上海对外贸易学院
2005 年度精品课程
《证券投资分析》
课程建设成果之一

CHAPTER 1
THE INVESTMENT SETTING
I. Rationale for Investment
A. Income streams and spending needs do not coincide
1. If income is greater than spending – people tend to invest the surplus
2. If spending is greater than income – people tend to borrow to cover the deficit
B. People would be willing to forgo current consumption only if they can achieve greater consumption in the future.
C. The rate of exchange between future consumption and present consumption is the pure rate of interest. Market forces determine this rate.
D. Investment is the current commitment of funds for a period of time to obtain a future flow of funds that will compensate the investor for the time the funds are committed, for the expected rate of inflation, and for the uncertainty of the future flow of funds.
II. Measures of Return and Risk
A. Measures of Historical Rates of Return
1. Holding Period Return (HPR) - the total return from an investment, including all sources of income, for a given period of time. A value of 1.0 indicates no gain or loss.
HPR
=
Ending Value of Investment (including cash flow during the holding period)
Beginning Value of Investment
2. Holding Period Yield (HPY) - the total return from an investment for a given period of time stated as a percentage.
HPY = HPR - 1
Annual HPR = HPR1/n where n is the number of years the investment is held
B. Computing Mean Historical Returns
1. Mean rate of return - the average of an investment's returns over time.
2. Single Investment a. Arithmetic Mean (AM) - a measure of mean return equal to the sum of annual returns divided by the number of years.

Arithmetic Mean =
Σ
HPY/n b. Geom etric Mean (GM) - the nth root of the product of the annual holding period returns for n years, minus one (1).
GM =[
π
HPR]1/n - 1 where
π
= the pr oduct of the annual holding period returns, i.e.,
(HPR)x(HPR2) x...(HPRn)
3. A Portfolio of Investments – The mean historical rate of return for a portfolio of investments is measured as the weighted average of the HPYs for the individual investments in the portfolio.
C. Calculating Expected Rates of Return
1 . Risk - the uncertainty that an investment will earn its expected rate of return.
2. Probability – the likelihood of an outcome
3. To compute the expected rate of return, th e investor assigns probability values to all possible returns. These probabilities range from zero (no chance) to one (complete certainty).
4. Expected Return
Expected Return
= i n ∑
=
1
(Prob.
of Return) x (Possible Return)
E(R i
)
= i n ∑
=
1
( P i
)( R i
)
Risk aversion - the assumption that most investors will choose the least risky alternative, all else being equal and that they will not accept additional risk unless they are compensated in the form of higher return.
D. Measuring the Risk of Expected Rates of Return
1. Variance - a measure of risk equal to the sum of t he probability of return times the squares of a return's deviation from the mean.
Variance
= n ∑ i
=
1
(Prob.)(Po ssible Return Expected Return)
2
2 = n ∑ i
=
1
( P i
)[ R i
E(R i
)]
2
2. Standard Deviation (
σ
) - a measure of risk equal to the square root of variance.
3. Coefficient of variation (CV) - a measure of relative variability that indicates risk

per unit of return. It is used to compare alternative investments whose rates of return and standard deviation vary widely.
CV
=
Standard Deviation of
Expected Rate of
Returns
Return
III. Determinants of Required Rates of Return
A. R ates of Return - vary over time and across investments (Exhibit 1.5).
B. The Real Risk-Free Rate (RRFR) - the basic interest rate assuming no inflation or uncertainty.
1. Factors that influence this rate
A. Time preference for consumption of income
B. Investment opportunities in the economy.
2. T his real risk-free rate is determined by the rea l growth rate of the economy that is impacted by growth rate of labo r force, hours worked, and rate of productivity
3. A positive relationship exists between the real growth rate in the economy and the
RRFR
C. The Nomin al Risk-Free Rate (NRFR) – incorporates inflation
1. Note th e substantial variation in government T-bill rates over time (Exhibit 1.6)
2. Factors that influence NRFR
A. Conditions in the Capital Markets - Relative ease or tightness (this is a short-run phenomenon)
B. Expected Rate of Inflation - this is a major influence (Exhibit 1.6)
Nominal RRFR = (1 + RRFR)(1 + Expected Rate of Inflatio n) -1
RRFR
=
(1
(1
+
Nominal RFR)
+
Rate of Inflation)
1
3. The Common Effect – all fact ors discussed thus far affects all investments equally irrespective of type or form.
D. Ris k Premium – varies from ass et to asset and is responsible for differences in rates of return between assets at a certain point in time. The major determinants of the risk premium are:
1. Business risk – uncertainty of income flows caused by the nature of a firm’s business. Sales volatility and operating le verage determine the level of business risk
2. F inancial risk – uncertainty caused by the use of debt financing
3. Liquidity risk - the inability to buy or sell an asset quickly with little price change.
4. Exchange rate risk - the uncertainty of returns on securities acquired in a

foreign currency.
5. Country risk - uncertainty due to the possibility of major political or economic change in the country where an investment has been made.
E.
F.
Risk Premium and Portfolio Theory
- Th e relevant risk measure for an individual asset is its comovem ent with the market portfolio
Fundamental Risk versus Systematic Risk
- Fundamental risk com prises business risk, financial risk, liquidity risk, exchange ra te risk, and country risk, while systematic risk refers to the portion of an individual asset’s total variance attributable to t he variability of the total market portfolio
G. Required Rate of Return – minimum acceptable rate of return from a n investme nt. Determined by RRFR, NRFR, and risk premium
IV. Relationship between Risks and Return
A.
Security Market Line (Exhibit 1.7)
B. Movements along the SML - A movement along the line indicates a change in the level of risk for a given company or asset. (Exhibit 1.8)
C. Changes in the Slope of the SML - A change in the slope of the SML indicates a change in the attitudes of investors toward risk--i.e., a cha nge in the required risk premium for a given asset or asset class. (Exhibit 1.10)
D. Shift in the SML (Exhibit 1.8)
Can be caused by a change in any of the following:
1. expected real growth in the economy
2. capital market conditions
3. expected rate of inflation.
E. Summary of Changes in the Required Rate of Return

CHAPTER 4
ORGANIZATION AND FUNCTIONING OF SECURITIES MARKETS
I. What is a Market?
A. A market is a means through which buyers and sellers are brought together to aid in the transfer of goods and/or services.
B. Characteristics of a "Good" Market
1. Timely and accurate information on price and volume of past transactions
2. Liquidity (ability to buy or sell quickly at a price close to prior price) a. Price continuity – prices do not change much from one transaction to another unless significant new information becomes available b. Depth – several potential buyers and sellers must be willing to trade at prices above and below the current market price
3. Low transaction costs (internal efficiency)
4. Rapid adjustment of price to new information (external efficiency or informational efficiency)
C. Organization of the Securities Markets
1. Primary markets are those where new securities are sold and funds go to issuing unit
2. Secondary markets are those where outstanding securities are bought and sold by investors. The issuing unit does not receive any funds in a secondary market transaction
I I. Primary Capital Markets
A. Government Bond Issues
1. Treasury Bills – negotiable, non-interest bearing securities with original maturities of one year or less
2. Treasury Notes – original maturities of 2 to 10 years
3. Treasury Bonds – original maturities of more than 10 years
B. Municipal Bond Issues
1. Method of sale a. Competitive bid – usually involves sealed bids b. Negotiated sale – involves contractual arrangements between underwriters and issuers c. Private placement – involves sale of securities directly to a small group of investors or institutional investors
2. Underwriting function – the investment banker purchases the entire issue from the issuer and resells the security to the investing public. The firm charges a

commission for providing this service. For municipal bonds, the underwriting function is performed by both investment banking firms and commercial banks a. Origination – involves the design of the bond issue and initial planning b. Risk-bearing – refers to the underwriter’s risk of reselling the securities to the investing public c. Distribution – selling to investors with the help of selling syndicate consisting of other investment banking firms and/or commercial banks if the issue is very large
3. Types of municipal bonds a. General obligation (GO) bonds – backed only by the full faith and credit of the issuer and not by any specific revenue source b. Revenue bonds – specific revenue source backs the bonds
C. Corporate Bond and Stock Issues
1. Types of new issues a. Seasoned new issues – new shares offered by firms that already have stock outstanding b. Initial public offerings (IPOs) – a firm selling its common stock to the public for the first time
D. Relationship with investment bankers
1. Negotiated arrangement
2. Competitive bid arrangement
3. Best-efforts arrangement
E. Introduction of Rule 415 (Shelf registration) – allows large firms to register security issues and sell them piecemeal during the following two years
F. Private Placement and Rule 144A – the company designs an issue of securities with the assistance of an investment banker and sells it to a small group of investors (individual or institutional)
A. Importance of Secondary Markets – enhances liquidity of the securities
B. Secondary Bond Markets
1. Secondary Markets for U.S. Government and Municipal Bonds – market makers are banks and investment firms
2. Secondary Corporate Bond Market – OTC (over-the-counter market)
C. Financial Futures Markets
D. Secondary Equity Markets
1. Securities Exchanges a. Alternative Trading Systems

−
Pure auction market
− market b. Call versus Continuous Markets – In a call market, trading for individual stocks takes place at specified times, while, in a continuous market, trades occur at any time the market is open
2. National Stock Exchanges (see Exhibit 4.3 for volumes) a. New York Stock Exchange (NYSE) b. American Stock Exchange (AMEX) c. Tokyo Stock Exchange (TSE) d. London Stock Exchange (LSE)
3. Trends a. New Exchanges in Emerging Economies such as Russia, China, Hungary,
Peru, etc. b. Consolidations in Developed Markets - driven by economies of scale and technology c. The Global Twenty-Four-Hour Market – made possible by advances in technology
E. Regional Exchanges and the Over-the-Counter Market
1. Regional Securities Exchanges
2. Over-the-Counter (OTC) Market a. Size of the OTC market – largest segment of the U.S. secondary market b. Operation of the OTC – referred to as a negotiated market in which investors directly negotiate with dealers c. The NASDAQ system – automated, electronic quotation system for the
OTC market d. Listing Requirements for NASDAQ – less stringent than that of the NYSE e. A Sample Trade
3. Third Market – OTC trading of shares listed on an exchange
4. Fourth Market – direct trading of securities between two parties with no broker intermediary
IV. Detailed Analysis of the Exchange Market
A. Exchange Membership
1. Specialists (will be discussed later)
2. Commission brokers – employees of a member firm who buy or sell for the customers of the firm
3. Floor brokers – independent members of an exchange who act as brokers for other members
4. Registered traders –members of the exchange who buy and sell for their own account
B. Types of Orders
1. Market orders
2. Limit orders
3. Short sales
4. Special orders

a. Stop loss order b. Stop buy order
5. Margin Transactions a. Initial margin b. Maintenance margin c. Margin call
C. Exchange Market Makers
1. U.S. Markets (Specialists) a. Functions of the specialist
−
broker for limit orders and special orders
−
dealer to maintain "orderly" market (market maker) b. Specialist income
−
Income derived from both functions depends upon the type of stocks.
−
Rates of return are large.
2. Tokyo Stock Exchange (TSE) a. Regular Members b. Saitori
3. London Stock Exchange (LSE) a. Brokers b. Jobbers
V. Changes in the Securities Markets – prompted by the significant and rapid growth of trading by large financial institutions
A. Evidence and Effect of Institutionalization
1. Average Size of Trades
2. Growth of Block Trades (see Exhibit 4.10)
3. Major effects of institutionalization a. Negotiated (competitive) commission rates b. The influence of block trades c. The impact on stock price volatility d. The development of a National Market System (NMS)
B. Negotiated Commission Rates
1. Background a. Minimum commission schedule b. Reaction to high commissions (give-ups & the use of the third and fourth market)
2. Negotiated Commissions (allowed on all transactions as of May 1, 1975)
C. The Impact of Block Trades
1. Block Trades on the Exchanges
2. Block Houses
3. Example of a Block Trade
D. Institutions and Stock Price Volatility
(No empirical support for the relationship between trading by large financial

institutions and stock price volatility)
E. National Market System (NMS)
1. Centralized Reporting of all Transactions
2. Centralized Quotation System a. Intermarket Trading System (ITS)
3. Central Limit Order Book (CLOB)
4. Competition Among Market Makers (Rule 390)
F. New Trading Systems
1. Super Dot
2. Display Book
3. Opening Automated Report Service (OARS)
4. Market Order Processing
5. Limit Order Processing
6. Global Market Changes a. London Stock Exchange (LSE) - Effects of the "Big Bang" b. Tokyo Stock Exchange (TSE) – more competition
G. Global Market Changes
1. NYSE Off-Hours Trading – prompted by erosion of NYSE’s market share
2. Listing Foreign Stocks on the NYSE – a priority for the NYSE
H. Future Developments
1. Continuing Consolidation of Security Exchanges
2. More Specialized Investment Companies
3. Changes in the Financial Services Industry a. Financial supermarkets b. Financial boutiques
2. Trading in Cybermarkets

CHAPTER 5
SECURITY-MARKET INDICATOR SERIES
I . Uses of Security Market Indexes
A. As benchmarks to evaluate the performance of professional money managers
B. To create and monitor an index fund
C. To measure market rates of return in economic studies
D. For predicting future market movements by technicians
E. As a substitute for the market portfolio of risky assets when calculating the systematic risk of an asset
II. Differentiating Factors in Constructing Market Indicator Series
A.
The Sample – should be representative of the total population
ƒ Size
ƒ
Breadth
ƒ Source
B.
Weighting of Sample Members
ƒ price-weighted
ƒ value-weighted
ƒ unweighted
C.
Computational Procedures
ƒ
arithmetic
ƒ compute an index and have all changes, whether in price or value, reported in
ƒ terms of the basic index average
I II. Stock-Market Indicator Series
D.
Price Weighted Series
1. Dow Jones Industrial Average – oldest and best-known of the stock market indexes a. Computation of DJIA – sum of the prices of 30 blue-chips stocks divided by adjusted divisor b. Criticisms of DJIA
ƒ Limited to 30 non-randomly selected blue-chip stocks
ƒ Includes mostly large, mature, blue-chip companies
ƒ
The divisor needs to be adjusted every time one of the companies in the index has a stock split
ƒ Biased in favor of high-priced stocks c. Dow Jones also publishes a 20 stock transportation average and a 15 stock utility average
2. Nikkei-Dow Jones Average (Nikkei Stock Average Index) a. 225 stocks on the First Section of the TSE

b. Criticisms of Nikkei-Dow
ƒ Is a price-weighted series. Hence, it suffers from the same shortcomings of the DJIA
ƒ Stocks included in the index comprise only about 15 percent of all stocks on the First Section of the Tokyo Stock Exchange
E.
Value Weighted Series
1. General computational procedure (See Exhibit 5.3)
2. Automatic adjustment for stock split
3. Examples of value weighted series (See Exhibit 5.5) a. Standard and Poor's Indexes b. New York Stock Exchange Index c. NASDAQ Series d. American Stock Exchange Market Value Index e. Wilshire 5000 Equity Index g. Financial Times Actuaries Indexes h. Tokyo Stock Exchange Price Index i. FT-Actuaries World Indexes j. Morgan Stanley Capital International Indexes k. Dow Jones World Stock Index l. Euromoney-First Boston Global Stock Index m. Salomon-Russell World Equity Index
F.
Unweighted Price Indicator Series
1. General computational procedure – all stocks in an unweighted index carry equal weight regardless of their price or market value
2. Examples of unweighted series a. Value Line Averages b. Financial Times Ordinary Share Index
3. Arithmetic and Geometric Means (See Exhibit 5.8)
G.
Global Equity Indexes
1. FT/S&P - Actuaries World Indexes (See Exhibit 5.9)
2. Morgan Stanley Capital International (MSCI) Indexes (See Exhibits 5.10 and
5.11)
3. Dow Jones World Stock Index (See Exhibit 5.12)
4. Comparison of World Stock Indexes – strong positive correlation between the three series mentioned above
H.
Bond-Market Indicator Series
1. Investment-Grade Bond Indexes (See Exhibit 5.13) a. Lehman Brothers b. Merrill Lynch c. Ryan Treasury d. Salomon Smith Barney

2. High-Yield Bond Indexes a. U.S. High-Yield Bond Indexes (See Exhibits 5.13 and 5.14) b. Merrill Lynch Convertible Securities Indexes
3. Global Government Bond Market Indexes
IV. Composite Stock-Bond Indexes
I.
Merrill Lynch-Wilshire U.S. Capital Markets Index (ML-WCMI)
J.
Brinson Partners Global Security Market Index (GSMI)
V. Mean Annual Security Risk-Returns and Correlations
A. There are clear differences among the series due to different asset classes (e.g., stocks versus bonds) and when there are different samples within asset classes
B. There is a positive relationship between the rate of return on an asset and its measure of risk
C. The security market indexes can be used:
ƒ to measure the historical performance of an asset class
ƒ as benchmarks to evaluate the performance of a money manager for a mutual fund, a personal trust, or a pension plan

CHAPTER 12
Chapter 10
ANALYSIS OF FINANCIAL STATEMENTS
I.
Major Financial Statements
ƒ Sheet
ƒ Income
ƒ
Statement of Cash Flows
A.
Generally Accepted Accounting Principles (GAAP)
ƒ Formulated by the Financial Accounting Standards Board (FASB)
B.
Balance Sheet - indicates at a certain point in time, what resources (assets) the firm controls and how it has financed these assets
C.
Income Statement - indicates the flow of sales, expenses and profit during a period
D.
Statement of Cash Flows - integrates the two prior statements, indicating how the balance sheet changes due to operating, investment and financing activities. It has three sections:
1.
Cash Flows from Operating Activities – the sources and uses of cash that arise from the normal operations of a firm
2.
Cash Flows from Investment Activities – change in gross plant and equipment plus the change in the investment account
3.
Cash Flows from Financing Activities – financing sources minus financing uses
E.
Alternative Measures of Cash Flow
1.
Cash Flow from Operations
2.
Free Cash Flow
F.
Purpose of Financial Statement Analysis - aids in the evaluation of management performance in several important areas, including profitability, efficiency, and risk
II.
Analysis of Financial Ratios
ƒ Financial ratios are used because numbers in isolation are of little value.
ƒ
Financial ratios are help to identify the strengths and weaknesses in a company’s financial health so that corrective action may be initiated in a timely manner
A.
Importance of Relative Financial Ratios – An individual financial ratio has little value except in relation to comparable ratios for other entities. Hence, only

relative financial ratios are relevant.
A firm’s performance is examined relative to:
1.
To the aggregate economy
2.
To the firm's industry
3.
To the firm's major competitors
4.
To the firm's own past performance
III.
Computation of Financial Ratios (5 major categories)
A.
Common Size Statements
ƒ “Normalize” balance sheet and income statement items to allow easier comparison of different-size firms
IV.
Evaluating Internal Liquidity
A.
Internal Liquidity Ratios
1.
Current
2.
Quick
3.
Cash
4.
Receivables
5.
Inventory
6.
Cash Conversion Cycle
V.
Evaluating Operating Performance
A.
Operating Efficiency Ratios
1.
Total Asset Turnover
2.
Net Fixed Asset Turnover
3.
Equity
B.
Operating Profitability Ratios
1.
Gross Profit Margin
2.
Operating Profit Margin
3.
Net Margin
4.
Common Size Income Statement
5.
Return on Total Capital
6.
Return on Total Capital including Leases
•
Implied Interest for Leased Assets
•
Implied Depreciation on Leased Assets
7.
Return on Owner's Equity
8.
The DuPont System
9.
An Extended DuPont System
VI.
Risk
A.
Business Risk
ƒ
Uncertainty of income caused by the firm’s industry

ƒ
Generally measured by the variability of the firm’s operating income over time
Two factors that contribute to the variability of operating earnings are:
1.
Sales
2.
Operating
B.
Financial Risk
ƒ
Additional obligation debt securities
ƒ The acceptable level of financial risk for a firm depends on its business risk
Three sets of financial ratios to measure financial risk are:
1.
Proportion of Debt (Balance Sheet) Ratios
•
Debt-Equity Ratio
•
Long-Term Debt/Total Capital Ratio
•
Total Debt Ratios
2.
Earnings or Cash Flow Ratios
•
Interest Coverage
3.
Cash Flow Ratios
•
Cash Flow-Coverage Ratio
•
Cash Flow-Long-Term Debt Ratio
•
Cash Flow/Total Debt Ratio
•
Alternative Measures of Cash Flow
C.
External Liquidity Risk
1. Determinants of Market Liquidity
VII.
Analysis of Growth Potential
ƒ The analysis of sustainable growth potential examines ratios that indicate how fast a firm should grow
A.
Importance of Growth Potential
ƒ For
ƒ For
B.
Determinants of Growth (RR x ROE)
ƒ The amount of resources retained and reinvested in the entity, and
ƒ
The rate of return earned on the resources retained
VIII.
Comparative Analysis of Ratios (in this case, for Walgreens)
A.
Internal Liquidity
B.
Operating Performance
C.
Risk Analysis

D.
Growth Analysis
IX.
Analysis of Non-U.S. Financial Statements
X.
The Quality of Financial Statements
A.
Balance Sheet - A high-quality balance sheet typically has a conservative use of debt or leverage
B.
Income Statement - The closer the earnings are to cash, the higher the quality of the income statement.
C.
Footnotes – The purpose of the footnotes is to provide information on how the firm handles balance sheet and income items. Hence, reading them is important.
XI.
The Value of Financial Statement Analysis
XII.
Specific Uses of Financial Ratios
A.
Stock Valuation Models
B.
Estimating Systematic Risk
C.
Estimating the Credit Ratings on Bonds
D.
Predicting Insolvency (Bankruptcy)
XIII.
Limitations of Financial Ratios

CHAPTER 13
AN INTRODUCTION TO SECURITY VALUATION
I.
An Overview of the Valuation Process
A.
The top-down, three-step approach
ƒ Both the economy/market and the industry effect have a significant impact on the total returns for individual stocks
B.
The bottom-up, stock valuation, stock picking approach
ƒ It is possible to find stocks that are undervalued relative to their market price, and these stocks will provide superior returns regardless of the market and industry outlook
II.
Why a Three-Step Valuation Process?
A.
General Economic Influences
ƒ
Monetary and fiscal policy measures have an impact on the economy of the country where they are enacted
ƒ The economic conditions influence all industries and companies
B.
Industry
ƒ An industry’s prospects within the global business environment will determine how well or poorly an individual firm will fare.
ƒ
Hence, industry analysis should precede company analysis
C.
Company
ƒ
Quantitative and Qualitative analysis
ƒ Estimation of the “intrinsic” value of the stock and comparison with the market price
D.
Does the Three-Step Process Work?
ƒ Results from academic studies support the use of the three-step investment process
III.
Theory Valuation
A.
Stream of Expected Returns (Cash Flows)
1.
Form of Returns – earnings, cash flows, dividends, interest payments, or capital gains
2.
Time Pattern and Growth Rate of Returns – money has a time value
B.
Required Rate of Return

1. The economy’s real risk-free rate of return
2. The expected rate of inflation during the holding period
3. A risk premium that is determined by the uncertainty of returns
C.
Investment Decision Process
ƒ Estimation of the intrinsic value of the investment at the required rate of return
ƒ
Comparison of intrinsic value with the market price
IV.
Valuation of Alternative Investments
A.
Valuation of Bonds
1.
Present value of interest
2.
Present value of principle
B.
Valuation Preferred Stock
1. Present value of dividend
C.
Approaches to the Valuation of Common Stock
ƒ Discounted Cash Flow Techniques
ƒ
Relative Valuation Techniques
D.
Why and When to Use the Discounted Cash-Flow Valuation Approach
1.
Dividends
2.
Operating free cash flow
3.
Free cash flow to equity
All of the above cash flow techniques are very dependent on:
ƒ The rate of growth and the duration of growth of the cash flows
ƒ The estimate of the discount rate
E.
Why and When to Use the Relative Valuation Techniques
1.
A good set of comparable entities is available
2.
Aggregate market is not at a valuation extreme
F.
Discounted Cash-Flow Valuation Techniques
1.
The Dividend Discount Model (DDM) – cost of equity is used as the discount rate a.
One-year Period b.
Multiple-Year Holding Period c.
Infinite Period Model
G.
Infinite Period DDM and Growth Companies
1. Assumptions of the infinite period DDM a. Dividends grow at a constant rate b. The constant growth rate will continue for an infinite period

c. The required rate of return (k) is greater than the infinite growth rate 9g)
H.
Valuation Tempor ary Supernormal Growth
I.
Present Value of Operating Free Cash Flows – weighted average cost of capital is used as the discount rate
J.
Present Value of Free Cash Flow to Equity – cost of equity is used as the discount rate
V .
Relative Valuation Techniques
A .
Earnings Multiplier Model (or P/E ratio)
B.
The Price/Cash Flow Ratio
C.
The Price/Book Value Ratio
D.
The Price/Sales Ratio
VI.
Estimating the Inputs: The Required Rate of Return and the Expected
Growth Rate of Valuation Variables
A.
Required Rate of Return (k)
1.
The Economy's Real Risk-Free Rate (RRFR)
2.
The Expected Rate of Inflation (I)
3.
The Risk Premium (RP) a.
Business risk, financial risk, liquidity risk, exchange rate risk, country risk b.
Changes in the risk premium
B.
Estimating the Required Rate of Return for Foreign Securities
1.
Foreign Real RFR
2.
Inflation
3 .
Risk
C.
Expected Growth Rate of Dividends
1.
Estimating Growth From Fundamentals
2.
Breakdown of ROE
3 .
Estimating Growth Based on History
D.
Estimating Dividend Growth for Foreign Stocks
1.
Retention
2.
Net Margin
3.
Total Asset Turnover
4.
Total Asset/Equity Ratio

I.
CHAPTER 14
MACROECONOMIC AND MARKET ANALYSIS: THE GLOBAL ASSET ALLOCATION
DECISION
Economic Activity and Security Markets
A.
Stock Market and Economy Relationship
ƒ A strong relationship exists between the economy and the stock market
B.
Stock Market As A Leading Indicator
1.
Stock prices reflect expectations of earnings, dividends, and interest rates
2.
Stock market reacts to various leading indicator series
3.
Stock prices consistently turn before the economy does
II.
Cyclical Indicator Approach to Forecasting the Economy
ƒ This approach contends that the aggregate economy expands and contracts in discernable periods
A.
Cyclical Indicator Categories
1.
Categories a.
Leading indicators – economic series that usually reach peaks or troughs before corresponding peaks or troughs in aggregate economy activity (see
Exhibit 12.2) b.
Coincident indicators – economic series that have peaks and troughs that roughly coincide with the peaks and troughs in the business cycle (see
Exhibit 12.3) c.
Lagging indicators – economic series that experience their peaks and troughs after those of the aggregate economy (see Exhibit 12.3) d.
Selected series – economic series that do not fall into one of the three main groups
2.
Composite Series and Ratio of Series (e.g., composite leading indicator index)
B.
Analytical Measures of Performance
1.
Diffusion
2.
Rates of Change
3.
Direction of Change
4.
Comparison With Previous Cycles
C.
Limitations of the Cyclical Indicator Approach
1.
False
2.
Currency of the data and revisions
D.
Leading Indicators and Stock Prices
E.
Other Leading Indicator Series
1.
CIBCR at the Columbia Graduate School of Business

a.
CIBCR b.
CIBCR c.
CIBCR
2.
Analysis of Alternative Leading Indicator of Inflation
3.
International Leading Indicator Series
4.
Surveys of Sentiment and Expectations a.
The University of Michigan Consumer Sentiment Index b.
The Conference Board Consumer Confidence Index
III.
Monetary
A.
Money Supply and the Economy
1.
Declines in the rate of growth of the money supply have preceded business contraction by an average of 20 months
2.
Increases in the rate of growth of the money supply have preceded economic expansions by about 8 months
B.
Financial Conditions Index
C.
Money Supply and Stock Prices
1.
Excess Liquidity and Stock Prices
2.
Historical Excess Liquidity in the United States (see Exhibit 12.5)
3.
Historical Excess Liquidity in Foreign Countries
D.
Other Economic Variables and Stock Prices
1.
Growth in industrial production
2.
Changes in the risk premium
3.
Twists in the yield curve
4.
Measures of unanticipated inflation
5.
Changes in expected inflation during periods of volatile inflation
E.
Inflation, Interest Rates and Security Prices
1.
Inflation and Interest Rates (see Exhibits 12.6 and 12.7)
2.
Interest Rates and Bond Prices a.
The relationship is clearly negative b.
Size of price change will depend on the bond’s characteristics
3.
Inflation, Interest Rates and Stock Prices – relationship is not direct and consistent
F.
Summary of Macroeconomics Analysis
ƒ There is ample evidence of a strong and consistent relationship between economic activity and the stock market
ƒ The stock market turns four to nine months before the economy does
ƒ To predict the future direction of the stock market using this approach, you must either forecast economic activity about 12 months ahead or examine economic indicator series that lead the economy by more than stock prices do

IV.
Analysis of World Security Markets
A.
Example: Goldman, Sach & Co. three-step top-down approach
B.
Inflation and Exchange Rates (see Exhibits 12.9, 12.10, 12.11 and 12.12)
C.
Correlations Among Returns (see Exhibits 12.13 and 12.14)
D.
Individual Country Stock Price Changes (see Exhibit 12.15)
E.
Individual Analysis (see Exhibits 12.16 and 12.17)
F.
World Asset Allocation (see Exhibit 12.18)

CHAPTER 15
BOND FUNDAMENTALS
I.
Basic Features of a Bond
A.
Public
1.
Payments: (periodically) and principal at maturity
2.
Term maturity a.
Short-term market) b.
Intermediate-term c.
Long-term
B.
Bond
1.
Intrinsic a.
Coupon – the income that the bond investor will receive over the life (or holding period) of the issue b.
Term to maturity – date or number of years before a bond matures
ƒ Term vs. serial obligation bond c.
Principal or par value – the original value of the obligation d.
Types of ownership
ƒ Bearer vs. registered bond
2.
Types of Issues a.
Secured (senior) bonds – backed by legal claim on some specified property
ƒ For example, mortgage bonds, equipment trust certificates, etc. b.
Unsecured bonds (debentures) – backed only by the promise of the issuer to pay interest and principal on a timely basis c.
Subordinated (junior) debentures – claim on income and assets that is subordinated to other debentures d.
Income bonds (revenue bonds for municipal issues) – interest is paid only if earned e.
Refunding issues – provide funds to prematurely retire another issue
3.
Indenture
4.
Features Affecting a Bond's Maturity a.
Call features (f reely callable, non-callable, deferred call, call premium) b.
Nonrefunding c.
Sinking
C.
Rates of Return on Bonds
HPR i, t
=
P i, t
+
1
+
Int
P i, t i, t

where:
HPRi,t = holding period return for bond i during period t
Pi,t+1 = market price of bond i at the end of period t
Pi,t = market price of bond i at the beginning of period t
Inti,t = interest payments on bond i during period t
HPY = HPR – 1
II.
The Global Bond Market Structure
A.
Size and Distribution (See Exhibit 18.1)
B.
Participating
1.
Government
2.
Government
3.
Municipalities
4.
Corporations
5.
International
C.
Participating
1.
Institutional a.
Life Insurance Companies b.
Commercial c.
Property and Liability Insurance Companies d.
Pension e.
Mutual
2.
Individual
D.
Bond
1.
Rating
2.
Description of bond ratings (see Exhibit 18.3)
III.
Alternative Bond Issues
A.
Domestic Government Issues
1.
United
2.
Treasury Inflation Protected Securities (TIPS)
3.
Japan
4.
Germany
5.
United
B.
Government Agency Issues
1.
United
2.
Japan
3.
Germany
4.
United Kingdom (no government agency issues)

C.
Municipal
1.
Japan, Germany and United Kingdom - limited market size
2.
United a.
Types: general obligation bonds (GOs) and revenue bonds b.
Tax-free
3.
ETY (equivalent taxable yield) = i/(1 – t)
4.
Municipal Bond Insurance
D.
Corporate
1.
U. S. Corporate Bond Market a.
Mortgage b.
Equipment Trust Certificates c.
Collateral Trust Bonds d.
Collateralized Mortgage Obligations (CMOs) e.
Asset-Backed Securities (ABS) f.
Certificates for Automobile Receivables (CARS) g.
Credit Card Receivables h.
Variable-Rate i.
Zero Coupon and Deep-Discount Bonds j.
High-Yield k.
Brief History of the High-Yield Bond Market l.
Distribution of High-Yield Bond Ratings m.
Ownership of High-Yield Bonds
2.
Japanese Corporate Bond Market a.
Regulation b.
Bond-rating c.
Minimum issuing requirements are specified by the Ministry of Finance d.
Bank
3.
Germany Corporate Bond Market a.
German mortgage bonds b.
German commercial paper c.
Private loan agreements (Schuldscheindarlehen)
4.
U.K. Corporate Bond Market a.
Debentures b.
Unsecured c.
Convertible
E.
International
1.
Foreign bonds (e.g. Yankee bonds) and Eurobonds
2.
United a.
Eurodollar b.
Yankee
3.
Japan a.
Samurai b.
Euroyen
4.
Germany a.
Eurobonds

5.
United a.
Bulldog
I V.
Obtaining Information on Bonds
A.
Interpreting Bond Quotes
1.
Corporate Bond Quotes (see Exhibit 18.8)
2.
Treasury and Agency Bond Quotes (see Exhibit 18.9)
3.
Municipal Bond Quotes (see Exhibit 18.10)

CHAPTER 16
THE ANALYSIS AND VALUATION OF BONDS
I.
The Fundamentals of Bond Valuation
A.
The Present Value Model
ƒ
The value of a bond equals the present value of its expected cash flows
1.
The Price-Yield Curve – Price moves inversely to yield
2.
Observations a.
Yield < coupon rate, bond will be priced at a premium to its par value b.
Yield > coupon rate, bond will be priced at a discount to its par value c.
Price-yield relationship is convex (not straight line)
B.
The Yield Model
II.
Computing Bond Yields
A.
Nominal (Coupon) Rate
B.
Current
C.
Promised Yield to Maturity (YTM)
1.
Most important and widely used measure
2.
Assumptions a.
Hold bond to maturity b.
Reinvest all interim cash flows at computed YTM
3.
Computing the Promised Yield to Maturity
4.
YTM for a Zero-Coupon Bond
D.
Promised Yield to Call (YTC)
ƒ Whenever a bond with a call feature is selling for a price above par equal to or greater than its call price, a bond investor should consider valuing the bond in terms of YTC rather than YTM
1.
Computing Promised Yield to Call
E.
Realized (Horizon) Yield
1.
Computing
III.
Calculating Future Bond Prices
A.
Realized (Horizon) Yield with Differential Reinvestment Rates

B.
Price and Yield Determination on Noninterest Rates
1. Accrued interest
C.
Yield Adjustments for Tax-Exempt Bonds
1. Fully taxable equivalent yield – adjusts the promised yield computation for the bond’s tax-exempt status
D.
Bond Books
IV.
Bond Valuation Using Spot Rates
V .
What Determines Interest Rates?
A.
Forecasting Rates
ƒ The ability to forecast interest rates and changes in these rates is critical to successful bond investing
B.
Fundamental Determinants of Interest Rates
1.
Risk-Free Rate, Expected Inflation and Risk Premium
2.
Effect of Economic Factors
3.
The Impact of Bond Characteristics a.
Quality of the issue as determined by its risk of default relative to other bonds b.
Term to maturity of the issue, which can affect price volatility c.
Bond indenture provisions, including collateral, call features, and sinking-fund provisions d.
Foreign bond risk, including exchange rate risk and country risk
C.
Term Structure of Interest Rates
1.
Yield Curves (See Exhibits 19.7 and 19.8)
2.
Creating the Theoretical Spot-Rate Curve
VI.
Calculating
VII.
Term-Structure
A.
Three Major Theories
1.
Expectations a.
Any long-term interest rate simply represents the geometric mean of current and future one-year interest rates expected to prevail over the maturity of the issue b.
Consistent Investor Actions
2.
Liquidity Preference Hypothesis a. Long-term securities should provide higher returns than short-term obligations because investors are willing to sacrifice some yields to invest in short-maturity obligations to avoid the higher price volatility of long-maturity bonds

3.
Segmented-Market Hypothesis (Preferred-Habitat, Institutional Theory or
Hedging Pressure Theory) a. Different institutional investors have different maturity needs that lead them to confine their security selections to specific maturity segments
4.
Trading Implications of the Term Structure a. Information on maturities can help you formulate yield expectations by simply observing the shape of the yield curve
B.
Yield
1.
Different
2.
Different
3.
Different coupons or seasoning
4.
Different
VIII.
What Determines the Price Volatility for Bonds?
A.
Interest Rate Sensitivity
B.
Bond Price Volatility
1.
Bond prices move inversely to bond yields
2.
Bond prices volatility is directly related to term to maturity
3.
Bond price volatility increases at a diminishing rate as term to maturity increases
4.
Bond price movements are not symmetrical
5.
Bond price volatility is inversely related to coupon
C.
Trading
D.
Duration
1.
Duration is a measure of interest rate sensitivity of a bond a.
Macaulay b.
Modified c.
Effective d.
Empirical
2.
Macaulay a.
Macaulay considers both the repayment of capital at maturity and the size and timing of coupon payments prior to final maturity b.
Characteristics of Duration
−
Duration of a bond is less than term to maturity (except zero coupon bonds)
−
There is an inverse relationship between coupon and duration
−
Zero coupon bonds have duration equal to maturity
−
There is a positive relationship between term to maturity and duration
−
There is a inverse relationship between YTM and duration
−
Sinking funds and call provisions cause decline in duration

E.
Modified Duration and Bond Price Volatility
1.
Modified duration can be used to approximate the interest rate sensitivity of an option-free (straight) bond
2.
Modified duration is always a negative value for a noncallable bond because of the inverse relationship between yield changes and bond price changes
3.
Trading Strategies Using Duration
F.
Bond
1.
The Price-Yield Relationship for Bonds (See Exhibits 19.18 and 19.19) a.
The price-yield relationship is not a straight line but a curvilinear relationship (i.e., convex)
−
This relationship can be applied to a single bond, a portfolio of bonds, etc.
−
The convex relationship will differ depending on the nature of the cash flows, that is, coupon and maturity b.
The Desirability of Convexity
2.
Determinants of Convexity a.
Convexity is a measure of the curvature of the price-yield relationship b.
Factors and bond convexity
−
Inverse relationship between convexity and coupon
−
Direct relationship between convexity and maturity
−
Inverse relationship between convexity and yield
3.
The Modified Duration – Convexity Effects
4.
Computation of Convexity
G.
Duration and Convexity for Callable Bonds
1.
Option-Adjusted
2.
Convexity of Callable Bonds
H.
Limitations of Macaulay and Modified Duration
1.
Major a.
The percentage change estimates using modified duration are good only for small-yield changes b.
Difficult to determine the interest rate sensitivity of a portfolio of bonds when there is a change in interest rates and the yield curve experiences a nonparallel shift c.
Initial assumption that cash flows from the bond are not affected by yield changes
2.
Effective a.
Effective duration measures the interest rate sensitivity of a bond taking into consideration that the cash flows of the bond can change when yields change due to the existence of embedded options b.
Putable
3.
Effective Duration Greater Than Maturity
4.
Negative Effective Duration
5.
Empirical

6.
Empirical Duration for Common Stock
IX.
Yield Spreads With Embedded Options
A.
Static Yield Spreads
B.
Option-Adjusted Spread (OAS)

CHAPTER 18
CHAPTER 18
STOCK MARKET ANALYSIS
I.
Applying the DDM Valuation Model to the Market
A.
Stock Market Multiplier:
1.
Varies widely over time
2.
Has a big impact on changes in the value of the market
3.
Very small changes in either k or g can affect the spread between k and g and change the value of the aggregate market substantially
B.
Market Valuation Using the Reduced Form DDM
1.
The Nominal Risk-Free Rate
2.
The Equity Risk Premium
3.
The Current Estimate of Risk Premium and k
II.
Estimating the Growth Rate of Dividends (g)
A.
Growth Rate
1.
Is equal to: a.
Retention rate - the proportion of earnings retained and reinvested b.
Return on equity (ROE) – rate of return earned on investment c.
An increase in either or both of these variables causes an increase in the expected growth rate (g) and an increase in the earnings multiplier
2.
Combining Estimates
B.
Market Valuation Using the Free Cash Flow to Equity (FCFE) Model
1.
The Constant Growth FCFE Model
2.
The Two-Stage Growth FCFE Model
III.
Valuation Using the Relative Valuation Approach
A.
Two-Part Valuation Procedure
B.
Importance of Both Components of Value
1.
Estimate future earnings per share for the stock-market series
2.
Estimate future earning multiplier for the stock-market series
IV.
Estimating Expected Earnings Per Share
A.
Estimating Gross Domestic Product (GDP)

B.
Estimating Sales per Share for a Market Series
C.
Estimating Aggregate Operating Profit Margin
1.
Capacity Utilization Rate
2.
Unit Labor Cost
3.
Rate of Inflation
4.
Foreign
D.
Estimating Depreciation Expense
E.
Estimating Interest Expense
F.
Estimating the Tax Rate
V.
G.
Calculating Earnings Per Share: An Example
Estimating the Earnings Multiplier For a Stock-Market Series
A.
Determinants of the Earnings Multiplier
B.
Estimating the Required Rate of Return (k)
C.
Estimating the Growth Rate of Dividends (g)
D.
Estimating the Dividend-Payout Ratio (D
1
/E
1
)
E.
Estimating an Earnings Multiplier: An Example
1.
The Direction of Change Approach
2.
Specific Estimate Approach
F.
Calculating the Estimate of the Value for the Market Series
VI.
Calculating the Expected Rate of Return on Common Stocks
A.
Other Relative Valuation Ratios
1.
Analysts compare these ratios to similar ratios for the aggregate market, other industries and stocks within an industry
2.
Calculation of Relative Valuation Ratios a.
Price-to-book-value (P/BV) ratio b.
Price-to-cash-flow (P/CF) ratio c.
Price-to-sales ratio
VII.
Analysis of World Markets

A.
Goldman, Sachs & Company Model
B.
Individual Analysis

CHAPTER 19
INDUSTRY ANALYSIS
I. Why Do Industry Analysis?
A. Cross-Sectional Industry Performance
1. There is a wide variation in industry performance. Therefore, industry analysis is important and necessary to uncover substantial performance differences among industries that will help identify both unprofitable and profitable opportunities.
B. Industry Performance Over Time
1. Industries do not perform consistently over time. Therefore, you must estimate future values of key variables.
C. Performance of Companies Within An Industry
1. There are wide performance differences across companies within most industries. Therefore, company analysis is necessary.
2. Implication of Dispersion within Industries
D. Differences in Industry Risk
1. Risk between industries differs, which means it is necessary to analyze it.
2. Risk measures for individual industries are relatively stable over time.
Therefore, historical risk measures may be of value.
E. Summary of Research on Industry Analysis
F. Industry Analysis Process
II. The Business Cycle and Industry Sectors
ƒ Economic trends can and do affect industry performance
ƒ By identifying and monitoring key assumptions and variables, we can monitor the economy and gauge the implications of new information on our economic outlook and industry analysis
A. Cyclical or Structural Changes
Cyclical changes in the economy arise from the ups and downs of the business cycle
Structure changes occur when the economy undergoes a major change in organization or how it functions
B. Rotation strategy is when one switches from one industry group to another over the course of a business cycle
C. Economic Variables and Different Industries
1. Inflation
2. Interest Rates

3. International Economics
4. Consumer Sentiment
III. Structural Economic Changes and Alternative Industries
A. Demographics
B. Lifestyles
C. Technology
D. Politics and Regulations
IV. Evaluating the Industry Life Cycle
Five Stage Model
1. Pioneering Development
2. Rapid Accelerating Growth
3. Mature Growth
4. Stabilization and market maturity
5. Deceleration of growth and decline
V. Analysis of Industry Competition
A. Competition and Expected Industry Returns
ƒ
Porter’s concept of competitive strategy is described as the search by a firm for a favorable competitive position in an industry
ƒ To create a profitable competitive strategy, a firm must first examine the basic competitive structure of its industry
ƒ The potential profitability of a firm is heavily influenced by the profitability of its industry
1. Porter’s Five Competitive Forces a. Rivalry among the existing competitors b. Threat of new entrants c. Threat of substitute products d. Bargaining power of buyers e. Bargaining power of suppliers
VI. Estimating Industry Rates of Return
A. Valuation Using the Reduced – Form DDM
1. Estimating the Required Rate of Return (k) a. Fundamental risk factors: business risk, financial risk, liquidity risk, exchange rate risk, and country risk

2. Estimating the Expected Growth Rate (g) a. Earnings Retention Rate b. Return on Equity
B. Industry Valuation Using the Free Cash Flow to Equity (FCFE) Model
1.
The Constant Growth FCFE Model
2.
The Two-Stage Growth FCFE Model
VII. Industry Analysis Using the Relative Valuation Approach
A. The Earnings Multiple Technique
1. Estimating Earnings Per Share a. Forecasting Sales Per Share e. Demonstrating a Sales Forecast
2. Forecasting Earnings Per Share – Earnings Forecasting and the Analysis of
Industry
Competition
B. Industry Profit Margin Forecast
1. The Industry’s Operating Profit Margin
3. Industry Interest Expense
4. Estimating Interest Expense
5. Industry Tax Rate
C. An Industry Earnings Estimate Example
D. Estimating an Industry Earnings Multiplier
1. Macroanalysis of an Industry Multiplier – Why a relationship?
2. Microanalysis of an Industry Multiplier
3. Industry Multiplier Versus the Market Multiplier
4. Comparing Dividend-Payout Ratios
5. Estimating the Required Rate of Return
6. Estimating the Expected Growth Rate (g)
7. Industry Expected Value and Rate of Return
VIII. Other Relative Valuation Ratios
A. The Price/Book Value Ratio
B. The Price/Cash Flow Ratio

C. The Price/Sales Ratio
IX. Global Industry Analysis
A. The macroeconomic environment in the major producing and consuming countries for this industry
B. An overall analysis of the significant companies in the industry and the products they produce
C. What are the accounting differences by country and how do these differences impact the relative valuation ratios?
D. What is the effect of currency exchange rate trends for the major countries?

CHAPTER 20
COMPANY ANALYSIS AND STOCK VALUATION
I. Company Analysis Versus the Selection of Stocks
A. Different factors determine the type of company and the type of stock, which means the two are not the same - e.g., the stock of a growth company is not necessarily a growth stock.
B. Growth Companies and Growth Stocks
ƒ Growth companies are those that consistently experience above-average increases in sales and earnings
ƒ
Growth stock is a stock with a higher rate of return than other stocks in the market with similar risk characteristics
C. Defensive Companies and Defensive Stocks
ƒ Defensive companies are those whose future earnings are likely to withstand an economic downturn
ƒ
Defensive stocks are those whose rate of return is not expected to decline during an overall market decline, or decline less than the overall market
D. Cyclical Companies and Cyclical Stocks
ƒ
Cyclical companies are those whose sales and earnings will be heavily influenced by aggregate business activity
ƒ Cyclical stocks are those that will experience changes in their rates of return greater than changes in overall market rates of return
E. Speculative Companies and Speculative Stocks
ƒ
Speculative companies are those whose assets involve great risk but those that also have a possibility of great gain
ƒ Speculative stocks possess a high probability of low or negative rates of return and a low probability of normal or high rates of return
F. Value versus Growth Investing
ƒ Value investing involved identifying and investing in stocks that appear to be undervalued for reasons other than earnings growth potential
ƒ Growth stock investing involves identifying and investing in the stock of companies that are experiencing rapid growth of sales and earnings
II. Economic, Industry, and Structural Links to Company Analysis
ƒ The analysis of companies and their stocks is the final step in the top-down approach to investing
A. Economic and Industry Influences

III. Company Analysis – groups various analysis components for discussion
IV. Firm Competitive Strategies
A. Defensive or Offensive Competitive Strategies
1. Defensive strategy involves positioning firm so that it its capabilities provide the best means to deflect the effect of competitive forces in the industry
2. Offensive strategy involves using the company’s strength to affect the competitive industry forces, thus improving the firm’s relative industry position
B. Porter's Competitive Strategies
1. Low-Cost Strategy – the low-cost producer, and hence the cost leader in its industry
2. Differentiation Strategy – firm positions itself as unique in the industry
C. Focusing a Strategy
Whichever strategy it selects, a firm must determine where it will focus this strategy
D. SWOT Analysis
1. Strengths – give the firm a comparative advantage in the marketplace
2. Weaknesses –when competitors have potentially exploitable advantages over the firm
3. Opportunities – environmental factors that could favor the firm
4. Threats – environmental factors that could hinder the firm in achieving its goals
E. Some Lessons from Lynch
1. Favorable Attributes of Firms a. Firm’s product should not be faddish b. Firm should have some long-run comparative advantage over its rivals c. Firm’s industry or product has market stability d. Firm can benefit from cost reductions e. Firms that buy back shares show there are putting money into the firm
F. Tenets of Warren Buffet
1. Business Tenets
2. Management Tenets
3. Financial Tenets
4. Market Tenets
V. Estimating Intrinsic Value
A. Present Value of Dividends
1. Growth Rate Estimates

2. Required Rate of Return Estimate
B. The Present Value of Dividends Model (DDM)
C. Present Value of Free Cash Flow to Equity
D. Present Value of Operating Free Cash Flow
1. Calculation of WACC
E. Relative Valuation Ratio Techniques
V I. Estimating Company Earnings Per Share
A. Company Sales Forecast
1. Sample Estimate of Walgreens Sales
B. Estimating the Company Profit Margin
VII. Walgreens Competitive Strategies
1. The Internal Performance c. Net Profit Margin Estimate d. Computing Earnings Per Share
A. Macroanalysis of the Earnings Multiplier
B. Microanalysis of the Earnings Multiplier
1. Comparing Dividend-Payout Ratios
2. Estimating the Required Rate of Return
3. Estimating the Expected Growth Rate
4. Computing the Earnings Multiplier
5. Estimate of the Future Value for Walgreens
C. Making the Investment Decision
1. Comparing Expected Rate of Return to Required Rate of Return
IX. Additional Measures of Relative Value
A. Price/Book Value Ratio

B. Price/Cash Flow Ratio
C. Price/Sales (P/S) Ratio
D. Summary of Relative Valuation Ratios
X. Analysis of Growth Companies
A. Growth Company Defined
B. Actual Returns Above Expected Returns
C. Growth Companies and Growth Stocks
D. Growth Companies and the Dividend Discount Model
E. Alternative Growth Models
F. No-Growth Firm
G. Long-Run Growth Models
1. Simple Growth Model
2. Negative Growth Model
3. What Determines the Capital Gain Component?
4. Dynamic True Growth Model
H. The Real World
XI. Measures of Value-Added
Economic Value Added (EVA)
EVA Return on Capital
An Alternative Measure of EVA
Market Value-Added (MVA)
Relationships Between EVA and MVA
The Franchise Factor
Growth Duration
Computation of Growth Duration
Intra-Industry Analysis
An Alternative Use of T
Factors To Consider
XII. Site Visits and the Art of the Interview
XIII. When To Sell
XIV. Influences on Analysts

A. Efficient Markets
B. Paralysis of Analysis
C. Analyst Conflicts of Interest
XV. Global Company and Stock Analysis
A. Availability of Data
B. Differential Accounting Conventions
C. Currency Differences (Exchange Rate Risk)
D. Political (Country) Risk
E. Transaction Costs
F. Valuation Differences
G. Summary

CHAPTER 21
TECHNICAL ANALYSIS
I. Underlying Assumption of Technical Analysis
A. The market value of any good or service is determined solely by the interaction of supply and demand
B. Supply and demand are governed by numerous rational and irrational facts
C. Stock prices tend to move in trends that persist for appreciable lengths of time
D. Changes in trend are caused by shifts in supply and demand factors and these shifts can be detected by an analysis of the market itself
II. Advantages of Technical Trading
A. Not heavily dependent on financial statements that can have problems or not contain sufficient information
B. Technicians do not have to have information first, only recognize movement to a new level for any reason
C. Technicians only invest when movement to a new equilibrium has begun
III. Challenges To Technical Analysis
A. Challenges to Technical Analysis Assumptions - based upon efficient market hypothesis (EMH)
B. Challenges to Technical Trading Rules
Moves may be self-fulfilling, but only temporary
Competition will neutralize the value of a technique.
Most rules are very subjective and critical values can change over time.
I V. Technical Trading Rules and Indicators
A. T ypical Stock Price Cycle (See Exhibit 16.2)
B. Contrary-Opinion Rules
ƒ Many technical analysts rely on technical trading rules that assume that the majority of investors are wrong as the market approaches peaks and troughs
ƒ
These technicians try to determine when the majority of investors is either strongly bullish or bearish and the trade in the opposite direction

1. Mutual Fund Cash Positions
2. Credit Balances in Brokerage Accounts
3. Investment Advisory Opinions
4. OTC versus NYSE Volume
5. Chicago Board Options Exchange (CBOE) Put/Call Ratio
6. Futures Traders Bullish on Stock Index Futures
C. Follow the Smart Money
1. The Confidence Index
2. T-Bill-Eurodollar Yield Spread
3. Short Sales by Specialists
4. Debit Balances in Brokerage Accounts (Margin Debt)
D. Other Market Environment Indicators a. Stocks Above Their 200-Day Moving Average
3. Block Uptick-Downtick Ratio
E. Stock Price and Volume Techniques
1. The Dow Theory
ƒ
Oldest technical trading rule a. Major trends - tides b. Intermediate trends - waves c. Short-run trends - ripples
2. Importance of Volume
3. Support and Resistance Levels
7. Multiple Indicator Charts
F. Technical Analysis of Foreign Markets
1. Foreign Stock Market Series
2. Technical Analysis of Foreign Exchange Rates
G. Technical Analysis of Bond Markets