Fundamental Analysis By Martin Brenner What is Fundamental Analysis? A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial, and other qualitative and quantitative factors. Major analysis for Value Investing Evaluating whether the security is underpriced or overpriced then trading based on that evaluation. The market overreacts to news which can lead to deals that investors can exploit. In the long run, the price will follow the intrinsic value. Typically used to value stocks, but can be used to value other securities like bonds. Questions to Ask Is the company growing? Is it making a profit? Can it beat out its competitors? Can it pay its debts? Is the management adequate? Is the stock a good investment Who Uses Fundamental Analysis? Almost everyone. Value investors include pretty much anyone who buys a stock thinking that it is cheap and the price will go up. Fundamental Investors Critics of Fundamental Analysis Technical Analysts Believers in the Efficient Market Hypothesis Financial Statements Income Statements Balance Sheet Statements of Retained Earnings Cash Flow Statement Balance Sheet Assets = Liabilities + Shareholders Equity Shows all available assets and liabilities along with the equity the company has access to. Important figures: Cash liquid asset the company can use to pay liabilities (high) Inventory unsold product the company has available (low) Accounts Receivable outstanding bills (low) Income Statement Revenues Expenses Cost of good sold Selling, general, and administrative expenses marketing, bills., R&D Earnings per share Cash Flow Net cash (or cash equivalents) moving into and out of a business. Positive cash flow => more money into a business => more liquid assets Split into three groups Operating money spent or received from day-to-day operations. Investing money spent on investment or obtained from the sale of an asset. Financing money given out or taken in loans Shown on the Statement of Cash Flows The Fundamentals Qualitative Less tangible factors that have an impact on the intrinsic value of a company 10K Form Quantitative The numbers that are used to determine is a company is currently profitable or a good investment Financial Statements (10K form/Annual Report) Qualitative Factors Business Model Vemma Verve Competition Moat Management Steve Jobs Regulation Drug companies/FDA Qualitative Factors Market Share Customers Industry Growth Quantitative Factors Revenue Net Income Expenses Cash Flow Debt Load Margin Free Cash Flow EBITDA (?) Revenue The money a company actually receives. The Top Line of an income statement. Price of Good X # of Good sold. Net Income Net income = Revenue Expenses Taxes = Total Earnings = Profit The Bottom Line Profit Margin Net Income / Revenue = (Revenue Costs) / Revenue Low profit margins show that a company struggles to keep costs low Management Quality Debt Load Total debt on the books of a company. Debt Load/Total Assets = Debt Ratio Lower is usually better. Book Value Total Assets Intangible Assets Liabilities Liquidation Compare to market price Value of company if liquidated Earnings Per Share Indicator of profitability Portion of profit translated to the common stock = (Net Income Preferred Dividend) / Average # of outstanding shares EBITDA Earnings Before Interest, Taxes, Depreciation, and Amortization Revenue Expenses (not including taxes, interest, depreciation, or amortization Net income with I,T,D,A added back onto it Evaluates profitability Price-to-Earnings Ratio (P/E) Share Price / Per-Share Earnings (EPS) Trailing P/E vs. Forward P/E Dollar amount an investor can expect to invest in a company in order to receive one dollar of that companys earnings Effects of Debt Averages: Dow P/E: 15.5 S&P P/E: Low P/E => undervalued company (or low expectations for growth) High P/E => high expectations for growth (or overvalued) Price-to-Book Ratio (P/B) = Stock Price / Total Assets Intangible Assets Market Price / Book Value Low P/B (below 1) could mean an undervalued stock or that something is very wrong fundamentally with the company Current Ratio Can a company pay off its short term liabilities with its short term assets? =Current Assets / Current Liabilities Average of Balance Sheet Quick Ratio Similar to Current Ratio, but does not include inventory (Current Assets Inventory) / Current Liabilities Debt to Equity Ratio = Total Liabilities / Shareholders Equity Measures quality of liabilities Debt used to finance assets relative to value of its stock Higher = Aggressive = Risky Increased volatility Return on Equity = Net Income / Shareholders Equity How much profit companys make through shareholders investments How efficiently does a company generate profits. 5%-20% average depending on industry Return on Investment Profit from an investment Total return cost of investment = ROI Compare ROIs amongst your portfolio to find out which are most valuable. Discounted Cash Flow Method of evaluating a companys intrinsic value using estimates of its future profits If you can accurately estimate how much a company is going to be worth, you can discount that value to get the current intrinsic value. Earnings Power Value (EPV) Sustainability of current earnings = Adjusted Earnings / Cost of Capital You determine adjusted earnings by taking operating earnings and normalizing for taxation, non-recurring charges, economic depreciation, cash/debt, etc. Compare EPV to Reproduction Cost to determine whether management creates value and the company has a competitive advantage Reproduction Cost cost another company would have to pay to have identical fundamentals. power-valuation-technique-epv-work-60553/power-valuation-technique-epv-work-60553/ Examples: