CHAPTER TWENTY-TWO FINANCIAL ANALYSIS

n WHAT IS FINANCIAL ANALYSIS? DEFINITION: the activity of providing inputs to the portfolio management process

FINANCIAL ANALYSIS n PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS THE ASSOCIATION OF INVESTMENT MANAGEMENT AND RESEARCH (AIMR) 3 acts as an advocate for the financial analyst profession 3 it host conferencing and workshops – designed to enhance the knowledge base of the memberships 3 it also publishes the Financial Analysts Journal

FINANCIAL ANALYSIS n PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS THE ASSOCIATION OF INVESTMENT MANAGEMENT AND RESEARCH (AIMR) 3 Chartered Financial Analysts – a subdivision of AIMR – is a program to establish a hurdle that creates a common set of investment knowledge for a select membership – it also promotes an ethical standard for the various types of investment professionals

FINANCIAL ANALYSIS n REASONS FOR FINANCIAL ANALYSIS TWO PRIMARY REASONS 3 to determine certain securities characteristics 3 to attempt to identify mispriced securities

FINANCIAL ANALYSIS n REASON #1: DETERMNING SECURITY CHARACTERISTICS estimate future sensitivity to major factors estimate dividend yield

FINANCIAL ANALYSIS n REASON #2: ATTEMPTING TO IDENTIFY MISPRICED SECURITIES use fundamental analysis approaches 3 valuation determines the intrinsic value compared to the current market value 3 estimate key financial variables such as – EPS next year – income growth next year

TECHNICAL ANAYSIS n DEFINITION: a form of security analysis that attempts to forecast price changes based on historical price and volume trends

TECHNICAL ANAYSIS n Two Groups of Strategies Used: 1. Momentum and Contrarian Strategies 2. Moving Average and Trading Range Breakout Strategies

TECHNICAL ANAYSIS 1. Momentum and Contrarian Strategies METHDOLOGY: 3 examine the returns over a time period just ended to identify – momentum investors who seek out stocks recently rising in price for purchase; falling for sale – contrarians who follow the opposite strategy of most investors contrarians base their strategy on the overreation theory

TECHNICAL ANAYSIS 2. Moving Average and Trading Range Breakout Strategies MOVING AVERAGE STRATEGY: 3 calculate a moving average over the last 200 days of closing prices 3 divdied today’s closing price into the moving average (SHORT-TO-LONG RATIO) 3 if short-to-long ratio is greater than 1, buy 3 if ratio is less than 1, sell

TECHNICAL ANAYSIS n 2. Moving Average and Trading Range Breakout Strategies TRADING RANGE BREAKOUT STRATEGY: 3 high and low prices for past 200 trading days are identified 3 if today’s close is greater than the high = buy! 3 if today’s close is less than the low = sell!

FUNDAMENTAL ANALYSIS n TOP-DOWN V. BOTTOM UP TOP-DOWN APPROACH 3 attempts to forecast in the following order 1. economic activity 2. industry performance 3. firm’s performance

FUNDAMENTAL ANALYSIS n TOP-DOWN V. BOTTOM UP BOTTOM-UP APPROACH: 3 attempts to estimate prospects in the following order: 1. The firm 2. The Industry 3. The economy

FUNDAMENTAL ANALYSIS n FINANCIAL STATMENT ANALYSIS INTEGRAL PART OF FUNDAMENTAL ANALYSIS 3 it helps the analyst understand a firm’s current condition 3 where it is headed 3 what factors affect it 3 how the factors affect it

FUNDAMENTAL ANALYSIS n FINANCIAL STATMENT ANALYSIS Review of Accounting Statements 3 includes a study of the three major statements prepared monthly by most accountants: – the balance sheet – the income statement – the statment of cash flows

FUNDAMENTAL ANALYSIS n FINANCIAL STATMENT ANALYSIS RATIO ANALYSIS 3 DEFINITION: a technique used to examine a company’s financial statements 3 Use of Ratios – as an absolute standard – as a comparative indicator – as a trend over time – in combination with technical analysis

FUNDAMENTAL ANALYSIS n FINANCIAL STATMENT ANALYSIS RATIO ANALYSIS 3 Types of Ratios – internal liquidity – operating performance – risk analysis – growth analysis

FUNDAMENTAL ANALYSIS n internal liquidity ratios: indicate the ability of the firm to meet future short-term financial obligations some liquidity ratios: 3 current ratio 3 quick ratio 3 cash ratio 3 receivables turnover

FUNDAMENTAL ANALYSIS n operating performance ratios: indicate how well the management is operating the business some examples: 3 total asset turnover 3 net fixed asset turnover 3 equity turnover

FUNDAMENTAL ANALYSIS n risk analysis ratios: indicates the uncertainty of income flows for the total firm and for the individual sources of capital (debt and stock) some examples: 3 debt to equity ratio 3 long-term debt/total capital ratio

FUNDAMENTAL ANALYSIS n growth analysis ratios: indicate how fast a firm should grow it involves analysis using several other ratios 3 net profit margin 3 total asset turnover 3 total assets/equity

END OF CHAPTER 22