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InvestingIntroduction to Business



Covered Today

Primer on investing

Qualitative analyses

Quantitative analyses



Why Invest?

Companies

Mobilize assets

Counteract inflation

Individuals

Save for retirement

Build wealth



Choosing Investment Vehicles

Qualitative Analyses

Economic climate

Industry traits Company traits

Quantitative Analyses

Profitability ratios

Leverage ratios

Efficiency ratios

Solvency ratios



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Qualitative Analyses



Economic Climate

Business Cycle

State of Credit

Consumer Confidence



Business cycle

*drastically oversimplied



Cyclicality

Correlation of stock performance with market

activity

Cyclical companies follow the market (Blue) Non-cyclical companies remain constant (Red)



State of Credit

Expense associated with borrowing money

Determines money supply

In the US, based on the prime rate set by the

federal reserve



Consumer Confidence

Attempts to predict consumer spending and saving

Difficult to measure

Indices:

Consumer Confidence Index (Conference board)

Consumer Sentiment Index (Mich. – Reuters)

Consumer Comfort Index (Bloomberg)



Business Traits

Industry Landscape

Product Differentiation

Management

Patents

Suppliers and Customer Channels

International Exposure

Brand Strength



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Quantitative Analyses



Efficient Market Hypothesis

‘The market always has perfect information, therefore

securities always trade at correct prices’

It is impossible to outperform the market

Stocks may deviate from that correct price on

occasion, but since these movements are random

you cannot consistently beat the market

Instead of picking stocks, invest in an index fund



Value Investing

Directly contradicts the Efficient Market Hypothesis

A strategy of selecting stocks that trade for less

than their intrinsic values

Value investors believe that the market overreacts

to good and bad news

Stock price fluctuations that do not correspond to

company fundamentals provide opportunities tovalue investors

Similar to discount shopping



Why Use Ratios?

Eliminate Scale

Allow comparison across time



Profitability

Evaluate the profitability of a company

Example Ratio:

Return on Equity

P/E

EPS

ROE = (Net Income/Shareholders’ Equity)

Price to Earnings = (Stock Price/Earnings per Share)

EPS = (Net Income / Shares Outstanding)



ROE

Return on Equity = Net Income

Stockholders Equity

This ratio is used to determine the return on capitalinitially invested by the owners of the firm

Generally a relationship of at least 10 % is desirable

for providing dividends and funds for future growth



EPS

EPS = Net Income / # Shares Outstanding

Shows how much of the companies profit would be

allocated to each outstanding share

Higher EPS numbers are generally more attractive

to investors than lower EPS numbers



P/E

P/E = Share Price

Earnings Per Share

A valuation ratio of a company’s current share price compared to its

per share earnings

Expresses how much an investor is willing to pay for a dollar of

earnings

P/E ratios reflect investor sentiments regarding future earnings

growth, high P/E ratios are indicative of bullish investors who believe

the company will experience rapid earnings growth in the future and

therefore investors pay a premium

Benchmark for P/E is between 16-18 but varies within different

industries



Leverage

Evaluate how the company is financed

Example Ratio

Debt to Equity

D/E = (Total Liabilities/Shareholders’ Equity)



Debt/Equity

Debt to Equity = Total Liabilities

Total Stockholders Equity

Shows the proportion of debt and equity financing for acompany

Too high debt levels indicate higher risk because acompany has to pay interest on its debt

Values depend on industry, but D/E is generally around 2

Auto companies (capital intensive) High D/E

Service companies Low D/E



Efficiency

How efficiently is the company operating

Example Ratio

Inventory Turnover Ratio

Net Profit Margin

Asset Turnover Ratio

IT = (Cost of Goods Sold/Average Inventory)

Net Profit Margin = (Net Income/Revenue)

Asset Turnover = (Revenue/ Average Total Assets)



Inventory Turnover Ratio

Inventory Turnover = Cost of Goods Sold

Average Inventory

Average Inventory = ((Last Year’s Inventory + Current Year’sInventory) / 2)

Shows how efficiently inventory is converted to soldproduct

A low ratio indicates low sales and high inventory,whereas a very high ratio can mean strong sales ortoo little inventory

Benchmark depends on industry



Net Profit Margin

Net Profit Margin = Net Income

Total Revenue

Shows how efficiently every dollar of revenue isconverted into profit for the company

Higher profit margins are more attractive toinvestors




Asset Turnover Ratio

Asset Turnover = Sales

Average Total Assets

How efficiently a company uses its assets to

generate sales

Generally, the higher asset turnover the better




Solvency

The ability of the company to repay its debts

Example Ratio

Current Ratio

Quick Ratio

Current Ratio = (Current Assets/Current Liabilities)

Quick Ratio = ((Cash + Securities + Accounts

Receivable) / Current Liabilities)



Current Ratio

Current Ratio = Current Assets

Current Liabilities

This ratio is used to see if, in an emergency, acompany can pay off its immediate debts by sellingits liquid assets

Generally a ratio of 2 to 1 is considered an indicatorof good financial position



Quick Ratio

Quick Ratio = Cash + Securities + Accounts Receivable

Current Liabilities

Stricter measure of solvency

How is this different from current ratio?

This ratio uses only the most liquid assets.

Liquid assets include: Cash, Securities, Accounts Receivable.

Inventory is not included (some companies have difficulty turning

it into cash)

Healthy companies will have a ratio of approximately 1



Additional Metrics

Price to Book = (Stock Price/Book Value of Assets)

Price to Revenue = (Stock Price/Revenue per Share)

PEG = (Price/Earnings) / Annual EPS Growth

A ratio that helps to explain a company’s P/E ratio

PEG is a ratio that is used to determine a stock’s

value while taking into account earnings growth As with P/E, a lower PEG ratio means that the stock

is more undervalued

Benchmark is approximately 1



Beta

Beta = volatility of a stocks’ movements

Beta = 1; the stock is as volatile as the overall stock

market on a whole (average volatility) Beta > 1; the stock is more volatile then the market

as a whole (ex: Tiffany’s)

Beta < 1; the stock is less volatile then the markets

as a whole (ex: Walmart)



Additional Investing Advice

Invest in What You Know

The average person doesn’t have the time to explore

unknown industries with proper analysis



Summary

1. Evaluate the state of the economy at large

2. Choose an industry and evaluate its state

3. Compare companies within the industry

Qualitative metrics

Management, Product Differentiation, etc.

Quantitative metrics Profitability, Leverage, Efficiency, Solvency

4. Buy or Sell

investing fa13 itb 2

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