GI Beginners’ Series: Class III

November 8, 2010
Agenda

 Review of P/E and Bond Fundamentals

 Fundamental Analysis
 Revenue Growth, Book Value
 ROE, Debt/Equity Ratio
 PEG Ratio
 Types of Orders
 Limit vs. Market
 Stop Order
 Bid vs. Ask
Bond Terminology

 Maturity
 Face value (assume $1,000)
 Coupon rate
 Federal Reserve
 Issues federal government bonds
 “Quantitative Easing”
Quantitative Easing

 Many believe the Fed will take a gradual approach to buying,

revealing a small initial purchase and intent to assess whether
another is needed after a certain period of time
 Primary dealers believe, in its entirety, such a program could
total anywhere from $500 billion—Jefferies Group Inc.'s
Jefferies & Co. and Citigroup Inc. are of this view—to $1.2
trillion, Cantor Fitzgerald Securities Corp.'s projection
 Overall, though, while more quantitative easing will help to
keep interest rates low, primary dealer banks aren't fully
convinced that the move will prove to be the U.S. economy's
knight in shining armor (WSJ)
Corporate Bond Example
Company XYZ issued $10,000 worth of $1,000
face value debt with a maturity of 5 years and
a coupon rate of 10%.
1200

1000

800
Your cash flows, after
loaning $1,000
600

400

200

0
1 2 3 4 5
Price-to-Earnings Ratio

How much, per $ of earnings, investors are

willing to pay for each share
P/E Ratio
 Based on latest earnings report

Forward P/E Ratio

 Based on forecasted earnings
Price-to-Earnings Ratio

Implications
 Growth Stock
 High P/E Ratio
 Forward P/E > P/E
 Lower earnings forecasted
 Forward P/E < P/E
 Higher earnings forecasted
Fundamental Analysis

 Focus on Financial Statements

 Use ratios to determine true value of a firm

 Measures are relative to the firm’s industry

 Champion Fundamentalists:
 Warren Buffet
 Peter Lynch
 Benjamin Graham
Fundamental Analysis

 P/E Ratio

 Revenue Growth from Period to Period

 Indicates expansion or contraction of business

 Book Value aka Shareholders’ Equity

 Equals Firm’s Assets minus its Liabilities
 Stock Price > BV per share (generally)
 Lower Stock Price relative to BV  better value
Fundamental Analysis

 Return on Equity
 Net Income divided by Book Value
 Indicates how well firm is able to generate profits
from shareholders’ equity

 Debt/Equity Ratio
 Total Debt divided by Book Value
 Indicates how much of the firm is financed by debt
 Take Corporate Finance (BUS 320) for further
examination of the dynamics of debt
Fundamental Analysis
 Price/Earnings Growth Ratio (PEG)
 P/E Ratio divided by Expected Growth
 Used to dig deeper into P/E Ratio
 PEG < 1  Firm is “cheap”
 PEG > 1  Firm is “overvalued”

 Example: Firm ABC

 Price=$100 EPS=$10 Expected Growth=12%
 P/E = 10
 PEG = 10/12 = 0.83
Beta

Represents the relationship between an index

and an individual stock
Calculated using regression
Typical Index: S&P 500

Can be positive, negative, or zero

Not a perfect predictor of stock price changes

Beta
Implications
 High Beta ( |Beta| > 1 )
 Volatile stock  Risky
 Low Beta ( |Beta| < 1 )
 Conservative stock  Safe
 Zero Beta
 No direct relationship between Index and Stock
 Negative Beta
 Stock moves in opposite direction of Index
Beta
Example
Stock ABC: Beta = 1.3
S&P 500: Up 1.0% for the day
ABC likely to increase by 1.3% that day

Morgan Stanley: Beta 1.34

S&P 500: Down .21% for the day
Morgan Stanley likely to increase by .28%
today (actual .26%)
Types of Orders
 Market vs. Limit Order
 Market Order: Execute trade immediately
 Limit Order: Execute trade as long as price is
within range
 Buying: Limit Price = Maximum Price to be paid
 Selling: Limit Price = Minimum Price to be received
 Stop Order
 Trade becomes active once Stop level is reached
 Typically used to prevent losses
 Can also be used on the buy-side
Market Orders
 Basically guaranteed sale will go through
 Will execute almost immediately
 May pay a higher (or lower) price than thought
 For large orders, shares may be bought at
different prices
 Example :Bought 10,000 shares of ABC
 4000 @ $21/share
 5000 @ $21.40/share
 1000 @ $22/share
 Unit cost = .4(21) + .5 (21.4) + .1(22) = 21.3
Limit Orders

 Avoid buying too high or selling too low

 Less likely to execute because there must be
a willing buyer or seller
 Limit order can only be executed at the limit
price or lower
 Limit order can only be executed at the limit
price or higher
Limit Orders

 Want to buy the stock of hot company trading at

$50/share, don’t want to pay more than $52
 Place limit order to buy stock at any price up to
$52
 Will not be caught buying the stock at $60/share
if it rises rapidly
Stop Orders
 Trade becomes active (a market order) once
stop level is reached
 Typically used to prevent losses
 Can also be used on the buy-side
 Can be activated by a quick fluctuation in price
 Example:
 Set a stop sell order for EXPE (beta = 2.15) for
$27/share (currently trading at $28)
 Falls to $26.30, then rises to $30
 Executed a market sell order at $27/share
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Fantasy Stock Market Game
 Rules
 Start with $100,000 (plus margin)
 Long-Short Only
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 Today’s change in
Current Rank Previous day’s rank Account Value (USD) Overall%
value

1. ManvirHeir (history) 1 $116,644.55 $0.00 +16.64%

2. wilmahchoo (history) 2 $113,311.22 $0.00 +13.31%

3. dfratto (history) 3 $110,906.24 $0.00 +10.91%

4. abhat26 (history) 4 $110,629.91 $0.00 +10.63%

5. schwayze (history) 5 $109,656.25 $0.00 +9.66%

6. JamesLB1992
6 $109,627.07 $0.00 +9.63%
(history)

7. SGuo26 (history) 7 $108,596.67 $0.00 +8.60%

8. cwconne (history) 8 $107,993.91 $0.00 +7.99%

9. mike6492 (history) 9 $107,554.07 $0.00 +7.55%

10. gwolozin (history) 10 $106,751.15 $0.00 +6.75%

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Class IV

 Technical Analysis

 Stock Screener

 Trading Strategies
 Diversification
 Margin