CHAPTER TWENTY-TWO

FINANCIAL ANALYSIS

FINANCIAL ANALYSIS

WHAT IS FINANCIAL ANALYSIS?•DEFINITION: the activity of providing

inputs to the portfolio management process

FINANCIAL ANALYSIS

PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS•THE ASSOCIATION OF INVESTMENT

MANAGEMENT AND RESEARCH (AIMR)acts as an advocate for the financial analyst

professionit host conferencing and workshops

– designed to enhance the knowledge base of the memberships

it also publishes the Financial Analysts Journal

FINANCIAL ANALYSIS

PROFESSIONAL FINANCIAL ANALYSIS ORGANIZATIONS•THE ASSOCIATION OF INVESTMENT

MANAGEMENT AND RESEARCH (AIMR)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

REASONS FOR FINANCIAL ANALYSIS•TWO PRIMARY REASONS

to determine certain securities characteristics

to attempt to identify mispriced securities

FINANCIAL ANALYSIS

REASON #1: DETERMNING SECURITY CHARACTERISTICS•estimate future sensitivity to major

factors

•estimate dividend yield

FINANCIAL ANALYSIS

REASON #2: ATTEMPTING TO IDENTIFY MISPRICED SECURITIES•use fundamental analysis

•approachesvaluation determines the intrinsic value

compared to the current market valueestimate key financial variables such as

– EPS next year– income growth next year

TECHNICAL ANAYSIS

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

TECHNICAL ANAYSIS

Two Groups of Strategies Used:1. Momentum and Contrarian Strategies2. Moving Average and Trading Range

BreakoutStrategies

TECHNICAL ANAYSIS

1. Momentum and Contrarian Strategies• METHDOLOGY:

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:

calculate a moving average over the last 200 days of closing prices

divdied today’s closing price into the moving average (SHORT-TO-LONG RATIO)

if short-to-long ratio is greater than 1, buyif ratio is less than 1, sell

TECHNICAL ANAYSIS

2. Moving Average and Trading Range Breakout Strategies•TRADING RANGE BREAKOUT

STRATEGY:high and low prices for past 200 trading

days are identifiedif today’s close is greater than the high =

buy!if today’s close is less than the low = sell!

FUNDAMENTAL ANALYSIS TOP-DOWN V. BOTTOM UP

•TOP-DOWN APPROACHattempts to forecast in the following

order1. economic activity2. industry performance3. firm’s performance

FUNDAMENTAL ANALYSIS TOP-DOWN V. BOTTOM UP

•BOTTOM-UP APPROACH:attempts to estimate prospects in the

following order:

1. The firm2. The Industry3. The economy

FUNDAMENTAL ANALYSIS FINANCIAL STATMENT ANALYSIS

•INTEGRAL PART OF FUNDAMENTAL ANALYSISit helps the analyst understand a firm’s

current conditionwhere it is headedwhat factors affect ithow the factors affect it

FUNDAMENTAL ANALYSIS FINANCIAL STATMENT ANALYSIS

•Review of Accounting Statementsincludes 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 FINANCIAL STATMENT ANALYSIS

•RATIO ANALYSISDEFINITION: a technique used to

examine a company’s financial statements

Use of Ratios– as an absolute standard– as a comparative indicator– as a trend over time– in combination with technical analysis

FUNDAMENTAL ANALYSIS FINANCIAL STATMENT ANALYSIS

•RATIO ANALYSISTypes of Ratios

– internal liquidity– operating performance– risk analysis– growth analysis

FUNDAMENTAL ANALYSIS internal liquidity ratios:

•indicate the ability of the firm to meet future short-term financial obligations

•some liquidity ratios:current ratioquick ratiocash ratioreceivables turnover

FUNDAMENTAL ANALYSIS operating performance ratios:

•indicate how well the management is operating the business

•some examples:total asset turnovernet fixed asset turnoverequity turnover

FUNDAMENTAL ANALYSIS 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:debt to equity ratiolong-term debt/total capital ratio

FUNDAMENTAL ANALYSIS growth analysis ratios:

•indicate how fast a firm should grow

•it involves analysis using several other ratiosnet profit margintotal asset turnovertotal assets/equity

END OF CHAPTER 22