Check the Vital Signs

Why Invest? Possibility of high returns Learn about companies and the people and products behind them Share on companies and products you already know – Who owns what, who produces what?

Methods for Valuing Stock Market Value – Worth what people are willing to pay – Doesn’t capture underlying value of company’s future Book Value (stockholders’ equity) – What company is worth (accounting) – Ignores intangible assets – Value of hard assets are distorted – Incomplete picture

Fundamental Analysis Search for intrinsic value – How does the company make money – What products does it sell – What is its position in the industry – What are their management practices – Sales Trends – Earnings trends

Fundamental Analysis Qualitative measures: – How does the company make money – Product Mix – Level of competition – Management – Strategy – Strength of brand

How do they Make Money? Sherwin-Williams Exxon Coca-Cola Hilton Amazon.com (How is the company’s business model)

Exemplars Name companies that exemplify each of these qualitative measures – Strong product mix – Intense industry competition – Exceptional management – Effective strategy – Strong brand

Quantitative Measures Number comparisons and ratios that can be used to determine financial health After what you’ve learned about financial statements what might be some useful qualitative measures? – Earnings – Sales – P/E ratios – Current Ratio Past performance is not necessarily and indicator of the future.

Estimate of Value Last step in fundamental analysis Compare to current stock price – Overvalued stocks are too expensive – Undervalued stocks are “on sale.” Many valid approaches – Some look at a few, widely accepted ratios – Some are more systematic and thorough – All recommend a good look at a company’s financial statements.

Measures are relative No single measure stands out as the only measure to watch Everything needs to be put in context Meaning comes when used: – As part of overall picture of the company – Over time – In comparison to other companies in the same industry.

Know the Company (Qualitative) What does the company do? How and where does it make its money? What is special about it?

Company Basics What does the company do? What is its business model? What is its product or service? Is there long- lasting appeal? Are there new products or services being developed? Where does the company do business? National, international or global? Who are its customers? Are they part of a specific demographic?

Company Basics Who’s running the company? Are they effective managers? How big is it? What are its annual sales, number of outstanding shares, capitalization, and number of stores or buyers? Is there a strategy for growth and for dealing with competition? What is special about the company? The brand, a product, a patent, a certain way of doing business?

Company Basics Who’s running the company? Are they effective managers? How big is it? What are its annual sales, number of outstanding shares, capitalization, and number of stores or buyers? Is there a strategy for growth and for dealing with competition? What is special about the company? The brand, a product, a patent, a certain way of doing business?

Competition Sector and Industry – Unique characteristics that affect the profit potential of companies in it – A sector is a subset of the economy in which companies share related products and services – Broader than industries and include things like energy, healthcare and consumer goods. – Industry is all business within afof work, utilities, hospitals, and retail apparel.

Competition Affects profit potential Intense competition affects strategic issues like: – Pricing decisions – Availability of suppliers and raw materials – Opportunities for growth Level of competition not tied to number of companies (soft drinks, few players, fierce competition).

Competition Barriers to entry – Low barriers may lead to intense competition – High barriers means that a steady stream of new competitors is unlikely

Quantitative Measures Quantitative measures are especially valuable in making comparisons. Ratios – Show the relationship between numbers on a company’s financial statements – Provide insight into how a company operates Use reputable secondary sources when comparing companies – Standard and Poor’s or Value Line – Often available free through public libraries – Time-savers that consolidate current and historical financial information into – easy-to-read, standardized formats

Quantitative Measures Sales – Healthy sales drive business, yet are an incomplete picture of company performance. – Companies with similar sales are likely to vary in profitability, depending on the following factors: Cost of goods sold Efficiency of operations Mergers and acquisitions Plans for new products, etc. – Amount of sales is not as important as sales growth. – Investors want to see a steady pattern of growth. – View sales as a first, general indicator that is part of a larger picture.

Quantitative Measures Earnings per share (EPS) Earnings are profits. Reveals how much profit goes to each share of common stock Calculated by dividing net earnings by the number of shares outstanding Increasing EPS means company is well run. Example: McDonald’s Corp. (NYSE: MCD) – EPS = net earnings / # of outstanding shares of common stock – 2004 net earnings = $2,279,000,000 – 2004 # of outstanding shares of common stock = 1,270,000,000 shares – $2,279,000,000 / 1,270,000,000 = 1.79 – In 2004, McDonald’s earned $1.79 for each share of outstanding common stock.

Quantitative Measures Various ways of calculating EPS Usually a trailing indicator based on past earnings Sometimes a forward indicator based on projected earnings Sometimes a combination of trailing and forward Compare “apples with apples” when you use EPS to compare companies.

Quantitative Measures Profitability Expressed as the percentage of sales retained as profit From the income statement, various levels of income are divided by sales. – Gross profit margin—percentage of sales left after subtracting the direct cost of producing the goods – Net profit margin or so-called “bottom line”—percentage of sales left after subtracting all expenses 3. Measures how well managers extract a profit from each dollar of sales

Quantitative Measures Profitability Example: McDonald’s Corp. (NYSE: MCD) – Net profit margin = net income / sales – 2004 total sales = $ billion (billion!) – 2004 net income = $2.279 billion – / = 12% – Put another way, McDonald’s had a net income of 12¢ of every dollar in sales.