Seminar Investasi dan Pasar Modal Session 2: Market Efficiency By Dr. Ir. Sugeng Purwanto MBA,FRM Jakarta, 10 February 2010 Source : BKM (2005). “INVESTMENTS”, 6 th Edition, Chaper 1-3, Page

FUNDAMENTAL ANALYSIS  FUNDAMENTAL ANALYSIS USES EARNINGS AND DIVIDENDS PROSPECTS OF THE FIRM, EXPECTATION OF FUTURE INTEREST RATES, AND RISK EVALUATION OF THE FIRM TO DETERMINE PROPER STOCK PRICES.  ULTIMATELY, IT REPRESENTS AN ATTEMPT TO DETERMINE THE PRESENT DISCOUNTED VALUE OF ALL PAYMENTS A STOCKHOLDER WILL RECEIVE FROM EACH SHARE OF STOCK.  IF THE VALUE EXCEEDS THE STOCK PRICE TRADED, THE FUNDAMENTAL ANALYST WOULD RECOMMEND PURCHASING THE STOCK.

PRESENT VALUE OF DIVIDEND STREAM ∞ Case : Constant growth rate of dividend D0D1D2D3D4D5D6D∞D0D1D2D3D4D5D6D∞ D 1 = D 0 (1 + g)D 2 = D 0 (1 + g) 2 D 1 = D 0 (1 + g)……. and so on

CONSTANT GROWTH VALUATION D 0 (1+g) D 0 (1+g) 2 D 1 (1+g) 3 P 0 = … (1 + k e ) 1 (1 + k e ) 2 (1 + k e ) 3 D 0 (1+g) P= k e - g PStock price per-share k e Investors required rate of return D 0 Current year dividend gSustainable growth rate

DETERMINATION OF SUSTAINABLE GROWTH RATE g = RETENTION RATE x RETURN ON RETAINED ERANINGS g = (1 – DPR) x RoE gSustainable growth rate DPRDividend Payout Ratio Percentage of earnings which is distributed as dividend 1 – DPRRetention rate (or plowback ratio) RoEReturn on Equity

CAPM (Capital Assets Pricing Mode) k = E ri = r f + β [E rm – r f ] E ri β SECURITY MARKET LINE [SML] rfrf A B C STOCK AUNDER-VALUED Price below its intrinsic value STOCK BFAIR-VALUED Price equal to its intrinsic value STOCK COVER-VALUED Price above its intrinsic value

FUNDAMENTAL ANALYSIS  FUNDAMENTAL ANALYSIS USES EARNINGS AND DIVIDENDS PROSPECTS OF THE FIRM, EXPECTATION OF FUTURE INTEREST RATES, AND RISK EVALUATION OF THE FIRM TO DETERMINE PROPER STOCK PRICES.  ULTIMATELY, IT REPRESENTS AN ATTEMPT TO DETERMINE THE PRESENT DISCOUNTED VALUE OF ALL PAYMENTS A STOCKHOLDER WILL RECEIVE FROM EACH SHARE OF STOCK.  IF THE VALUE EXCEEDS THE STOCK PRICE TRADED, THE FUNDAMENTAL ANALYST WOULD RECOMMEND PURCHASING THE STOCK.

TECHNICAL ANALYSIS Technical analysis as the use of specific market-generated data for the analysis both aggregate stock prices (market indexes or industry average) and individual stocks. 1.Technical analysis is based on published market data and focuses on internal factors by analyzing movements in the aggregate market, industry average, or stock. 2.The focus of technical analysis is identifying changes in the direction of stock prices which tend to move in trends as the stock prices adjusts to a new equilibrium level. 3.Technicians attempt to assess the overall situation concerning stocks by analyzing technical indicators, market sentiment, momentum and other indicators.

EFFICIENT MARKET HYPOTHESIS [EMH] THE NOTION THAT STOCKS ALREADY REFLECT ALL AVAILABLE INFORMATION IS REFERRED TO AS THE EFFICIENT MARKET HYPOTHESIS. THE WEAK-FORM EMH ASSERTS THAT STOCK PRICES ALREADY REFLECT ALL INFORMATION THAT CAN BE DERIVED BY EXAMINING MARKET TRADING DATA SUCH AS THE HISTORY OF PAST PRICES, VOLUME, OR SHORT INTEREST. THE SEMISTRONG-FORM EMH ALL PUBLICTLY AVAILABE INFORMATION REGARDING THE PROSPECTS OF A FIRM MUST BE REFLECTED ALREADY IN THE STOCK PRICES. SUCH INFORMATION INCLUDES, IN ADDITION TO PAST PRICES, FUNDAMENTAL DATA ON THE FIRM’S PRODUCT LINE, QUALITY OF MANAGEMENT, BALANCE SHEET COMPOSITION, PATENT HELD, EARNING FORECAST, AND ACCOUNTING PRACTICES. THE STRONG-FORM EMH THAT STOCK PRICES REFLECT ALL INFORMATION RELEVANT TO THE FIRM, EVEN INCLUDING INFORMATION AVAILABLE ONLY TO COMPANY INSIDERS. 9

STOCK PRICE MOVEMENTS Stock Price AnalysisChallenged by: Efficient Market Hypothesis [EMH] Insider Trading/Information * Strong-form EMH Fundamental Analysis* Semi-strong-form EMH Technical Analysis* Weak-form EMH Note. EMH have three forms : Strong-form EMH, Semi-strong-form EMH, Weak-form EMH

Critical Reading - PGS Orientation Week - Sugeng Purwanto PhD, FRM COMPANY SHAREHOLDERS INVESTMENTSOPERATIONSFINANCING Dividends are the only cash flow to shareholders The value is the discounted of the dividends streams at Shareholders’ cost of equity (k) Shareholders’ investment With opportunity costs of cost of equity (k e ) Note: Company’s investments (capital budgeting decisions). Company cost of capital is Weighted Average Cost of Capital (WACC). WACC = w e * k e + w d * k d (1 – Tax Rate) k d : Cost of Debt; W e weight of equity portion; W e weight of equity portion “k e ”

Critical Reading - PGS Orientation Week - Sugeng Purwanto PhD, FRM DETERMINATION OF SUSTAINABLE GROWTH RATE g = RETENTION RATE x RETURN ON RETAINED ERANINGS g = (1 – DPR) x RoE gSustainable growth rate DPRDividend Payout Ratio Percentage of earnings which is distributed as dividend 1 – DPRRetention rate (or plowback ratio) RoEReturn on Equity 12