practical investment management by robert.a.strong slides ch08
TRANSCRIPT
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CHAPTER EIGHT
Practical Investment Management
Robert A. Strong
FUNDAMENTAL ANALYSIS II
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Market Analysis The Major Indexes The Greenspan Model The Equity Risk Premium
Outline
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Company Analysis The Greenspan Model Growth At a Reasonable Price (GARP) Pro-Forma Earnings
EBITDA The Growing Role of Cash Flow DuPont Analysis Present Value of Growth Opportunities
Regulation Fair Disclosure
Outline
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The Major Indexes
A portfolio of securities, or equivalently, anindex like the S&P 500 or the Dow Jones
Industrial Average, can be valued using the
dividend discount model (DDM).
Recall that DDM states that the current
share price equals the discounted value of
a perpetually growing stream of dividends:
( )gk
gDP
+=
1
0
0
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We can substitute earnings fordividends, and, with a few minor
adjustments, apply the basic DDM
to indexes.
The Major Indexes
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The Equity Risk Premium
Equity risk premium is the anticipatedreturn advantage to common stock over
fixed income securities.
Equity risk premium may be presented
relative to short-term Treasury bills or to
long-term Treasury bonds.
There is growing evidence that in the future
the equity risk premium is going to be lessthan it has historically been.
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Company Analysis
There are several important ways in which
analysts can dig deeper into the company.
What do you think of this company?
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The Greenspan Model
The Greenspan model can be adapted for
use with individual equity securities.
Greenspan stock value
= estimated annual earnings per share10-year Treasury rate
Greenspan stock value > stock price
the stock is undervalued Greenspan stock value < stock price
the stock is overvalued
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The Greenspan Model
Insert Table 8-3 here.
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Growth At a Reasonable Price (GARP)
The GARP (Growth At a Reasonable Price)technique seeks to combine elements of
both growth and value investing.
Value investors like low price/earningsratios, while growth investors like high
growth rates.
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The PEG ratio, which is the principal GARPyardstick, combines both perspectives.
PEG ratio =
price earnings ratio.
annual earnings per share growth rate
GARP investors like a low number, and
many seek stocks with a PEG ratio that isless than one.
Growth At a Reasonable Price (GARP)
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Growth At a Reasonable Price (GARP)
Insert Table 8-4 here.
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Pro-Forma Earnings
In general, pro forma earnings refer to net
income excluding the effects of write-downsor goodwill amortization.
Pro forma earnings data give the investor
more reliable information on which toassess future corporate prospects.
However, the more firms choose to exclude
from net income, the better their earnings
ratios will look. Pro forma earnings are also called cash
earnings orcore earnings.
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EBITDA
EBITDA (earnings before interest, taxes,depreciation, and amortization) is similar to
pro forma earnings in that it excludes non-
operational expenses from the earnings
figure. People involved in the valuation of
businesses often base their analysis in part
on EBITDA multiples and may call thefigure operating cash flow.
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The Growing Role of Cash Flow
Many analysts prefer to focus on cash flowrather than on earnings.
There are many legitimate choices the
firms accountants may take as they work
their way down the income statement, but
cash flow is much less subjective.
Free cash flowrepresents a firms cash
flow minus the amount required fornecessary capital expenditures.
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DuPont Analysis
DuPont analysis investigates the interplayof three aspects of corporate performance:
Profitability: Is the company selling its
products for more than it costs to provide
them?
Efficiency: Is the company making
productive use of its assets?
Leverage: To what extent does the firm rely
on bondholders and the bank?
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DuPont Analysis
Insert Figure 8-2 here.
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DuPont Analysis
Insert Table 8-5 here.
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DuPont Analysis
Insert Figure 8-3 here.
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Present Value of Growth Opportunities
The present value of growth opportunities
(PVGO) comes from closer scrutiny of the
dividend discount model.
It is the difference between the stock price
and the present value of a perpetual streamof the current earnings level.
PVGOk
EPS
P +=1
0
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Present Value of Growth Opportunities
Insert Table 8-6 (PepsiCo and
Coca-Cola Stock Data) here.
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Regulation Fair Disclosure
In August 2000, the Securities andExchange Commission approved
Regulation Fair Disclosure (Regulation FD).
The principal provision of the rule prevents
companies from giving material
information to security analysts, mutual
funds, or institutional investors unless the
company simultaneously issues the sameinformation to the general public.
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However, to avoid violating the rule,companies in general have begun to
provide less information between quarterly
reports.
Regulation Fair Disclosure
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Market Analysis The Major Indexes The Greenspan Model The Equity Risk Premium
Review
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Company Analysis The Greenspan Model Growth At a Reasonable Price (GARP) Pro-Forma Earnings
EBITDA The Growing Role of Cash Flow DuPont Analysis Present Value of Growth Opportunities
Regulation Fair Disclosure
Review