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 profession
it host conferencing and workshops– designed to enhance the knowledge base of the memberships
it also publishes the Financial Analysts JournalFINANCIAL 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 securitiesFINANCIAL 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
• approaches
valuation determines the intrinsic value compared to the current market value
estimate 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 Strategies
2. Moving Average and Trading Range Breakout Strategies
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, buy
if ratio is less than 1, sellTECHNICAL ANAYSIS
2. Moving Average and Trading Range Breakout Strategies
• TRADING RANGE BREAKOUT STRATEGY:
high and low prices for past 200 trading days are identified
if 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 APPROACH
attempts to forecast in the following order 1. economic activity2. industry performance 3. firm’s performance
FUNDAMENTAL ANALYSIS
TOP-DOWN V. BOTTOM UP
• BOTTOM-UP APPROACH:
attempts to estimate prospects in the following order:1. The firm
2. The Industry 3. The economy
FUNDAMENTAL ANALYSIS
FINANCIAL STATMENT ANALYSIS
• INTEGRAL PART OF FUNDAMENTAL ANALYSIS
it helps the analyst understand a firm’s current condition
where it is headed
what factors affect it
how the factors affect itFUNDAMENTAL ANALYSIS
FINANCIAL STATMENT ANALYSIS
• Review of Accounting Statements
includes 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 ANALYSIS
DEFINITION: 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 ANALYSIS
Types 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 ratio
quick ratio
cash ratio
receivables turnoverFUNDAMENTAL ANALYSIS
operating performance ratios:
• indicate how well the management is operating the business
• some examples:
total asset turnover
net fixed asset turnover
equity turnoverFUNDAMENTAL 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 ratio
long-term debt/total capital ratioFUNDAMENTAL ANALYSIS
