Course Content
MARKET ORGANIZATION AND STRUCTURE
This chapter is covered in Reading 36 of Study Session 12 of the institute. After reading this chapter, the candidate should be able to: a. explain the main functions of the financial system; b. describe classifications of assets and markets; c. describe the major types of securities, currencies, contracts, commodities, and real assets that trade in organized markets, including their distinguishing characteristics and major subtypes; d. describe types of financial intermediaries and services that they provide; e. compare positions an investor can take in an asset; f. calculate and interpret the leverage ratio, the rate of return on a margin transaction, and the security price at which the investor would receive a margin call; g. compare execution, validity, and clearing instructions; h. compare market orders with limit orders; i. define primary and secondary markets and explain how secondary markets support primary markets; j. describe how securities, contracts, and currencies are traded in quote-driven, order-driven, and brokered markets; k. describe characteristics of a well-functioning financial system; l. describe objectives of market regulation.
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LOS A: Main Functions of Financial System
LOS B: Classification of Assets and Markets
LOS C: Types of Assets
LOS D: Financial Intermediaries
LOS E: Positions of Investors
LOS F: Margin
LOS G and H: Order Types
LOS I: Primary and Secondary Markets
LOS J: Trading
LOS K: Well Functioning System
LOS L: Objectives of Market Regulations
SECURITY MARKET INDEXES
This chapter is covered in Reading 37, of Study Session 12 of the material provided by the institute. After reading this chapter, a student should be able to: a. describe a security market index; b. calculate and interpret the value, price return, and total return of an index; c. describe the choices and issues in index construction and management; d. compare the different weighting methods used in index construction; e. calculate and analyze the value and return of an index given its weighting method; f. describe rebalancing and reconstitution of an index; g. describe uses of security market indices; h. describe types of equity indices; i. describe types of fixed-income indices; j. describe indices representing alternative investments; k. compare types of security market indices.
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LOS A: Security Market Index
LOS B: Index Return
LOS C: Index Construction
LOS D and E: Index Weightings
LOS F: Rebalancing and Reconstitution of Indices
LOS G: Uses of Security Market Indices
LOS H: Types of Equity Indices
LOS I: Fixed Income Indices
LOS J and K: Alternative Investment’s Indices
MARKET EFFICIENCY
This chapter is covered in Reading 38, of Study Session 12 of the material provided by the institute. After reading this chapter, a student should be able to: a. describe market efficiency and related concepts, including their importance to investment practitioners; b. distinguish between market value and intrinsic value; c. explain factors that affect a market’s efficiency; d. contrast weak-form, semi-strong-form, and strong-form market efficiency; e. explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management; f. describe market anomalies; g. describe behavioral finance and its potential relevance to understanding market anomalies.
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LOS A: Market Efficiency
LOS B: Market Value Vs. Intrinsic Value
LOS C: Factors That Affects the Market Efficiency
LOS D and E: Weak, Semi-Strong, & Strong Form of Market Efficiency
LOS F: Market Anomalies
LOS G: Behavioral Finance
OVERVIEW OF EQUITY SECURITIES
This topic is covered in the reading 39 of study session 13 of the study material provided by the institute. After reading this chapter a student should be able to: a. describe characteristics of types of equity securities; b. describe differences in voting rights and other ownership characteristics among different equity classes; c. distinguish between public and private equity securities; d. describe methods for investing in non-domestic equity securities; e. compare the risk and return characteristics of different types of equity securities; f. explain the role of equity securities in the financing of a company’s assets; g. distinguish between the market value and book value of equity securities; h. compare a company’s cost of equity, its (accounting) return on equity, and investors’ required rates of return.
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LOS A and B: Equity Securities
LOS C: Public & Private Equity Securities
LOS D: Non-Domestic Equity
LOS E: Risk and Return Characteristics of Different Types of Equity Securities
LOS F: Role of Equity Securities in Financing of Company’s Assets
LOS G: Market Value Vs. Book Value
LOS H: Cost and Return on Equity
INTRODUCTION TO INDUSTRY AND COMPANY ANALYSIS
This topic is covered in reading 40 of study session 13 of the study material provided by the institute. After reading this chapter a student should be able to: a. explain uses of industry analysis and the relation of industry analysis to company analysis; b. compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system; c. explain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical”; d. explain how a company’s industry classification can be used to identify a potential “peer group” for equity valuation; e. describe the elements that need to be covered in a thorough industry analysis; f. describe the principles of strategic analysis of an industry; g. explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and price competition; h. describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance; i. compare characteristics of representative industries from the various economic sectors; j. describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk; k. describe the elements that should be covered in thorough company analysis.
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LOS A: Industry Analysis
LOS B and C: Grouping and Classification of Company
LOS D: Peer Group
LOS E: Components of Industrial Analysis
LOS F: Principles of Strategic Analysis of Industry
LOS G: Effects of Various Factors
LOS H: Life Cycle Models
LOS I and J: Industry Comparison
LOS K: Elements of Thorough Company Analysis
EQUITY VALUATION: CONCEPTS AND BASIC TOOLS
This topic is covered in reading 41 of study session 13 of the study material provided by the institute. After reading this chapter a student should be able to: a evaluate whether security, given its current market price and a value estimate, is overvalued, fairly valued, or undervalued by the market; b describe major categories of equity valuation models; c describe regular cash dividends, extra dividends, stock dividends, stock splits, reverse stock splits, and share repurchases; d describe dividend payment chronology; e explain the rationale for using present value models to value equity and describe the dividend discount and free-cash-flow-to-equity models; f calculate the intrinsic value of a non-callable, non-convertible preferred stock; g calculate and interpret the intrinsic value of equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate; h identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate; i explain the rationale for using price multiples to value equity, how the price to earnings multiple relates to fundamentals, and the use of multiples based on comparables; j calculate and interpret the following multiples: price to earnings, price to an estimate of operating cash flow, price to sales, and price to book value; k describe enterprise value multiples and their use in estimating equity value; l describe asset-based valuation models and their use in estimating equity value; m explain the advantages and disadvantages of each category of the valuation model.
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LOS A : Intrinsic Value and Market value
LOS B: Categories of Equity Valuation Model
LOS C: Dividends, Stock Splits, and Share Repurchases
LOS D: Dividends Payment Chronology
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LOS E: Present Value Models
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LOS F: Intrinsic Value of Non-Callable Non-Convertible Preferred Stock
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LOS G: Gordon Growth Model
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LOS H: Multi-Stage Dividend Discount Models
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LOS I and J: Price Multiples
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LOS K: Enterprise Value Multiples
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LOS L: Asset Based Valuation
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LOS M: Advantage and Disadvantages of Each Model
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Equity Investments
About Lesson

A thorough company analysis should cover the following:

a.  A detailed analysis of the financial position of the company.

b.  An overview of the company’s product and services.

c.  The details about the competitive strategies of the company, as to whether it is offensive or defensive, and their ability to execute such strategies.

d.  An analysis as to whether the company is going for the cost leadership strategy or the product differentiation strategy.

     i.  A cost leadership strategy is one where the company aims to be a low-cost producer and targets to gain market share with lower prices. Here the company aims to be more efficient. Thus, it is important to analyze the efficiency of the operations of the company.

    ii.  The differentiation strategy aims at providing unique goods and services to the customers in terms of quality, type, or availability. The premium price charged for the services or goods provided should be justified by its quality. The analyst should analyze the effectiveness of such strategies.

Thus, having considered the above, a company analysis report should cover the following:

a.  An overview of the company,

b.  Details about the relevant industry characteristics,

c.  Analysis of demand for the company’s goods and services,

d.  Analysis of supply characteristics, including an analysis of the cost of goods and services,

e.  The details about the company’s pricing environment,

f.  An in-depth financial analysis.

The exhibit-8 provides a sample checklist of things to be considered for company analysis. They are:

Corporate Profile

·       Identity of company’s major products and services, current position in the industry, and history

·       Composition of sales

·       Product life-cycle stages/experience curve effects

·       Research & development activities

·       Past and planned capital expenditures

·       Board structure, composition, electoral system, anti-takeover provisions, and other corporate governance issues

·       Management strengths, weaknesses, compensation, turnover, and corporate culture

·       benefits, retirement plans, and their influence on shareholder value

·       Labor relations

·       Insider ownership levels and changes

·       Legal actions and the company’s state of preparedness

·       Other special strengths or weaknesses

Industry Characteristics

·       Stage in its life cycle

·       Business-cycle sensitivity or economic characteristics

·       Typical product life cycles in the industry (short and marked by technological obsolescence or long, such as pharmaceuticals protected by patents)

·       Brand loyalty, customer switching costs, and intensity of competition

·       Entry and exit barriers

·       Industry supplier considerations (concentration of sources, ability to switch suppliers or enter suppliers’ business)

·       Number of companies in the industry and whether it is, as determined by market shares, fragmented or concentrated

·       Opportunity to differentiate product/service and relative product/service price, cost, and quality advantages/disadvantages

·       Technologies used

·       Government regulation

·       State and history of labor relations

·       Other industry problems/opportunities

Analysis of Demand for Products/Services

·       Sources of demand

·       Product differentiation

·       Past record, sensitivities, and correlations with social, demographic, economic, and other variables

·       Outlook—short, medium, and long term, including new product and business opportunities

Analysis of Supply of Products/Services

·       Sources (concentration, competition, and substitutes)

·       Industry capacity outlook—short, medium, and long term

·       Company’s capacity and cost structure

·       Import/export considerations

·       Proprietary products or trademarks

Analysis of Pricing

·       Past relationships among demand, supply, and prices

·       Significance of raw material and labor costs and the outlook for their cost and availability

·       Outlook for selling prices, demand, and profitability based on current and anticipated future trends

Financial Ratios and Measures

(in multi-year spreadsheets with historical and forecast data)

I.         Activity ratios, measuring how efficiently a company performs such functions as the collection of receivables and inventory management:

·       Days of sales outstanding (DSO)

·       Days of inventory on hand (DOH)

·       Days of payables outstanding (DPO)

II.         Liquidity ratios, measuring a company’s ability to meet its short-term obligations:

·       Current ratio

·       Quick ratio

·       Cash ratio

·       Cash conversion cycle (DOH + DSO – DPO)

III.         Solvency ratios, measuring a company’s ability to meet its debt obligations. (In the following, “net debt” is the amount of interest-bearing liabilities after subtracting cash and cash equivalents.)

·       Net debt to EBITDA (earnings before interest, taxes, depreciation, and amortization)

·       Net debt to capital

·       Debt to assets

·       Debt to capital (at book and market values)

·       Financial leverage ratio (Average total assets/Average total equity)

·       Cash flow to debt

·       Interest coverage ratio

·       Off-balance-sheet liabilities and contingent liabilities

·       Non-arm’s-length financial dealings

IV.         Profitability ratios, measuring a company’s ability to generate profitable sales from its resources (assets).

·       Gross profit margin

·       Operating profit margin

·       Pretax profit margin

·       Net profit margin

·       Return on invested capital or ROIC (Net operating profits after tax/Average invested capital)

·       Return on assets or ROA (Net income/ Average total assets)

·       Return on equity or ROE (Net income/Average total equity)

V.         Financial Statistics and Related Considerations, quantities, and facts about a company’s finances that an analyst should understand.

·       Growth rate of net sales

·       Growth rate of gross profit

·       EBITDA

·       Net income

·       Operating cash flow

·       EPS

·       Operating cash flow per share

·       Operating cash flow in relation to maintenance and total capital expenditures

·       Expected rate of return on retained cash flow

·       Debt maturities and ability of the company to refinance and/or repay debt

·       Dividend payout ratio (Common dividends/Net income available to common shareholders)

·       Off-balance-sheet liabilities and contingent liabilities

·       Non-arm’s-length financial dealings

 

 

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