sheet

R ITFMA

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 ITFMA

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_activi ties

R ITFMA

Statement of Retained Earnings

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

R ITFMA

The Balance Sheet

It 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 ITFMA

Show Me the Numbers!

Price to Sales Price to Earnings (P/E) Beta Current Ratio Price to Book Gross Profit Margin Return on Equity (ROE) Debt Ratio

R ITFMA

Price to Sales

Share Price P/S ! Revenue Per Share

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 ITFMA

Price to Earnings

Share Price P/E ! Earnings Per Share

Companies with no growth do not have a P/E ratio A high P/E ratio could mean higher growth in the future

R ITFMA

Price to Book
Share Price P/B ! Total Assets - Intangible Assets &Liabilities

Compares the companys share price to their book value A low P/B ratio could mean: Stock undervalued Something very wrong

R ITFMA

Gross Profit Margin

Revnues - Cost of Goods Sold ! Revenue

How much do they get to keep? Use in comparison to other companies to determine who has the highest Gross Profit Margin

R ITFMA

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 ITFMA

Return on Equity (ROE)

Net Income ! Shareholder's Equity

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

R ITFMA

Debt Ratio

Total Debts ! Total ssets

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

R ITFMA

Current Ratio

Current ssets ! Current iabilities

Measure of ability to pay short-term liabilities Higher ratios means the more capable a company is to paying back short-term debt

R ITFMA

Is This Company Profitable?

Gross Margin/Profit/Income, Net Income Look at companys 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 ITFMA

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 ITFMA

Management
Is management stable? Recent change in management? Has change in management affected the stock price? HP Probe

R ITFMA

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

R ITFMA

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 ITFMA

Dividends

The power of dividends.

GE 1996 Dividend: $.35 GE 2006 Dividend:$1.00 Thats 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 share
R ITFMA

Dividends
Not always a good thing?

Can indicate lack of growth

Dividend may be unsustainable

The effects of cutting a dividend

R ITFMA

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 ITFMA

Stock Buybacks

Income Statement

R ITFMA

A Nastie Example
for tying the importance of financial statements together

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

R ITFMA

Benchmarking How do we compare?

The most widely accepted benchmark is the performance of the Standard and Poors 500 Index.

R ITFMA

Benchmarking Continued

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 ITFMA

ANF up 300% in past five years

Standard and Poors Fortune 500 Index up less than 50% in past five years

R ITFMA

Other Methods of Benchmarking

Financial ratios used to compare a firms financial performance to a competitors Popular ratios are Profit Margin, Return on Assets, Inventory Turnover, and the Quick Ratio

R ITFMA

Key Ratios, using the Industry as a Benchmark

Profitability Company Industry Median 35.10% 6.40% 4.20% 18.3% 9.4% 12.3% Market Median1 51.80% 6.30% 4.80% 9.3% 1.6% 4.2%
R ITFMA

Gross Profit Margin Pre-Tax Profit Margin Net Profit Margin Return on Equity Return on Assets Return on Invested Capital

66.70% 19.40% 12.00% 36.7% 20.4% 27.6%

Valuation Price/Sales Ratio Price/Earnings Ratio Operations

Company 2.10 17.37

Industry Median 0.96 19.03

Market Median1 2.15 18.62 Industry Market Median Median1 5.36 4.7 57.47 5.6

Company 11.62 2.4

Days of Sales Outstanding Inventory Turnover

Financial

Company

Industry Market Median Median1 2.18 0.9 1.71 1.2

R ITFMA

Current Ratio 1.90 Quick Ratio 1.0

ANF and the Competitive Landscape

R ITFMA

R ITFMA

Where to Invest?

R ITFMA

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 ITFMA