The Capital Market: Trading value
The Investors: The claimants on value
Debtholders
Cash from Secondary sale of debt Debtholders
Operating activities Investing activities Financing activities
• long-term perspective as opposed to short-term gain
Dot-com bubble: Dell illustration
• Late 1990’s: unlimited faith in prospect of new technology and internet firms; bubble burst in 2001
• For the y/e 2000 Dell had reported earnings of $1.7 billion on sales of $25.3 billion. The MV of Dell’s shares at the time was $146.4 billion – 3 * the MV of GMC and Ford Motor Company combined (P/E 8.5 / 5.0 respectively)
What are we doing?
Part of fundamental analysis: • Financial statement analysis and valuation of shares so as to give
well informed investment advice to an equity investor.
• Personal gains:
– If markets are not efficient, the proper analysis helps in identifying mispriced companies.
– 1980’s: market efficiency paradigm widely accepted → passive investment
• Financial analysis – Analysis of financial performance and financial position using ratio and cash flow analysis
Process of fundamental analysis
• Forecasting the future – Forecasting of payoffs through forecasts of balance sheet, income statement and cash flows
• Dell’s shares traded at a P/E of 87.9!
• Despite healthy trading and forecasted growth Dell’s stock appeared over-valued. – In 2000 the per share stock price fell from $58 in early 2000 to $29 in 2003. The price had only recovered to $40 in 2005.
– Evidence of market inefficiency → active investment and a renewed interest in fundamental analysis (Warren Buffet)
– Fundamental analysis:
• anchoring on reliable information (accounting) rather than rumours and speculations;
Understanding the Past
Business analysis Accounting analysis
Financial analysis Forecasting Valuation
Trading on the valuation
Process of fundamental analysis
- Ryanair case: good preparation for the coursework
- Exercises: For your own work
- Tutorials: good preparation for the exam
- Coursework
Nikola.Petrovic@ Thursday, 13-14.00 Friday, 11.30-12.30 1B14
Week 12
A Framework for Fundamental Analysis
Business Analysis
BusiThe firm: The value generator
Cash from loans
Interest and loan payments
– Surviving firms reported earnings turned out to be a better indicator of future performance
– Most of the intangible assets disappeared
– The much-criticised SoFP (B/S) also provided good forecasts.
• Similar to what sell-side equity within brokerage houses are doing (as opposed to buy-side analysts affiliated with institutional investors)
• Final product: equity research report
Cash from share issues
Dividends and cash from share repurchases
Shareholders
Cash from Secondary sale of shares Shareholders
Source: Penman, p. 8
What are we doing?
They are doing: • Fundamental analysis: contextual analysis of all publicly available
information in order to value the company.
• Technical analysis: spotting share price time-series patterns in order to predict movement of prices.
• Business analysis – Economic factors – Industry structure – Competitive strategy – Corporate strategy
• Accounting analysis – Evaluation of the extent to which a firm’s accounting captures the underlying business reality – Understanding accounting distortions
• Note of caution in regard of financial statement analysis:
– Financial statement analysis can be done for various purposes: credit analysis, competitive benchmarking, analysis of mergers and acquisitions, etc.
• Financial analysts are: – information intermediaries; they digest information and provide summary information to the public/less sophisticated investors. – especially important where capital markets are well developed.
Dot-com bubble: The role of financial statements
• The role of F/S is to “anchor the investor on the rising tide of speculation” with hard information – Earnings did matter! Losses reported by new economy firms during the bubble turned out to be a good predictor of failure
Dot-com bubble: What were the analysts doing?
• They were riding the wave: – involved in short-term speculation of the market mood rather than providing more sober picture to their clients based on fundamentals of the companies. – Analysis based on internet clicks that do not generate any income