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Fundamentals of Investing: Analyzing Common Stocks
Terms in this set (32)
consists of gathering information, organizing it into a logical frame- work, and then using the information to determine the intrinsic value of common stock.
provides a measure of the underlying worth of a share of stock. It provides a standard for helping you judge whether a particular stock is undervalued, fairly priced, or overvalued.
Top down analysis to stock valuation
Traditional security analysis usually takes a top-down approach: It begins with economic analysis, moves to industry analysis, and then arrives at a fundamental analysis of a specific company.
analysis that assesses the general state of the economy and its potential effects on businesses. consists of a general study of the prevailing economic environment— often on both a global and domestic basis
analysis that deals with the industry within which a particular company operates. It looks at the overall outlook for that industry and at how companies compete against each other in that industry.
analysis that looks at the financial condition and operating results of a specific company. These include the company's investment decisions, the liquidity of its assets, its use of debt, its profit margins, and its earnings growth.
efficient market hypothesis
hypothesis: 1. Securities are rarely, if ever, substantially mispriced in the marketplace. 2. No security analysis, however detailed, is capable of identifying mispriced securities with a frequency greater than that which might be expected by random chance alone.
key economic factors
1. Government fiscal policy: Taxes, Government spending, Debt management, 2. Monetary policy: Money supply, Interest rates, 3. Other factors: Inflation, Consumer spending, Business investments, Foreign trade, and foreign exchange rates
Financial Statements used to evaluate stocks
balance sheet (what a company owns and what it owes), income statement (financial summary of operating results for a specific time) , statement of cash flows (financial summary of firm's cash flow
current ratio and net working capital
measure ability to meet short term liabilities,
= current assets/current liabilities
net working capital
measures dollar amount of equity in working capital
=current assets-current liabilities
accounts receivable turnover, inventory turnover and total asset turnover
accounts recievable turnover
captures the relationship between a firm's receivables balance and its sales
= sales revenue/ accounts receivable
measures the average length of time a company holds inventory
=sales revenue/inventory dollars
some analysts use CGS/inventory dollars, which results in a lower turnover and is more accurate
total asset turnover
indicates how efficiently assets are being used to support sales
=sales revenue/total assets
A high total asset turnover figure suggests that corporate resources are being well managed and that the firm is able to realize a high level of sales (and, ultimately, profits) from its asset investments.
leverage measure ratios
indicates the amount of debt being used to support the resources and operations of the company
debt equity ratio and times interest earned
debt equity ratio
measures the relative amount of funds provided by lenders and owners
=long-term debt/stockholder's equity
times interest earned
is a so-called coverage ratio. It measures the ability of the firm to meet ("cover") its fixed interest payments
=earnings before interest and taxes/interest expense
net profit margin, return on assets (ROA), return on equity (ROE), equity mulitplier
net profit margin
indicates the rate of profit being earned from sales and other revenues
=net profit after taxes/sales revenue
return on assets (ROA)
looks at the amount of resources needed to support operations. Reveals management's effectiveness in generating profits from the assets it has available, and is perhaps the most important measure of return.
ROA=net profit after taxes/total assets
ROA=net profit margin X total asset turnover
return on equity (ROE)
Return on investment (ROI), as it's sometimes called—measures the return to the firm's stockholders by relating profits to shareholder equity. Closely watched by investors because of its direct link to the profits, growth, and dividends of the company.
ROE=net profit after taxes/stockholder's equity
the expanded ROE measure indicates the extent to which financial leverage (or "trading on the equity") can increase return to stockholders.
ROE= ROA X Equity multiplier
Shows that the use of debt has magnified the firm's returns to stockholders.
= total assets/ stockholder's equity
common stock or market ratios
price-to-earnings(P/E) ratio, Earnings per share (EPS), PEG ratio, dividends per share, payout ratio, book value per share, price-to-book-value ratio
relates the company's earnings per share (EPS) to the market price of its stock.
= net price of common stock/ EPS
Other things being equal, you would like to find stocks with rising P/E ratios because higher P/E multiples usually translate into higher future stock prices and better returns to stockholders. But even though you'd like to see them going up, you also want to watch out for P/E ratios that become too high (relative either to the market or to what the stock has done in the past). When this multiple gets too high, it may be a signal that the stock is becoming overvalued (and may be due for a fall).
= (Net profit after taxes - Preferred dividends) / Number of common shares outstanding
compares the company's rate of growth in earnings.
=Stock's P/E ratio / 3 to 5 year growth rate in earnings
dividend per share
translates total common dividends paid by the company into a per-share figure
= Annual dividends paid to common stock/ Number of common shares outstanding
indicates how much of its earnings a company pays out to stockholders in the form of dividends
= Dividends per share/ Earnings per share
book value per share
a measure that deals with stockholders' equity. Actually, it is simply another term for equity (or net worth). It represents the difference between total assets and total liabilities.
Note that in this case we're defining equity as common stockholders' equity, which would exclude preferred stock. That is, common stockholders' equity = total equity - preferred stocks
= Common stockholders' equity/Number of common shares outstanding
relates the book value of a company to the market price of its stock. Widely used by investors, this ratio shows how aggressively the stock is being priced. Most stocks have a price-to-book-value ratio of more than 1.0—which simply indicates that the stock is selling for more than its book value. In fact, in strong bull markets, it is not uncommon to find stocks trading at 4 or 5 times their book values, or even more.
= Market price of common stock/Book value per share
THIS SET IS OFTEN IN FOLDERS WITH...
Investments Ch 6- Common Stocks
Chapter 5: Modern Portfolio Concepts
Chapter 6: Common Stocks
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OTHER SETS BY THIS CREATOR
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