Western Capital MarketsFundamental Analysis

Technical vs. Fundamental Analysis

• Technical Analysis: predicting future prices based on past market data, eg. Price and volume

• Fundamental Analysis focuses on the fundamentals of the company

Intrinsic Value vs. Market Value

Intrinsic Value: The actual value of a company or an asset, irrespective of current market capitalization

• Market Value: the market assessment of a company’s value at any given moment

• Market value is what you pay, intrinsic value is what you get

Fundamental Analysis

• Fundamental analysis is an attempt to estimate the intrinsic value of a company

• There are different ways that this can be done:• Top-down approach• Bottom-up approach

Top-Down Approach

• Current state of the economy• In times of prosperity:

• Increased employment• Increased income• Increased spending• Increased sales• Companies invest/grow, higher sales translate

to increased profits, dividends, and higher stock prices.

Note: even poorly run companies may see these increases in sales and profits.

Top-Down Approach

• In times of economic downturn:• Decreased employment• Decreased income• Decreased spending• Decreased sales, earnings, stock prices

Economic Variables vs. The Stock Market

Choosing an Industry

• Once you have developed an outlook for the economy, you can forecast how you think it will affect certain industries.

• Cyclical industries move in the same direction as the economy, are hit hard by rising interest rates.• Automobiles, construction, steel, lumber

Choosing an Industry

• Stable Industries, or countercyclical, do not fluctuate as much as cyclical companies, especially during recession.• Food• Beverage• Public utility companies

Company Analysis

• After identifying the attractive industries, evaluate the financial conditions of companies within those industries• Competitive Analysis• Management Analysis• Financial Analysis

Competitive Analysis

• Industry may grow, but a company that doesn’t compete well may not capitalize on a growing industry.

• Look at various factors in comparison to the competition.• Resources • Product Range• Product Success• Innovation

Management Analysis

• A company with effective management will be more successful in meeting its sales and earnings objectives

• Tricky to evaluate as an investor• Read the past news• Top and middle management turnover• Look at company websites, read the sales

strategies, etc.• E-mail questions to investor relations staff, speed

and quality of response may clue about management.

Financial Analysis

• Balance Sheet:• Assets• Liabilities

• Income Statement:• Earnings

• Statement of Cash Flows• Often used in complement with Income

Statement

Valuation Methods

• Relative Valuation:• Trading Comps:

• Financial Ratios• Implied value based on multiples of

comparable companies

• Fundamental Valuation:• Valuation of Assets• Discounted Cash Flow Approach

Asset Valuation

• Method of valuation based historical or present value of assets, minus liabilities

• Relates to the balance sheet• Ignores the future• Ignores Risk• Preferred by the most conservative

investors

Time Value of Money

• A dollar received today is worth more than a dollar received tomorrow

• 1938 - John Burr Williams (1899-1989) first developed the Discounted Cash Flow approach to valuation

Discounted Cash Flow Approach

• Value of a company equals the net present value of future cash flows discounted at an appropriate rate

• Many variables involved• Many valuation methods are based on

the principles of DCF• Dividend Discount Model• Discounted Cash Flow Analysis

Discounted Cash Flow Analysis

1. Forecast free cash flows for the period of projection2. Estimate the cost of capital

• (Weighted Average Cost of Capital - WACC)

3. Estimate continuing value4. Discount to the present5. Add the value of excess cash and other non-

operating assets6. Deduct financial debt to get market value of equity

Discounted Cash Flow Analysis

Discounted Cash Flow Method

• Pros:• Potentially the most accurate approach to

measuring intrinsic value

• Cons:• As good as its assumptions• Assumptions can change over time

Fundamental Analysis

• Intrinsic Value - Concept of ownership• Stock is a claim of ownership

• Estimates Estimates Estimates• Numbers are important, but business

experience is more so• Common Sense

The Masters!

Warren Buffet

•DCF Method

•Bottom-up

•Coca-Cola

Benjamin Graham

•Value Investing