Investments II Bracker exam 2

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CFA Code of Ethics

Act with integrity, competence, diligence, respect and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets. Place the integrity of the investment profession and the interests of clients above their own personal interests. Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities. Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession. Promote the integrity of and uphold the rules governing capital markets. Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.

• Given industry data on dividends, growth rates, profitability, etc., students should be able to identify the appropriate stage of the industry life cycle a particular industry falls into

Best judgment.

Cyclical stocks

Cyclical stocks refer to firms that do better when the economy is strong and worse than average when the economy is weak. they move disproportionately in the same direction as the overall economy. Ideally you want to buy cyclical stocks right as or immediatley beforteh economy starts to move up from the bottom and sell right as the economy hits it's peak.

Dividend Val. Model with PE based terminal value

Dividend valuation model (with PE-based terminal value) Forecast revenues for next 5-7 years on a year-by-year basis (from forecasted growth rates) Forecast costs as a percentage of revenues (from historical levels and allow for fluctuation moving forward) Use forecasted revenues and costs to forecast EPS Forecast dividends for next 5-7 years on a year-by-year basis (from historical levels and allow for fluctuation moving forward) At last year of projected EPS, project a forecasted PE multiple. Take forecasted PE multiple times EPS to forecast terminal value Estimate appropriate discount rate Solve for PV of dividends and terminal value This model is more accurate than a more traditional dividend discount model as the terminal value is not based purely on dividends. Highly dependent on assumed PE multiple applied to estimate terminal value.

What is the purpose of top down economics?

If you look at your returns overtime a lot of it will have to do with macro issues. Idea is that the big picture is most likely going to outweigh the little picture.

From your valuation models, you identify the stock as worth $40.85. It is currently trading for $40.10. Based on this, the stock is undervalued and you should buy it. Discuss.

In this case, we should think of the stock as fairly valued, not undervalued. Your valuation precision is not accurate enough to recognize that a stock that is trading for 2% less than estimated fair value is REALLY trading for less than its fair value. That said, it may still be a worthwhile purchase. Assuming your required return is accurately measuring what rate of return you need to compensate you for the risk, you should be earning that rate of return (or very slightly higher). At this point, it would be a matter of (a) seeing how it fits with your portfolio, (b) evaluating how confident you are with the firm's prospects/management etc., (c) considering other potential investments, etc. The key here is that it is not an undervalued bargain, but may still represent a reasonable investment as it is not clearly overvalued.

Monopoly and Investment application

Monopolies are generally not common in the US because of our anti trust laws but they have existed by government permission in the area of public utilities.

discuss how government regulations influence the cost structure, risk and investment implications of an industry

Most industries are also affected by government regulation. This applies to the automobile industry where safety and exhaust emissions are regulated and to all industries wheree artier water and noise pollution are of concer. Many industires engaged in interstate commerce such as utilities railroads and telephone companies have been strongly regulated by the government. Most industries are affected by gov't expenditures this is specifically true for industries involved in defense education health care and transportation. This is why many large investment firms just focus on one industry

secular stocks

Secular growth stocks are companies whose revenues are tied more towards industry or products that are growing rapidly without much impact from the economy. The challenge here is that these stocks tend to be expensive. (high pe and high mv/bv ratios. and can collapse quicly at first signs of slowing growth. While you do not necessarily need to enter these at the exact time the products start to take off, the exit timing can be critical.

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What is the historical relationship between real GDP and inflation? What lesson might be learned from observing this relationship?

The historical relationship is that there is an inverse relationship between real GDP and inflation. Higher inflation leads to lower real GDP. The lesson may be that the Fed should focus its attention first on keeping inflation under control and only secondarily on economic growth.

You valued a stock at $50.66. Six months later, the stock is trading for $89.24. Based on this, your valuation analysis was incorrect. Discuss.

There are several things that could have caused this discrepancy. The easiest way to think about it is to separate into two broad categories - potentially foreseeable and random shocks. Random shocks are (by definition) events that we couldn't reasonably include in our outlook. For example, should you incorporate the impact of a terrorist attack on McDonald's stock? Probably not. However, could there be a coordinated attack on fast food chains (or even an isolated one) that would make people less likely to eat at McDonald's? Sure. Given the low probability and the difficulty in estimating the impact, it is probably not worth considering, but it is there. Could we see Berkshire Hathaway (or some other conglomerate) decide to acquire McDonald's? Again, yes...but it is probably unlikely enough to ignore in our modeling. Super health benefits to McNuggets, the complete collapse of the potato crop and countless other highly unlikely events can occur. These are all random shocks. We could also see a situation where McDonalds places greater emphasis on its breakfast menu, selling more premium coffee, expanding profit margins and grows faster than expected. This may be something that an analyst could have put together from carefully considering all the information available on McDonalds which others may have missed (or underestimated the probability of success). Even potentially foreseeable that are properly estimated can lead to valuation issues. For example, assume you are looking at a pharmaceutical company with a major new drug that is entering its last stage of testing. Great results may cause the stock to be valued at $100, good results at $80 and poor results at $50. If you assign probabilities to each of those at 0.25, 0.50, and 0.25 respectively you get a value of $77.50 today. However, after the results, there is a 1 in 4 chance that the stock will be at $100 and a 1 in 4 chance that the stock will be at $50. To properly evaluate our valuation analysis, we need to (a) think in terms of averages over longer periods of time and (b) process. This is what makes investing so challenging (and fun) - it is difficult to make sure you are doing it well. You can "run hot" or "run cold" for longer than you'd expect and confuse random fluctuations with real results. Imagine if you were trying to raise a kid and had a magical stove that would occasionally result in a minor burn (0.2 probability) and occasionally hand out free candy (0.8 probability) with random outcomes. After the first three times of getting candy, the kid is going to think that touching the stove is a good thing. Once the idea that it can burn OR give candy is realized, the kid might start looking for connections - when I wore my Spidey shirt, I got candy. When I had shoes on I got burned. How long will it take to figure out (a) it is entirely random and (b) what are the correct probabilities? Likely long enough to make your dentist and doctor each plenty of money from addressing cavities and burned hands. With investments our payouts are like the magic stove which makes it both critical and difficult to have a good underlying process.

to discuss how qualitative analysis differs from quantitative analysis with respect to stock valuation analysis

Winnebago is ranked third in the RV industry with a market share of about 19% in the motorized unit market and 4% in the towables. They are behind Thor Industries (35%/50%) and Forest River (24%/36%). Their market share has dropped in the past couple years in the motorized unit area, but are increasing their towables through acquisition and internal growth. While Winnebago has a smaller portion of the market, they are a leader in brand awareness and the only manufacturer to win the RV Dealers Association's Quality Circle award every year since the award began in 1996. Barriers to entry are high and Morningstar rates a narrow economic moat. The RV industry was devastated in the Financial Crisis of 2008-09, but has since started to recover. Winnebago's sales per share fell from $29.44 in 2007 to $7.27 in 2009 and EPS fell from $1.76 to a loss of $2.44 during that same time period. Winnebago revenues soared by 64% in in the second quarter of 2017 vs. the second quarter of 2016. However, this is largely a result of their acquisition of Grand Designs in the towable space. This acquisition will make historical data less meaningful in our valuation models. EPS grew by 10.5% from 2015 to 2016. Again, with the acquisition of Grand Designs, the EPS for the 2nd quarter of 2017 was up by 63% vs. the 2nd quarter of 2016. The stock market has rebounded sharply since 2009 lows which has lead to a recovery in 401(k) plans and household wealth levels. It has also added about 10% since the 2016 election. The economy has been seeing slow, but positive growth over the past few years with employment numbers showing gains. These two factors may make more people feel comfortable about retiring and making a large purchase. Winnebago is making a major push in their towable segment. They entered this market in December 2010. With the acquisition of Grand Design towables have become a much larger portion of their business (about 46% of revenues) and they are approaching a 5% market share. They are also seeing significant growth in their Winnebago branded towables (about 40%). Challenges in their motorized unit division is making the towable market more essential. Their balance sheet has noticeably weakened in the last year as their current ratio has fallen to 1.94 (from over 3 a year ago) and they took on over $300M in LT Debt for the first time as a result of the acquisition. The acquisition also generated significant goodwill which will be amortized going forward - conference call transcript provides a breakdown. Their CEO, Michael Happe (a KU grad) is in his second year at the helm. This adds to both the opportunities and uncertainty as he is moving more aggressively to create growth and vision for Winnebago. The towables market has higher profit margins which may boost Winnebago's margins going forward. Also, towables account for 87% of the unit RV market share and 61% of the revenue market share. Motorized segment say declining revenue (down 3% year-over-year) to go with slightly declining market share. Adding geographic diversity to their production facilities and operations (Junction City, OR; Eden Prairie, MN; Forest City, IA; Middlebury, IN).

Standard b Provide some examples of ways in which investment professionals could receive pressure from clients, fund managers, investment banking relationships, public companies, credit rating agencies, issuer-paid research and/or travel funding. To get credit for a "value added response" you should (a) provide two examples, (b) briefly explain how your example may pressure the analyst to compromise his/her independence and objectivity, and (c) what should be done to avoid this.

andard IB deals with Independence and Objectivity in investment analysis. Specifically, "Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another's independence and objectivity."

leading indicator

change direction in advance of general business conditions and are of prime importance to the investor who wants to anticipate rising corporate profits and possible price increases in the stock market.

Coincident indicator

move approximately with the general economy.

lagging indicator

usually change directions after business conditions have turned around.

Relate industry life cycle to valuation analysis

are created because of economic growth, competition , availability of resources, and the resultant market saturation by the particular goods and services offered. ////A form of fundamental analysis that looks to compare the valuation of one security to another, to a group of securities or within its own historical context. Valuation analysis is done to evaluate the potential merits of an investment or to objectively assess the value of a business or asset.

Pure Competion and Investment application

companies in pure competition do not have a differentiated product such as corn soy beans or other commodities. firms will often compete by trying to create percieved differences in product quality or service.

Oligopoly and Investment application

have few competitors and are quite common in large future US industries such as automobiles steel oil airlines and aluminum. competition can be intense and profitability can suffer as a result of price wares and battles over market share. Increasingly, oligopolistic industries are facing internatioational competition which has altered their competitive stages.

Monopolistic Competition and Investment application.

is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes.

NIRP

is an unconventional monetary policy tool whereby nominal target interest rates are set with a negative value, below the theoretical lower bound of zero percent.

Nominal GDP

is gross domestic product (GDP) evaluated at current market prices, GDP being the monetary value of all the finished goods and services produced within a country's borders in a specific time period.

Taper

is the gradual winding down of central bank activities used to improve the conditions for economic growth. ... These can include changes to conventional central bank activities, such as adjusting the discount rate or reserve requirements, or more unconventional ones, such as quantitative easing (QE).

Identify Various sources of data to analyze different companies

Company Web Page - Investor Relations (Kansas City Southern Investor Relations) • Quarterly and Annual Reports - Analysts should get familiar with the firm by looking over the last 2-3 annual reports and the last 4-8 quarterly reports. • Conference Calls - Some firms post most recent conference call on their IR page. For many larger firms, transcripts of these calls may also be available through Morningstar, SeekingAlpha and other sources. Reading through the last 4-8 conference call transcripts is recommended. (Kansas City Southern Conference Call Transcript) • Presentations - Some firms post recent investor presentations (often a PowerPoint slideshow) on their IR page. • Other Analysts • It is worthwhile to check out the analysis of Morningstar, Value Line and other analysts to get their take on the company. While each analyst should do their work independently, knowing what others are thinking can help you avoid missing things and help you identify where your outlook differs from consensus. • Financial News • An analyst must keep up with all news releases about the company. A source like Yahoo!Finance or Google Finance can be a good information aggregator. Professionals have much better data sources such as Bloomberg and Factset. • Other • The more you know about competitors, suppliers, and (if appropriate) the end-sellers of the firm's products, the better you understand the firm.

How would you describe the nature of competition in oligopolies and what is the potential effect on profitability? How has international competition affected oligopolies?

Competition in oligopolies can vary dramatically. While price-fixing and collusion are illegal, it is easier to accomplish on a passive basis when there are few players. If firms can avoid overly competitive pricing strategies, industry profits will be larger. However, if one player in the industry decides to aggressively seek market share, the other players will need to also lower prices in order to stay competitive. This will result in industry profits approaching zero (and in some cases can become negative if one player acts out of spite or seeks to push others out of the industry). Thus, oligopolies have the potential to be very profitable industries, but also have the potential to be destructive to investors if all parties do not "behave" independently. International competition reduces oligopolies as it typically increases the number of competitors in the industry. This is often good for consumers, but may be less beneficial for stockholders.

4) Assume that a CFA Charterholder is charged with a misdemeanor marijuana charge. There is no evidence that this interfered with her work and was not used at work. Address how and why this action would fit relative to Standard 1D. How would your answer change if an analyst was known to be an active customer of a legal store in Colorado?

"Members and Candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity or competence." Effects personal actions and integrity and is a reflection upon the company.

ZIRP

is a macroeconomic concept describing conditions with a very low nominal interest rate, such as those in contemporary Japan and December 2008 through December 2015 in the United States.

Real GDP

reflectgs gross domestic product in constant dollars, which eliminates the effects of inflation from GDP. Real GDP measures output in physical terms rather than in dollars that are inflated by price increases.

Identify and define porters five forces

1) Threat of Entry Threat of Entry refers to the question of how difficult it is for new firms to enter the industry. If there are substantial barriers to entry (moats), then current firms in the industry will be able to maintain higher profits. If there are few barriers to entry, then firms will have to accept lower profits. Examples of barriers to entry include legal barriers, patents, extensive startup costs, long-term contracts with customers, etc. 2) Threat of Substitute Goods Substitute Goods refer to other products that aren't necessarily the same, but are similar. For instance, if you are evaluating the Fast Food Industry, substitute goods may include casual dining (Applebees, Olive Garden, etc.) or convenience foods at home (frozen pizzas, microwave dinners, etc.). The more substitute goods that are available, the less pricing power available for a firm. Side note - a common mistake here is to think of Wendy's as a substitute for McDonalds, but those are firm substitutes instead of industry substitutes and fall under the rivalry category. 3) Bargaining Power of Buyers The more concentrated your customers are, the greater their bargaining power. The greater their bargaining power, the lower your profit margin is likely to be. It is important in this analysis to remember who your direct customer is. For instance, if you are Ford, your "buyers" are not individuals, but dealers. Any haggling over price is done between the individual and the dealer NOT between the individual and the car manufacturer. If you are a manufacturer and selling your products to Wal-Mart, they are going to have substantial bargaining power. On the other hand if you use smaller, regional specialty shops the buyers will have less bargaining power. 4) Bargaining Power of Suppliers The fewer the number of potential suppliers, the greater their bargaining power. If you need a specific component (for example, a specialized microchip) that has only one supplier, you will likely have higher costs associated with the product. On the other hand, if you are dealing with a commodity product (such as grain) for a major component of your product the suppliers will have virtually no bargaining power. 5) Rivalry Among Existing Competitors Some industries face significant competition among existing competitors. When one firm reduces prices, other firms in the industry must do the same. If a "price war" erupts, the industry profits will tend to be smaller for all firms in the industry. Typically, the more firms that exist within an industry, the greater the rivalry will be. The competitive structure of the industry does not determine whether or not an industry (or a stock within that industry) is a good/bad investment. Instead, the industry analysis helps with valuation analysis. All else equal, the more competitive the industry the lower the ability of firms within that industry to maintain high profit margins. Also, the competitive structure of the industry is not dependent on any one factor, but on balance. For example, while there are high barriers to entry in the airline industry, it is still very competitive due to high levels of rivalry among existing competitors and substitutes (driving or just not going on the trip).

Discuss the following comments: • "In order to improve the economy, the government should raise taxes to reduce the budget deficit." • "In order to improve the economy, the government should cut spending to reduce the budget deficit." • "In order to control inflation, the Federal Reserve needs to create a more restrictive monetary policy." • "A policy to allow the first $5000 in dividend income to be exempt from taxes would help improve the economy and increase stock prices."

Again, these are more open-ended questions, so I won't give detailed responses here. If these were test questions, I would be looking for logical answers that you support rather than a specific response. However, there are a few key ideas that I would want to see addressed. In the first one, I would want to see something on the idea that raising tax rates may or may not impact tax revenues (you can make your own argument as to where we are on the Laffer curve) AND that a budget deficit is not automatically bad for the economy (you can make your own argument as to whether or current situation has a deficit that needs to be reduced to help the economy or not). For the second question, I would want to see the same discussion regarding the role of a budget deficit and the economy AND what impact cutting government spending would have on the economy. For the third questions, I would want to see an argument of whether a more restrictive monetary policy would help control inflation, what a more restrictive monetary policy would imply, and whether or not controlling inflation is an important goal (either in general or specifically in our current economic environment). For the fourth policy, I would want to see why you thing making dividend income exempt from taxes would impact (a) the economy and (b) stock prices. You might also choose to discuss if it is necessary (given IRAs and 401(k) plans) and what whether it is fair in terms of capital vs. labor.

Discuss the quote by Peter Lynch on the role of Economic Forecasting. Do you agree/disagree and why?

Again, this is an open-ended question that would be graded based more on your ability to compare/contrast the arguments for the bottoms-up approach relative to the top-down approach. If I was asking this on a test, I would want to see: • A clear distinction between both approaches and a brief explanation of each • Advantages and disadvantages of each An argument for why YOU think the advantages of the approach you prefer outweigh the disadvantages relative to the approach you don't prefer. Note that a big problem most people have is they focus entirely on the approach they prefer and ignore the other. If I say I prefer lobster to steak, that is entirely acceptable (even if you prefer the other). However, I need to be able to say why I like lobster BETTER than steak, not just why I like lobster in order to make a compelling argument that I prefer lobster to steak. And my argument should be more than "Because lobster is good and steak sucks!

explain the difference between first-level and second-level thinking and why this is essential to stock valuation analysis

Anyone who thinks investing is easy must use superficial and simplistic thinking. "The first-level thinker simply looks for the highest-quality company, the best product, the fastest earnings growth, or the lowest p/e ratio. He's ignorant of the very existence of a second level at which to think, and of the need to pursue it." If I introspect, I can take comfort that my research into the oil industry allowed me to avoid value traps. On the other hand, my lack of research and my first level thinking on the DRAM industry led me to underestimate the amount of risk in Micron ( MU ). Second level thinking needs to begin with questioning conventional wisdom and your own assumptions. What misconceptions are everyone else acting upon? Marks' uses the example of the housing boom leading up to 2008. Many people bought homes with the belief that housing prices never fall. First level thinkers like shiny objects, and as a result the underlying asset has risen and likely becomes overvalued. In my observation, many retail investors don't even understand such concepts as market capitalization or shares outstanding. I've seen such crazy logic such as "Tesla is ~$250 per share and Netflix is ~$99 per share, I like Netflix better because it's a better value." These speculators are "valuing" companies by comparing relative prices. Read more: http://www.nasdaq.com/article/howard-marks-memo-the-importance-of-second-level-thinking-cm519244#ixzz4dotjIpmb

Forecasts of revenues, expenses discount rates and other variables that enter into valuation models are virtually guaranteed to be wrong. Given that, why go through the valuation process?

At the time I type this, Priceline is trading for $1315, Amazon for $558 and Ford for $13.70. How can you tell whether those values make sense and represent a buying opportunity or a selling opportunity without some sense of what each share is worth? Let's say that you really think Ford has some great new cars, their production is becoming more efficient, and their latest marketing campaign is likely to attract new customers. Everything is great with the underlying company. Does that make it a buy at $15? How about at $20? $40? What price is an opportunity for you as an investor and at what price is all the good news "baked-in"? It is not enough to think that the company will do well or do poorly. You have to define what exactly you mean by "do well" or "do poorly" and see if, given that outlook, it makes sense to buy/sell the stock today. While you know you'll be wrong on a regular basis, the key is trying to get unbiased forecasts (equally likely to be too optimistic as too pessimistic). If your values are unbiased, then by spreading your investment portfolio across a number of stocks you believe are undervalued, you have a greater chance of being right ON AVERAGE.

defensive stocks

Defensive stocks refer to firms that tend to be more stable than the overall economy. When the economy is weak they see only small drops in revenues. However, when the economy is strong, they tend to see revenues grow slower than the overall economy. The idea is to buy into defensive stocks stock right as the economy is peaking and sell them right as the economy is weakening.

s how qualitative analysis informs quantitative analysis with respect to stock valuation

Demographics Nearly half of Winnebago's customers are 60+ years old and the 65+ age demographic is expected to grow by 69% between 2012 and 2030. According to Morningstar - "...baby boomers total 78 million and this aging group adds 350,000 people to Winnebago's target customer base each month." The over 45 age group is forecasted to grow by more than 30 million by 2030. (Typical owner is 48 years old). Also, the ownership percentage for 35-54 age group has grown from 9% to 11.2% from 2005 to 2011. While this data is old it indicates increased demand within the industry. Industry experts are calling for continued growth in RV sales. Risk Factors Very sensitive to economic conditions and equity markets. If these take a downturn, so too will Winnebago's outlook. See impact of 2008-09 financial crisis. Gas prices greatly influence cost of ownership. While this is not currently an issue, it is a risk factor going forward. If interest rates rise, that could negatively impact dealerships and financed purchases. The acquisition of Grand Design, expanding facilities, increased debt levels and aggressive new CEO add to firm-specific risk (along with opportunities). Morningstar rates "Uncertainty" as "Very High" Beta is also extremely high indicating the high market risk.

Be able to identify discounted cash flow and explain the concept. The advantages and disadvantages.

Discounted Cash Flows - Forecast a cash flow measure (Dividends, Free Cash Flow to Equity, Free Cash Flow to Firm), choose the appropriate discount rate, solve for Present Value • Advantages • Provides an intrinsic value of the company that is fundamentally sound. • Easy to compare the intrinsic value to current value to determine attractiveness of stock at its current price. • Disadvantages • Requires several assumptions on growth rates of revenues, expenses, and discount rates over multiple years. • Requires a "terminal" cash flow that also has assumptions leading to potential error. • Models based on dividends are likely to understate the true value (as cash flows are returned to investors through buybacks and reinvested into the firm). Models based on free cash flows are likely to overstate the true value (as they assume investors can buy the entire company at the current stock price).

Specifically what is meant to be accomplished at each stage? How does it differ from bottom up approach.

Economic Analysis Look at economic activity (Fiscal/Monetary Policy, GDP Growth, Inflation, Employment, Consumer Spending, Leading Economic Indicators, etc.) to help determine asset allocation, baseline required return, and identify sectors that may thrive in that economic environment Industry Analysis Look at Industry Life Cycle, Competitive Structure, Supply/Demand conditions, Demographic issues, etc. that helps determine whether an industry exhibits attractive investment potential Company Analysis Forecasts of discount rates, cash flows, financial stability, earnings quality, management/strategic strength, etc to pinpoint which companies to invest in. Nobody can predict interest rates or such you can only focus on what's actually happening. Make sure the company your investing in is actually doing well with the product they are putting out.

Fed funds, discount rate, and the impact of interest rates on economy

Fed changes the discount rate periodically to reflect its attitude toward the economy. The discount rate is the interest rate the federal reserve charges commercial banks on very short term loans. The fed does not make a practice of lending funds to a single commercial bank for more than two or three weeks, and so this charge can influence an individuals bank's willingness to borrow money for expansionary loans to industry. The fed can also influence bank behavior by issuing policy statements or jaw boning.

If the investor does not correctly identify the crossover point between growth and expansion, what might happen to the price of the stock?

First, let me state that this is a poorly worded question in that a single investor does not influence the price of the stock. Also, it depends on if the crossover point occurs later than expected or earlier than expected. If the former - crossover point arrives later than the markets anticipate - the stock will exhibit higher than average rates of return until the crossover point arrives. This is because the actual growth (and therefore cash flows) will be higher than the markets were expecting, pushing the price up. However, if the crossover point arrives sooner than the markets anticipate, the stock price is likely to fall significantly once investors realize that growth is no longer as high as previously anticipated. It is not uncommon to see stocks in growth industries fall by 20-30% in a single day on earnings shortfalls where earnings are still positive and growing...just growing slower than anticipated. The PE ratio will typically fall with lower growth. In a situation where markets do correctly anticipate the crossover point from accelerating to decelerating growth, the PE will still fall...just much more gradually. Since earnings are still growing (faster than the overall economy, just not accelerating), the earnings will still be rising and the stock price will not have a noticeable dip (and should even continue to rise slowly) as the growth in EPS will offset the drop in the PE ratio.

What is fiscal policy?

Fiscal policy refers to government spending and taxation from the perspective of their impact on the economy. Keynesian economics argues that government spending can be an economic stimulus that should be used to help the economy during periods of recession/ depression to jumpstart the economy. The argument is that government spending will push money into the economy, people will spend it on other items and the multiplier effects will create economic growth to get us out of the recession. During periods of strong economic periods, government spending should be reduced in order to avoid an overheated economy and to reload the ammunition for the next downturn. Many other argue that government spending can not pull an economy out of a recession because a the government does a poor job of allocating spending relative to the private sector and b rational individuals recognize that higher government spending must be paid for through higher taxes at some point and thus will reduce spending/ Investment to prepare for the higher taxes that will be coming. There is also an argument that gov't spending is as low process because of the political process and implentation lag. Taxes, all else equal are assumed to be a damper to economic activity in both modes. The main difference is that the keynesian approach argues that gov't spending can, in the right situation, offer enough positive benefits to offset the drag of taxation. Not that fiscal policy as it is addressed here is focused on the economic impact of government spending in general. It does not really address where that money is being spent which it probably should or address the gov't spending for defense, education, emergency, or other issues that may not be driven by a pure economic growth argument. I'm

FCFE

Free Cash Flow to Equity Model Forecast revenues for next 5-7 years on a year-by-year basis (from forecasted growth rates). Forecast costs as a percentage of revenues (from historical levels and allow for fluctuation moving forward). Free Cash Flow to Equity = Net Income + Dep & Amort - Capital Expenditures - increases in non-cash working capital Note that this ignores looking at net new debt. A more refined model could include this, but it may not add much incremental value. After a set number of years, assume constant growth and apply constant growth model to find value of FCFE during constant growth stage. Note that you could also use the H-Model if you suspect the firm will still be growing faster than its constant growth rate when you hit the end of your year-by-year forecasts. Estimate appropriate discount rate (SML or other) Discount cash flows back to today to solve for fair value (divide by shares outstanding to get per share value) Ignores value of cash on hand (although could be factored in). See Winnebago Analysis

Explain why low interest rates make housing stocks and other related stocks more attractive.

Houses are bought/sold largely on affordability. Affordability is viewed more by monthly payment rather than home price. Lower interest rates lead to significantly lower monthly payments. For someone borrowing $150,000 on a 30-year mortgage at 3.75%, the monthly principal and interest is $694.67. Borrowing the same amount at 7% or 10% would lead to monthly principal and interest payments of $997.95 or $1316.36. Another way to think of it is that for someone who can afford a $750 monthly mortgage payment (principal plus interest) and is taking out a 30-year mortgage, that person can borrow $161,947 at 3.75%, $112,731 at 7%, or only $85,463 at 10%. Thus, lower interest rates lead to greater home affordability which makes more people buy houses (and buy bigger, more expensive houses) which leads to greater profitability for housing and related firms - pushing up their stock prices. However, again, let me throw in the disclaimer. First, everyone is aware of this relationship, so to profit from it you must spot the trend and react before others. Second, sometimes it doesn't work quite as well. For instance, interest rates dropped significantly in late 2008 and stayed low through 2016. However, home prices didn't start to rise until about 2012 after falling for 2008-2011. This is because home prices got too high in 2006/07 and collapsed in some cases by over 50% in 2008-09. After someone buys a home for $300,000 and sees it at $150,000 a couple years later (and may still owe $260,000 on it), their desire/ability to buy a new house is not likely impacted much by low rates. Thus, while low rates may be a positive factor for housing, they are not the only factor. Economic health, recent trends in housing prices, availability of credit, demographics, costs of materials/labor, etc. can also have big influences on housing and related stock prices. An investor that doesn't look at the full picture is likely to make bad choices.

In regard to Federal Reserve open-market activity, if the Fed buys securities, what is the likely impact on the money supply? Is this likely to encourage expansion or contraction of economic activity?

If the Fed is a net buyer of securities, that should act to increase the money supply (and lower interest rates as more money is available). This should, in turn, help lead to economic expansion as it makes investment projects for firms more attractive. Essentially, it is lowering the cost of capital which should make the NPV of prospective projects larger and push more borderline project into attractive projects. However, there are some potential problems. One, while it can influence the discount rate to evaluate investment projects, it does not (at least directly) change the forecasted cash flows. Without demand, the forecasted cash flows of the projects may still be too low to be driven by interest rates. Second, if interest rates are already low, lowering them is likely to have little or no impact. Another issue that is largely ignored about low interest rates is the impact that they can have on retirees who are using their retirement funds for income. Assuming someone has $500,000 in at retirement, interest rates of 6% will generate $30,000 a year in current income (which can be supplemented with social security or slight drawdown of principle). Alternatively at 2% interest rates, the retiree will only get $10,000 in current income which may require a much quicker drawdown of principle or force the retiree to extend their risk exposure which can also have some severe consequences.

Standard 1 c One of the areas mentioned under misrepresentation is that misrepresentation is not only stating something that is false, but also leaving out something important (omission). Discuss why omission may be just as important of misrepresentation as stating something that is false. From a practical perspective, how would you separate out omission that is intentional vs. unintentional? Does intent matter or is it irrelevant if critical information is omitted? Another issue that arises with this standard is plagiarism. Discuss why it is important to appropriately cite sources and to not pass off the work of others as your own. Additionally, why might this be difficult to implement even if you are trying to avoid plagiarism?

If your handling someone's money you want to establish a good foundation of trust. If you're an investor that leaves out important information, then people are going to eventually find out your word isn't dependable. Word of mouth is a very dangerous thing. Intentional omission could be telling your client if they do invest, the opportunities your organization has to grow are significant, but you leave out that you don't pay dividends until the 3rd quarter of the fiscal year. Unintentional omission may be telling your client you expect returns of 4%, but you have to remember the risk in the market is unpredictable. He's not intending to mislead the client because neither him or the investor can predict the market. The intent doesn't matter though, if the investor is painting this big picture to the client about company growth that is unrealistic according to their assets how could you trust them? Investors have to cite their sources properly to establish what I talked about earlier, trust with a client. If an investor sends a client research project that another firm has come up with, that's definitely a misrepresentation of an investment opportunity to a client. They really don't know the specifics of that investment opportunity, let alone it's simply not their idea. Investors also can't steal investment tips from leading analyst either because it's not their original idea that their giving to the client. This would be difficult to implement anyway because clients have access to the internet and could easily found out where the idea of the investment opportunity started.

10) Firm A is a rapidly growing firm while Firm B is a stable, slow growing firm. In which case is it more important to account for changes in non-cash working capital in your cash flow estimates?

It would be more critical to account for changes in non-cash working capital for Firm A. This is due to the fact that for Firm A, they are likely to see their inventory and accounts receivable grow along with the firm's revenues as it takes more inventory to meet the higher revenues and more accounts receivable (assuming credit sales) will be generated at higher sales levels. This will be partially offset by the growth in accounts payable and accruals, but typically we see rapidly growing firms require significant investments in working capital (and capital expenditures) to support the growth. As firms mature, they become "cash cows" as the working capital and capital expenditure growth becomes smaller relative to operating cash flows. It would also be worthwhile to consider the nature of the firm. A retailer or manufacturer is likely to see greater growth in inventory than a service-oriented firm, software firm, etc. Think about the importance of inventory to the firm's revenue base. In addition, does the firm do much on credit sales? If they are primarily a cash business, accounts receivable growth will be less demanding. If they sale a lot on credit, accounts receivable growth may be substantial. What is their cash conversion cycle (Days to collect + days to turn inventory - days to pay for purchases)? If it is close to 0, we should see little demand for additional working capital. If it is high, we will see greater demand for working capital to facilitate growth.

What is Monetary policy

Monetary policy refers to the federal reserves influence on the money supply and interest rates. First, I would like to dress a major misconception many people have. The fed does not set interest rates in general. While the fedral reserve can have a significant influence on interest rate, especially on the shorter maturity end, most interest rates are set in the financial markets. the fed may participate in those markets, but is not the only player so does not control the rate. The standard policy is that monetary policy is another tool( like fiscal policy that can be used to stimulate or restrain economic growth and inflation. If the economy is weak, monetary policy would be used to increase money supplies and lower interest rates. If there is more money available and the interest rates are low, capital budgeting projects that were e not positive NPV before may become so which should lead to economic growth. The downside is that too much money in the economy can lead to inflation. Therefore, when the economy is strong, the fed will typically act lower the supply and increase rates in order to restrain economic growth and keeep inflation in check. Like fiscal policy. there is a long between policy and action and results however it is a different lag. Fiscal policy tends to take a long time to be implemented while monetary policy takes a longer time to notice the effects. Most estimates put a 6-12 month lag between the time action is taken and responses are felt. Imagine driving a car where there was a notcable lag bewteen your attempts to step up on the gas/ brakes and how much harder you will make it driving. Critics of the federal reserve argue that monetary policy should should not be an economic tool, but instead a stable money base and entirely market driven interest rates would allow private industry to better allocate capital. Because economic forecasting is already difficult and the challengees of implementing monetary policy without unintended consequences partly due to the lag and partly cut to the complexity of the economy. monetary policy may be a prescription that causes more harm than good. I am not in that camp. While i recognize the limitations of monetary policy, I feel it can be a worthwhile tool. however i do think it is important to recognize that it is not a perfect tool.

Define relative Evaluation and be able to identify advantages and disadvantages

Relative Valuation - Take one or more relative valuation metrics (P/E, P/B, P/S) and put it into context compared to peer firms or historical norms. •Advantages • Simple to implement • Doesn't require forecasts which are prone to error •Disadvantages • There may be valid reasons why Wal-Mart has a higher/lower multiple than Target which requires subjective adjustment • There may be valid reasons why Wal-Mart has a higher/lower multiple today than its past 3 year average which requires subjective adjustment • Relative valuation to peers tends to overprice at market peaks and underprice at market bottoms. Historical valuation will lag in a trending market.

Discuss sources of data for company analysis and how you would use sources.

One of the best starting places for data in company valuation is the company's investor relations segment of their web site. This will often include a variety of data including SEC filings (10Q and 10K reports), annual reports, investor presentations, and quarterly conference calls. It is a good idea for an investor to spend a significant amount of time reading through the last couple years of data to understand where the firm is at the moment, how it got there, and where it is headed. While greater emphasis should be placed on the most recent information, reports from previous quarters/years help provide investors with a better contextual basis for forecasting where the firm is headed. When reviewing conference calls, significant time should be spent thinking about the questions from analysts and the answers provided by management. This highlights where other analysts are seeing issues/concerns/opportunities. Other analysts are also a great source of data. For example, it is worthwhile to review reports from other analysts to make sure you understand what their thinking is and the basis for their outlook. It is essential to remember that your goal is not to duplicate their analysis (there is no value added in doing so), but to offer YOUR views on the company's outlook, risks, financials, etc. If you are different than other analysts, it does not mean you are wrong. It does mean that you should review your analysis and make sure you are confident with the "why" and "how" behind your forecasts. It may also be worthwhile to look at competitors and others in the chain. For instance, if you are analyzing Tyson (a major chicken producer) and you notice that supermarkets and restaurants are commenting on consumers moving away from chicken, that is worthwhile information. If you are looking at a trucking firm and notice that Exxon and BP are forecasting higher production costs for oil drilling/refining, you can anticipate higher costs going forward for fuel. If you notice that rails are saying that they are going to limit price increases to try to take market share from other transportation firms, that may mean more pricing pressure for your firm.

Current GDP Growth

REAL NOMINAL Annualized Growth Since 1960 Annualized Growth Since 1960 GDP 3.01% GDP 6.45% Consumpion 3.27% Consumpion 6.70% Investment 3.55% Investment 6.31% Govt Expenditures 1.93% Govt Expenditures 6.06% Annualized Growth Since 1992 Annualized Growth Since 1992 GDP 2.52% GDP 4.50% Consumpion 2.89% Consumpion 4.80% Investment 3.56% Investment 4.73% Govt Expenditures 1.05% Govt Expenditures 3.79% Annualized Growth Since 2007 Annualized Growth Since 2007 GDP 1.34% GDP 2.98% Consumpion 1.59% Consumpion 3.22% Investment 0.78% Investment 1.63% Govt Expenditures 0.09% Govt Expenditures 2.10%

We discussed three approaches to valuation - Relative Valuation, Free Cash Flow to Equity, and Dividend Discount with PE Predicted Terminal. Discuss the advantages/disadvantages of each.

Relative valuation provides the advantage of simplicity. It is relatively straightforward to collect data on historical/peer values of P/E, P/S, P/B or other ratios and to use the appropriate denominator times the ratio to estimate price. However, the flaw with this approach is it doesn't adequately capture changes in the company (which may justifiably cause the stock to trade at higher or lower ratios than historical norms) or differences between peers (which may cause the stock to trade at higher or lower ratios than peers). While you can combine them (maybe Chipotle historically trades at a 20% premium to its peers), it does not account for changing competitive advantages/growth rates/risks where that stock justifiable trades at a higher/lower premium to its peers than it has historically. Free Cash Flow to Equity has the advantage of being theoretically sound. The value of any financial asset is the present value of all future cash flows which that asset will generate. If I own the entire firm, I get all the free cash flows to equity. Unfortunately, it assumes that I do own the entire firm (individual stocks typically trade at a discount to what would be paid in a takeover - unless the difference between the true value and the stock price is large enough to allow one entity to acquire all the shares, the FCFE model may continually overstate value). Also, it assumes that one can accurately forecast cash flows (which require forecasting revenues, expense, capital expenditures, changes in NC Working Capital, etc.) and discount rates appropriately throughout infinity. This is an impossible task. If the forecasts are unbiased (equally likely to overestimate value as underestimate), you can be right on average which would be beneficial from a portfolio perspective. However, we are likely to have systematic biases due to behavioral issues. Also, while we don't necessarily predict every cash flow individually, we need to hit a terminal value which is also likely to have significant forecast error (and often assumes a constant growth). The dividend discount with PE Predicted Terminal value is reasonable. Dividends over the next few years are likely to be forecasted with a reasonable (not 100%) degree of accuracy. However, if we are forecasting out 4+ years we can be assured that our EPS forecast for the terminal year is just a guess and is likely to be wrong. Also, the assumed PE ratio is likely to be wrong. When you multiply an unreliable EPS forecast by an unreliable PE ratio, you are likely to have an unreliable terminal price as well. The discount rate assumption is also problematic (just like in the FCFE model).

What is meant by the concept of rotational investing?

Rotational investing refers to moving from sector to sector based on the stages of the economic cycle. For example, when the economy is bottoming out, you want to move into cyclicals to be well-positioned for the subsequent economic upturn. When the economy is peaking, you want to be unloading the cyclicals and moving into defensive stocks to be positions for the subsequent economic downturn. Different industries (sectors) have different degrees of cyclical vs. defensive characteristics, so you will transition through these sectors depending on where the economy is headed, recognizing that you need to anticipate the movement in the economy (change weights proactively instead of reactively). That is the "playbook" for rotational investing. Unfortunately, everyone has a copy of the playbook so it is hard to use it to get an edge. If everyone is selling the same stocks at the same time and buying the same stocks at the same time, there is no benefit (you will pay more to buy and get less when you sell). Therefore, in order for this approach to be beneficial, you need to anticipate the economic cycle better than everyone else and respond quicker. As this is far easier said than done, I am not a fan of rotational investing. It also is likely to lead to more trading (which generates higher trading costs and more ST capital gains).

Characteristics of the 5 industry life cycle stages

Stage I: No cash dividends (development) stage includes companies that are getting started in business with a new idea, product, or production technique that makes them unique. Firms in this stage are usually privately owned and are financed with the owner's money as well as with capital rom friends, family and a bank. Stage II (Growth) represents an industry or company that has achieved a degree of market acceptance for it's products. At this stage, earnings will be retained for reinvestment and sales and returns on assets will be growing at an increasing rate. Stage III ( Expansion- In stage 3 sales expansion and earnings continue but at a decreasing rate. As the industry crosses from the growth stge to the expansion stage (decelarating growth) the slope of the line becomes less steep, signaling slower growth. Maturity stage IIII- Maturity occurs hen the industry sales grow at a rate equal to the economy as measured by the long term trend in gross domestic product. Some analysts like to use the growth rate of the S&P 500 index for comparison because the growth rate of these 500 large companies sets the norm for mature companies. Stage IIIII- Decline stage: In unfortunate cases, industries suffer declines in sales if product innovation has not increased the product base over the years. Declining industries may be specific to a country passenger trains are such an example.

If an investor fears higher inflation, what possible industries might he or she choose for investment?

The "textbook" answer here is to move to industries which sell commodities (lumber, oil, gold) which can benefit from increasing prices or to industries with pricing power who can easily raise their prices at levels equal to or greater than inflation. Industries to avoid are industries who hare heavy users of commodities and/or are unable to pass along cost increases to customers. However, it is once again time to get away from the textbook answer and recognize the practical issues. First, as with the previous two questions, everyone else has this same playbook so we need to better anticipate changes in inflation and respond quicker in order to get any net benefit from the textbook strategy. Another (closely related) issue is that really it is not inflation that we should focus on, but our expectations of inflation vs. the market's expectations. If we anticipate inflation is going to be higher than consensus estimates it is important to shy away from banks (as they will be lending money at too low of a rate). High inflation or low inflation IF THEY ARE ANTICIPATED will not help us from an investment strategy. Instead focusing on deviations from expectations are where investors have a chance to earn their edge.

Think about valuation analysis from the perspective of an analyst vs. a portfolio manager. Why might a portfolio manager have less confidence in valuation estimates? Why might a portfolio manager rely on input from several analysts?

The analyst is the "boots on the ground" forces. The analyst needs to truly understand the firm and the industry/environment it operates in. The analyst needs to understand where the firm's competitive advantages/disadvantages are, what can go right, what can go wrong, what the regulatory environment is, how conservative/aggressive management is with guidance/outlook, etc. The portfolio manager instead is more like the general - less concerned with the details behind each stock and more concerned with how the stocks go together in the portfolio. It is understanding how much exposure there is to each industry, what is the overall risk, how much confidence should be placed in the outlook of a specific analyst, etc. As each analyst is going to cover small segments of the overall market (it is unreasonable to have detailed analysis on 1000+ stocks), the portfolio manager is going to rely on input from several analysts to make decisions for the portfolio as a whole.

You valued a stock today using the two valuation spreadsheets and get a value range of $95-103. The current price of the stock is $42. What is your appropriate course of action?

The first thing you need to ask yourself is "Why do I think that the stock is worth 2.5 times what everyone else does?" The most likely answer is that you missed something. You forecasted revenues too high, growth rates too high, expenses too low, capital expenditures too low (although the dividend + PE model is less sensitive to cap. Expenditures so that is not likely the key issue), discount rate too low, etc. Something is likely causing your earnings and free cash flow estimates to be too high, your discount rate to be too low or a combination of both. Double-check your numbers and your calculations. Also, think through the logic behind the numbers. Is there an issue you missed the first time around? Is there a reason you may be overly optimistic? If you are confident in your analysis and feel like your numbers are valid, you should be able to clearly identify where you are different than the consensus and be confident in your analysis. The most likely answer when your value is substantially different than the market is that you are wrong. However, there is a possibility is that you see an opportunity that others do not. If you are ultimately right, the market will eventually recognize it and the stock price will go up.

key components of gdp and their relative importance.

The four areas are personal consumption (people buying goods and services), government expenditures (at both Federal and local levels), private investments (corporations spending money on property, plant and equipment), and net exports (if we have net imports, this will be a drag on GDP). Personal consumption has been both the largest and fastest growing component over the last few decades. Looking at GDP, it can be easy to see the debate of fiscal policy. On the plus side for government spending, it is a direct component of GDP and therefore it is easy to conclude that increased government spending will increase GDP. Additionally, if that government spending gets in the hands of consumers or businesses, it will give them more money to spend on personal consumption or private investments (the multiplier effect). Alternatively, since government spending must be funded, it could create a drag on personal consumption and private investment as tax burdens increase. Also, it should be noted that we need to focus on REAL GDP and not nominal GDP. Nominal GDP includes the effects of inflation while REAL GDP focus on income after controlling for inflation. As it doesn't do us any good to increase our wealth by 5% if everything costs 5% more, real GDP is more important than nominal GDP. However, when we get to forecasting cash flows for individual companies we should be forecasting nominal as the expected inflation rate is part of the discount rate. Therefore, real GDP is more critical to understanding economic growth, but nominal GDP is likely to be more closely related to the cash flows of the S&P 500.

11) Do leading indicators tend to give longer warnings before peaks or before troughs? What is the implication for the investor?

The leading indicators tend to give more warning near peaks. This means that one does not need to act quite as quickly to avoid getting caught in a large decline. However, they tend to give less warning before a trough. This means that those waiting for the right moment to jump back in are more likely to wait too long if they are too cautious in their reaction.

How can you estimate a firm's expected capital expenditures and depreciation going forward?

There are a couple of ways to look at this. One of the tools is listening to the conference calls (or reading the transcripts) and see if they offer any guidance on capital expenditures and/or depreciation rates. Some companies do (especially firms with significant capital expenditures) and some don't. Typically this will give an outlook for the next year and you may see further information provided in the Q&A as analysts try to gather information to help their models. Another approach is to look at historical data from the past 3-5 years and see how much the firm is spending on capital expenditures. This information will be in the Statement of Cash Flows. Depreciation is also provided in the statement of cash flows. Note that depreciation is a function of PPE, not revenues so it will not automatically grow with revenues. Instead it will tend to grow with PPE. Capital expenditures are more likely to be a percentage of sales basis (although leverage may allow it to be a declining percentage of sales over time). A couple of things to be careful about on the historical approach include lumpiness and differing depreciation rates. Capital expenditures are "lumpy" in that firms may spend a lot one year in building a new distribution center, factory, etc. and then not spend as much the next two years. So try to understand what the story behind the numbers is instead of just looking at the raw numbers. Depreciation is also not always going to be the same proportion of PPE. Depending on the asset mix, depreciation can be a higher/lower rate of PPE from year to year. However, it typically will be reasonably consistent unless the firm is making some major changes to their asset mix. Another tool to help you with this is reading through the annual report, investor presentations, and any news headlines on the company. This will give you "color" on the growth outlook and spending plans of the firm. For example, if you read that your firm opened 40 new stores last year and is expected 60 this year you can expect capital expenditures to rise. On the other hand, if they are looking at 20 new stores (or cutting stores), then you can expect capital expenditures to drop. Ideally, an analyst will use all of these tools to help forecast capital expenditures and depreciation. Listening to conference calls, looking at historical data, reading additional information all provide pieces to the puzzle to help provide insight and better forecasts. You can also look at other analysts and see if you are in the same range as them. Again, you don't want to mimic other analysts, but if you are noticeably different, you want to be able to justify your reasoning. Knowing you are different may help you notice something you missed or it may help you prepare a defense of why you are different.

Suggest two companies that have continued to grow in nongrowth industries and explain why.

There are many possible examples you can use here, I won't list them because it would be a LONG list and the names of companies will change regularly. However, the reasons why are The company is outperforming the industry and taking market share. Due to better management or proprietary products/technology, some firms consistently outperform others. Therefore while the industry may not be growing faster than the overall economy, the firm grows by taking market share. The company expands its market. This is one of the reason companies have international strategies is it allows them to extend growth by entering new geographic areas. It also can occur by reaching a new customer base (gun manufacturers producing pink guns to attract a younger female demographic or a yogurt firm marketing a "men's" yogurt). The company moves outside the industry. In the 1990's, Apple was a computer company. In the 2000's it redefined itself as a consumer technology company and generated tremendous growth. Nike moved from a shoe company to an athletic apparel company that sells shoes. These moves are not always successful as sometimes attempts to move outside a firm's area of expertise result in poorly managed operations and the anticipated growth does not materialize.

Who has the greater advantage for research and development in the pharmaceutical industry, large drug companies or smaller ones?

There are two ways to look at this. Large drug companies are more likely to develop a steady stream of new drugs through R&D as the have the R&D budget to have both greater scale and scope. However, the also have a larger current revenue base so it is harder for any one new development to significantly move the needle. Smaller companies will be limited to more narrow capabilities and are going to be more hit or miss. While this will result in greater risk, these companies also can generate tremendous upside if their R&D leads to a successful new product as their revenue base is much smaller. Therefore, larger drug companies are often a less risky, lower potential return segment while smaller drug companies are higher risk and higher potential return.

Discuss the following observations from the recent University of Michigan Consumer Sentiment Index (Note - since Jan 2000, the average has been 82.5 with a high of 112 and a low of 55.3): October 90.0 November 91.3 December 92.6 January 92.0

These measures indicate a mild uptrend in consumer sentiment, increasing to its highest levels since prior to the Financial Crisis. This was likely impacted by a solid stock market, the general improvement in economic activity and employment, and most importantly, the significant drop in gasoline over that time, leaving consumers with more money to spend on other items. This is a positive sign that the economy is on solid ground. That said, consumer sentiment is a notoriously volatile indicator and is seen as a lagging indicator. While an upbeat and optimistic consumer is positive for the economy as it will drive consumer spending (one of the largest components of GDP), consumer sentiment is largely reactive to other economic factors which is why it is more of a lagging economic indicator.

to apply Michael Porter's Five Forces of Competition to an industry analysis

Threat of Entry - While at first glance, the barriers to entry may not appear large, economies of scale (mass production), scope (multiple product lines) are essential to competing in this industry which raises the capital requirements to enter the industry. Marketing expenses are also something that require a lot of capital. Production/Distribution chains need established. Finally, grocery store shelf space is limited and larger companies carry more clout for negotiating prices/shelf space with large retailers like Wal-Mart. These factors would lead me to place the threat of entry as low. Threat of Substitutes - There are many substitutes to breakfast cereal. Skipping breakfast, fast food breakfast, traditional bacon/eggs/toast, nutrition bars, fresh fruit, smoothies, etc. The vast array of substitutes make the threat of substitutes high. Bargaining Power of Buyers - The buyers are not as much the end consumers, but the retail chains. Consolidation in the retail market over the last several decades have led to fewer retailers which increases the bargaining power of buyers. However, bargaining power is relative as the breakfast cereal aisle is largely dominated by Kellogg and General Mills so I would place bargaining power of buyers as moderate (but would also accept high). Bargaining Power of Suppliers - The suppliers to the breakfast cereal market are largely commodity suppliers (grains, sugars and flavorings) and cardboard for boxes and the plastics for the bags. However, there are two other suppliers that are worth noting. The first is labor (factory workers, marketing, distribution, management, developers, etc.). This is a mix of low to higher bargaining power with the more skilled

What is the advantage of using a composite of indicators (such as the 10 leading indicators) over simply using an individual indicator?

Using multiple indicators is likely to give a clearer indicator of the overall health of the economy for multiple reasons. One is that each indicator contains quite a bit of noise with both measurement error (many indicators get revised in later releases) or just random fluctuations from month-to-month that aren't indicative of the true trend. Second is that multiple indicators give a broader perspective. For example, if the S&P is down slightly, but all other 9 indicators are up it is more likely that the S&P is wrong (maybe due to random noise, but maybe due to investors being too optimistic the previous month or some other factor).

to explain why stock valuation will be wrong, provide methods for improving the information content of forecasts (scenario, sensitivity, and simulation analysis along with comparisons to current market price)

Valuation should be taken with a healthy degree of skepticism. It IS wrong as there is no way you have accurately forecasted every single input. • Think of valuation more as a range than a single point • You may incorporate scenario analysis or Monte-Carlo Simulation to get a better picture of the range of possible values • You should constantly be monitoring for new information which will change the inputs and the value • If your value is far from the current market price, you are likely missing something. Take time to re-evaluate all your inputs and think about the validity of your assumptions. •Market prices may deviate from value of your model due to other factors (primarily the market is more optimistic or pessimistic about the firm's potential than you are). Be careful about your degree of confidence. Both of the valuation models presented in the previous slides are VERY sensitive to inputs. Valuation is more than a spreadsheet. It is understanding the economy, industry and firm. • What is the potential market for the firm's products/services? • What competitive pressures does it face that will impact its potential margins? • What impact does regulation, economic data, disruptive technology, etc. have on your firm? • How can the firm expand it's reach and do so in an economically viable way? For example, international operations, new products, new markets for similar products, acquisitions, etc.? Keep in mind that growing sales without growing cash flows/income is not adding value. • What are the potential risks? You might think of these risks in two dimensions - impact and likelihood. How would these impact your model? • If you have a buy (stock is significantly undervalued) or sell rating (stock is significantly overvalued), can you explain why? This does not mean explain the "good" or "bad" aspects, but why the market has not recognized them appropriately. What are you seeing that others are missing? • Don't be results oriented...but don't ignore results. • One of the biggest struggles in investing is that there is not a one-to-one link between good decision good outcome or bad decision bad outcome. Good decisions will lead to bad outcomes and bad decisions will lead to good outcomes. The process is about shifting the odds slightly in your favor. Unfortunately it is very difficult to uncover errors in your process because of the erratic nature of feedback. This is why diversification of firm-specific risk is essential.

How might weather patterns impact economic numbers and how relevant is this to stock valuation?

Weather patterns are partially accounted for by seasonally adjusted numbers. However, when the weather is unseasonably warm or cold, this can restrict economic activity in general and in cause industry specific effects. For example, a summer that is hotter than expected may see slower construction spending and fewer outdoor activities. It may see higher usage of electricity to run air conditioners. A drought may see higher farm commodity prices. Extreme storms (tornadoes, hurricanes, etc.) in metropolitan areas may cause economic slowness in some segments of the economy and greater spending in other areas (construction, home improvement, etc.). Some companies are extremely sensitive to weather conditions. The key is that weather fluctuates and can cause minor pressures on certain economic segments.

Rotatational Investing and the challenges of incorporating it?

refers to the practice of moving in and out of various industries over the business cycle. As the business cycle moves from a trough to a peak, different industries benefit from economic changes that accompany the cycle. For example as interest rates bottom out, houses become more easily financed and cost less per month to purchase. Because of this, housing stocks,home builders, lumber, and housing related industries such as household durable goods benefit from lower interest rates. Unfortunately, the collapse of the housing market in the most recent recession was not helped by low int. rates.

discuss how supply/demand of input factors influence the cost structure, risk and investment implications of an industry

supply and demand relationships are very important because they affect the price structure of the industry and it's ability to prduce quality products at a reasonable cost. The cost variable can be affected by many factors. For example high relative hourly wages in basic industries are somewhat responsible for the inability of u.s to compete in the world markets for these products. Availibility of raw material is also an important cos factor. Industries such as aluminum and glass need to have an abundance of low cost bauxite and silicon to produce their products. Unfortunately, the aluminum industry uses very large amounts of electricity in the production process so the low cost of bauxite may be offset by the hight cost of energy. Energy costs are a concern to all industries. The availability of reasonably priced energy sources is particularly important to the airline and trucking industry.


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World History:The Columbian Exchange

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PR Quizzes Exam 2 (8,9,11,12,15,17)

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Chapter 3: The costs of production

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