Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 14 Stock Analysis and Valuation

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-2 Chapter Objectives Describe how to interpret stock quotations Illustrate how to conduct an analysis of a firm Describe how to conduct an industry analysis of stocks Explain how to value stocks

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-3 Stock Quotations Price quotations readily available from the Internet, stock brokers or financial newspapers Provide information about the price of each stock over the previous day or a recent period

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-4 Stock Quotations

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-5 Financial Planning Online: Stock Information Go to: This Web site provides stock quotations for the stocks that you specify. It also provides a summary of financial market conditions and links to information about investments.

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-6 Analysis of the Firm Annual report –Balance sheet: a financial statement that indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time –Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-7 Analysis of the Firm Exhibit 14.2: Balance Sheet for Stewart Corporation (numbers are in millions)

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-8 Analysis of the Firm Exhibit 14.3: Income Statement for Stewart Corporation (number are in millions)

Copyright ©2004 Pearson Education, Inc. All rights reserved.14-9 Analysis of the Firm Firm-specific characteristics –Analysis of a firm’s income statement and balance sheet can reveal the following characteristics: –Liquidity Current ratio: the ratio of a firm’s short-term assets to its short-term liabilities Show the firm’s ability to cover expenses

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm –Financial leverage: a firm’s reliance on debt to support its operations Debt ratio: a measure of financial leverage that measures the proportion of total assets financed with debt Times interest earned ratio: a measure of financial leverage that measures the ratio of the firm’s earnings before interest and taxes to its total interest payments

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm –Efficiency Inventory turnover: a measure of efficiency; computed as the cost of goods sold divided by average daily inventory Average collection period: a measure of efficiency; computed as accounts receivable divided by average daily sales Asset turnover ratio: a measure of efficiency; computed as sales divided by average total assets

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm –Profitability Operating profit margin: a firm’s operating profit divided by sales Net profit margin: a measure of profitability that measures net profit as a percentage of sales Return on assets: a measure of profitability; computed as net profit divided by total assets Return on equity: a measure of profitability; computed as net profit divided by stockholder’s equity

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm Exhibit 14.4: Ratios Used to Analyze Stewart Corporation

Copyright ©2004 Pearson Education, Inc. All rights reserved Financial Planning Online: Determining Industry Norms Go to: This Web site provides information on various industry groups and allows you to obtain financial information on firms you specify in any industry.

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm –Information provided by Value Line Recent stock price PE ratio Dividend yield Rating of the firm Beta Financial statistics Trading volume

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm Exhibit 14.5: An Example from Value Line Investment Survey

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm Go to: economies.htmlhttp:// economies.html This Web site provides information about economic conditions that can affect the values of investments.

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm Focus on Ethics: Accounting fraud –Many firms recently used fraudulent financial statements –Motivation for fraud Manager compensation Short-tem focus –Revenue-inflating techniques Recognizing revenue before it is earned Recognizing revenue from cancelled orders

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm –The Enron and WorldCom scandals Over-reported revenue and under-reported expenses Many stockholders lost their entire investment –Preventing future accounting fraud Use independent auditor New rules from Security and Exchange Commission

Copyright ©2004 Pearson Education, Inc. All rights reserved Economic Analysis of Stocks Involves assessing economic conditions that can affect a firm’s stock price Economic growth: a measure of growth in a country’s economy over a particular period –Gross domestic product (GDP): the total market value of all products and services produced in a country

Copyright ©2004 Pearson Education, Inc. All rights reserved Economic Analysis of Stocks –Weak economic conditions Lowers demand and stock prices Consumers spend less, further lowering demand –Fiscal policy effects Fiscal policy: the means by which the U.S. government imposes taxes on individuals and corporations and by which it spends its money

Copyright ©2004 Pearson Education, Inc. All rights reserved Economic Analysis of Stocks Interest rates –Stocks perform better when interest rates are low –Some stocks are more sensitive to interest rates than others –The Federal Reserve uses monetary policy to influence interest rates

Copyright ©2004 Pearson Education, Inc. All rights reserved Economic Analysis of Stocks Inflation: the increase in the general level of prices of products and services over a specified period –Consumer price index (CPI): a measure of inflation that represents prices of various consumer products –Producer price index (PPI): a measure of inflation that represents prices of products used to produce other products

Copyright ©2004 Pearson Education, Inc. All rights reserved Economic Analysis of Stocks Exhibit 14.6: Sources of Economic Information

Copyright ©2004 Pearson Education, Inc. All rights reserved Industry Analysis of Stocks Stock prices susceptible to industry conditions –Increased demand generally leads to higher stock prices –Changes in competition also affect demand, earnings, and stock prices

Copyright ©2004 Pearson Education, Inc. All rights reserved Industry Analysis of Stocks Industry indicators –Various publications and online sources for information on specific industries –Industry stock index measures how the market value of firms within an industry has changed over time

Copyright ©2004 Pearson Education, Inc. All rights reserved Industry Analysis of Stocks Exhibit 14.7: Sources of Economic Information

Copyright ©2004 Pearson Education, Inc. All rights reserved Stock Valuation Estimate the market value of a stock before purchasing Price of stock based on the demand for the stock versus its supply Technical analysis: the valuation of stocks based on historical price patterns

Copyright ©2004 Pearson Education, Inc. All rights reserved Stock Valuation Fundamental analysis: the valuation of stocks based on an examination of fundamental characteristics such as revenue or earnings, or the sensitivity of the firm’s performance to economic conditions

Copyright ©2004 Pearson Education, Inc. All rights reserved Stock Valuation Price-earnings (PE) method: a method of valuing stocks in which a specific firm’s earnings per share are multiplied by the mean industry price-earnings (PE) ratio Price-Earnings (PE) Ratio = P/E

Copyright ©2004 Pearson Education, Inc. All rights reserved Stock Valuation –You can use the PE ratios of stocks to value a firm as follows: Look up the PE ratios of stocks in the firm’s industry. Multiply the average industry PE ratio times the firm’s earnings per share. Compare your estimated value of the firm’s stock to its market value to determine whether the stock is undervalued or overvalued.

Copyright ©2004 Pearson Education, Inc. All rights reserved Stock Valuation –Deriving an estimate of earnings May use last year’s earnings or estimate expected earnings Value Line and other investment services provide such forecasts –Limitations of the PE method Forecasting earnings is difficult Some firms are involved in multiple industries

Copyright ©2004 Pearson Education, Inc. All rights reserved Financial Planning Online: Earnings Estimates for Valuing Your Stock Go to: today.html today.html This Web site provides recent earning per share estimates of a firm that you specify, which you can use when applying the PE method of valuation.

Copyright ©2004 Pearson Education, Inc. All rights reserved Stock Valuation Price-Revenue (PR) method: a method of valuing stocks in which the revenue per share of a specific firm is multiplied by the mean industry ratio of share price to revenue –Limitations of the PR method Difficulty in deciding which firms to use for comparison Revenues don’t indicate how well a firm is managed

Copyright ©2004 Pearson Education, Inc. All rights reserved Integrating Your Analyses Analyzing the firm, the economy and the industry allows assessment of future performance Economic, industry, and firm-specific conditions impact a firm’s stock price

Copyright ©2004 Pearson Education, Inc. All rights reserved Analysis of the Firm Exhibit 14.8: Factors That Increase and Decrease the Stock’s Price

Copyright ©2004 Pearson Education, Inc. All rights reserved Financial Planning Online: Screening Stocks for Investment Decisions Go to: This Web site provides a list of stocks that meet criteria that you specify for performance over the last year, such as PE ratio and other characteristics.

Copyright ©2004 Pearson Education, Inc. All rights reserved Stock Market Efficiency Efficient stock market: a market in which stock prices fully reflect information that is available to investors –Indicates that investors should be able to accurately identify undervalued stocks Inefficient stock market: a market in which stock prices do not reflect all information that is available to investors

Copyright ©2004 Pearson Education, Inc. All rights reserved How Stock Valuation Fits within Your Financial Plan Key decisions about stock for your financial plan are: –Should you consider buying stock? –How should you value stocks when determining whether to buy them? –What methods should you use for investing in stocks?

Copyright ©2004 Pearson Education, Inc. All rights reserved Integrating Key Concepts

Part 1: Financial Planning Tools Part 2: Liquidity Management Part 3: Financing Part 4: Protecting Your Assets and Income Part 5: Investing –In Chapter 13 we learned about investment fundamentals –In Chapter 14 we learned about stock analysis and valuation –In Chapter 15 we will cover investing in stocks –In Chapter 16 we will learn about investing in bonds –In Chapter 17 we will learn about investing in mutual funds –In Chapter 18 we will cover asset allocation Part 6: Retirement and Estate Planning