investments

Growth Stocks (examples)

Exhibit consistent growth unrelated to the business cycle; tend to outperform in bull markets. Many are in middle-to-late stages of the expansionary stage. Tend to be fully valued and recognized (McDonalds,Disney, Coke)

Most large pharmaceuticals companies are in the ___ stage of life cycle

Expansion

What is the historical relationship between real GDP and inflation?

Inversely related; as inflation rises real GDP falls

How can the Fed influence economic activity? (Three ways)

Reserve Requirements, Discount Rate, and OMO

During economic expansion (increase in GDP) stock prices ___

Rise

Inventory Turnover Ratio (formula/meaning)

Sales / Inventory ; How quickly inventory is produced and sold

Asset Turnover Ratio (formula/meaning)

Sales / Total Assets ; How effectively a company utilizes its assets to generate sales revenue

The length of lead time between the peak in stock prices and the peak in economic activity is getting ____

Shorter

Top-Down Approach

Starts with an analysis of the economy, moves to industry, and finally to the company analysis and valuation

Bottom-Up Approach

Starts with the company analysis and valuation, moves to industry, and finally to an analysis of the economy

People who follow the the bottom up approach are commonly referred to as ____

Stock Pickers

___ are used to signal to investors that the company is making a profit

Stock dividends

___ are the most accurate and reliable leading indicator of GDP

Stock prices

The more saturated an industry gets with competitors, the ____ the life cycle will be

further

"Growth companies" may not be as well known or recognized as ___.

growth stocks

Stocks with ____ growth opportunities and high ____ lead to a high P/E

high, expected earnings

Activity Ratios measure ____

how effectively a company uses its assets to generate sales

Often it is not a whole ___ that goes into decline, but the ___ in the industry that cannot compete

industry, weakest company

P/Es tend to be higher when inflation and interest rates are ___

low

Stocks with ___ P/B outperform higher price to book value stocks.

low

Industries with ___ products are hardly affected by the business cycle such as ___.

low-price-elastic; cigarettes and alcohol

Pharmaceuticals are a ____ and are usually ____ on the economy.

necessity, not dependent

Industry Structure determines the potential ___ of firms.

profitability

Higher ROE results from greater ___, efficient use of ___, and higher ___.

profitability, assets, leverage

The FDA is one of the most ___ and strict enforcement agencies in the world.

risk-averse

Automobiles are ___ to the business cycle and do better in a ___ period.

sensitive, boom

Housing is ____ to the economy and does better in a ___ with ___ interest rates.

sensitive, recession, low

The S&P 500 and GDP seem to have ___ long term growth paths

similar

The ___ often anticipates the end of a ____ and stock prices usually ___ before real GDP shows an increase

stock market, recession, turn up

ROE impacts the ____ of a stock. Higher ROE = ___ and ___.

Intrinsic Value, Better Investment, Higher growth

Benchmark is the ratio of dollars spent on ___ as a percentage of ___

R&D, sales

Growth Rate Formula

ROE * b aka rentention rate: ( 1 - dividend payout ratio)

Bond yield spreads ___ during a contraction and ___ during an expansion.

Widen, Narrow

The pharmaceutical industry is growing ___ than the economy or S&P 500, but growth is ____

faster, decelerating

PEG less than ___ is good. The ___ the PEG, the better the value.

1; lower

In general, companies in stage __ become profitable

2 (growth)

Recession

2 more consecutive quarters of negative real GDP

If a company has a P/E of 25 and is projected to grow 20%, it would have a PEG ratio of ___.

25/20 or 1.25

With only a ___ success in passing FDA approval, much R&D is spent on ___, but a success can reap large profits for a firm

3.3% ; failures

In the maturity stage, dividends may range from ___ earnings

40-50%

A complete business cycle, trough to trough, is an average of _____.

5/5.5 years

What is the difference between a growth company and a growth stock?

"Growth companies" exhibit rising returns on assets each year and sales and earnings that are growing at an increasing rate. They are in the growth phase of the life cycle curve, whereas "growth stocks" may already be in the expansion stage.

Quick Ratio, also known as ____, formula

"The Acid Test" (Current Assets - Inventory) / Current Liabilities

P/B less than ___ means the stock is undervalued. P/B of .8 means stock is selling for ___.

1 ; $.80 per share for every dollar of its book value; can liquidate at $1.000 and earn $.2 per share

What are the four goals of Federal Government Economic Policy?

1. Stable prices (a low inflation rate) 2. Business stability at high levels of production (low levels of unemployment) 3. Sustained economic growth (real growth in gross domestic product) 4. A balance in international payments (primarily a balance of exports and imports but also including cash flows in and out of the U.S.)

What are Porter's five competitive forces that affect prices and profitability in an industry?

1. Threat of entry by new competitors 2. Threat of substitute goods 3. Bargaining power of buyers 4. Bargaining power of suppliers 5. Rivalry among existing competitors

Five Stages of the Industry Life Cycle

1.Development, 2. Growth, 3. Expansion, 4. Maturity, D celine

Can take up to ___ of R&D before submission to the FDA for approval

10 years

Dividend payout ratios in the decline stage somtimes rise to ___ of earnings

100% or more

Historical average S&P 500 P/E = ___. A P/E of ___ in this environment is considered low.

15, 10

In terms of the business cycle, distinguish between a trough and a peak.

A trough represents the end of a recession and the beginning of an expansion, and a peak represents the end of an expansion and the beginning of a recession.

What two factors are probably most important in influencing the P/E ratio for an individual stock? Suggest a number of other factors as well.

An individual stock's P/E ratio is heavily influenced by its growth prospects and the risk associated with its future performance. Other important factors include: Debt to equity ratio Dividend policy The firm's industry Quality of management Quality of earnings

Earnings Yield Formula

Annual EPS / Current Stock Price

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

As interest rates bottom out, houses become more easily financed and cost less per month to purchase.

Inflation is ___ for the overall stock market. Rising inflation leads to higher interest rates, which tends to ___ stock prices.

Bad, depress

Rising Inflation (industries of a rotational investor)

Basic materials, energy stocks and commodities

What does beta represent?

Beta measures individual company risk against market risk (usually S&P 500)

Leading Indicators

Change direction in advance of general business conditions

Crossover Point

Change from accelerating growth to decelerating growth; occurs at the start of the expansionary phase

What are some industries in which there are growth companies?

Computer networking, cellular telephones, biotechnology, or medical electronics.

Forward P/E

Current price divided this coming year's earnings; what you are paying for $1 of the upcoming year's earnings

____ industries tend to be sensitive to short-term business cycle swings

Customer-oriented, such as durable goods (washers and dryers, fridges, stoves, cars)

In anticipation of an economic upturn, allocate a higher portion of portfolio to ___ stocks and ___ stock.

Cyclical, high Beta

Dividend Payout Ratio

DPS / EPS

In an economic downturn, allocate portfolio to ___ stocks such as utilities and high-quality noncyclical stocks

Defensive

Times Interest Earned

EBIT / Interest

The inverse of a stock's P/E is its ____

Earnings Yield

What are the three elements of the valuation process (FUNDAMENTAL ANALYSIS)?

Economic Analysis, Industry Analysis, and Company Analysis

During a recession (GDP decreasing), stock prices ___

Fall

Monetary Policy

Federal Reserve determines the "appropriate" levels for the money supply and interest rates

What factors besides inflationary considerations and growth factors influence P/E ratios for the general market?

Federal Reserve poly and interest rates Federal deficits The government's leading indicators Mood and confidence of the population International considerations Many other factors also affect the market

Rising Interest Rates (industries of a rotational investor)

Food, pharmaceutical, beverage, tobacco stocks

The Pharmaceutical Industry is a ___ industry with ___

Global, high barriers to entry

Fiscal Policy

Government's taxing and spending policies

How can companies with non-constant growth be analyzed?

Growth is divided into periods of present value cash flows, that is summed to obtain the share price.

In an economic downturn, a bond investor should hold short-term ____ -quality bonds while yield spreads are ____.

High, low

Falling Interest Rates (industries of a rotational investor)

Housing, home building, lumber, household durable good stock

How does the pattern of cash dividend payments change over the cycle?

In general, the dividend payout ratio is non existent in the development stage and by the end of the growth stage low cash dividends may be started. The cash dividend and payout ratio will gradually increase through the rest of the life cycle reaching between 45 and 55 percent of earnings depending upon the industry. In the decline stage, the dividend may rise or fall dramatically depending upon the individual company situation.

If the Fed buys securities, what is the likely impact on the money supply?

Increase in the money supply (expansionary)

Intrinsic Value quick estimate

Intrinsic Value = P/E * Expected EPS

What type of industries tend to carry the highest P/E ratios?

Investors appear to have some preference for firms that have a high technology and research emphasis. Thus, firms in technology, biotech, medical research, health care, and sophisticated telecommunications often have higher P/E ratios than the market in general. This does not mean that firms in these industries possess superior investment potential, but merely that investors value their earnings more highly because of higher expected growth rates, which may or may not materialize.

CAPM (Ke) Formula

Ke = Rf + Beta*(Rm - Rf)

Who has the greater advantage for research and development in the pharmaceutical industry?

Large drug companies

Stock prices tend to ___ overall economic activity by approximately ____

Lead, 5 months

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

Longer warning before peaks than troughs.

In anticipation of an economic upturn, a bond investor should lengthen bond maturity within a portfolio and shift from high-quality bonds to ___ quality bonds because yield spreads begin to ___

Low, narrow

Probability Ratios measure ____.

Managers ability to control expenses and generate income from sales

In general, ___ industries are related to growth in the overall economy.

Mature

Gross Domestic Product (GDP)

Measures output and consumption within the US in a given year

___ have led to large firms that are able to pool resources to develop larger ____

Mergers, economies of scale

Coincident Indicators

Move approximately with the overall economy

Some industries prosper during recessions, such as

Movies

Net Profit Margin (formula/meaning)

Net Income / Sales ; Shows how much of each dollar being earned is translated into profits

Return on Equity (ROE) formula

Net Income / Total Stockholders Equity

Example of companies that have continued to grow in nongrowth industries

Nike and McDonalds. Despite the saturation for their products in the domestic market, international demand has allowed them to maintain double digit growth

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

Once investors realize that the growth rate has permanently slowed, they will pay a lower price-earnings ratio for the current earnings per share and the price will fall.

ROE can be decomposed into its ___ and ___ components.

Operational, Financial

Pirce-to-Book Multiple (P/B) formula and meaning

P/B= Total Market Value of Stock /Book Value per Share (value line) ; What the stock is worth today relative to what it costs

Price to Earnings Ratio (formula/meaning)

P/E = Current Stock Price per Share / Annual EPS ;

Relative P/E

P/E of specific company divided by the P/E of the 'market' (S&P 500)

PEG Formula

PEG = Price Earnings Ratio / Growth in EPS

Cyclical Stocks (examples)

Performance is directly related to business cycle (Retail, Airlines, Houses, Automobiles, Construction)

Defensive Stocks (example)

Performance is unrelated to the business cycle; tend to outperform in bear markets (pharmaceuticals, utilities, food staples)

What component of GDP has been growing the most rapidly over the past three decades?

Personal Consumption (account for more than 60% of GDP)

Four components of GDP:

Personal Consumption, Government Expenditures, Gross Domestic Private Investment, Net Exports

Drugs have ___ life cycles due to ___.

Predictable; Development process, Approval process, Remainder of life under patent protection (10 years maximum

___ is the most frequently quoted valuation ratio

Price to Earnings Ratio (P/E)

In considering P/E ratios for the overall market, what has been the relationship between price-earnings ratios and inflation?

Price-earnings ratios and inflation have been inversely related. Higher inflation was associated with lower P/E ratios and vice versa.

Industries suffer declines in sales during stage 5 if ___

Product innovation has not increased the product base over the years

ROE = ____ * _____ * ______

Profit Margin + Asset Turnover + Equity Multiplier

In the pharmaceutical industry, is government regulation tougher in the United States than in foreign countries?

The U.S. is tougher. The U.S. Food and Drug Administration (FDA) is considered to be one of the most risk averse and strict enforcement agencies in the world, and it is not unusual for drugs to be approved for use in other countries before receiving approval from the FDA.

What two conditions are necessary to use the formula for Required Rate of Return?

The growth rate must be constand and Ke must be greater than g (the growth rate)

Rotational Investing

The practice of moving in and out of various industries over the business cycle.

Why might a firm begin paying stock dividends in the growth stage?

To indicate that the company is profitable but still needs its cash for expansion

Book Value formula and meaning

Total Assets - Total Debt ; value of the company if it were to liquidate, what the company is worth on the balance sheet

Equity Multiplier

Total Assets / Total Equity ; Higher leverage increases equity

Debt Ratio

Total Liabilities / Total Assets

Total Market Value of a Stock

Total Market Value of Stock = Share Price x Number of Shares Outstanding

Because of the emphasis of trading from one industry to another, a rotational investor incurs more ____.

Trading Costs

Because of the emphasis of trading from one industry to another, a rotational investor incurs more ____

Trading costs

Inflation tends to be the highest around economic ____ and lowest around economic ___ .

Upturn, contraction

Lagging Indicators

Usually change direction after business conditions have turned aorund

Porter's five competitive forces ____ from industry to industry, and directly effect the ____.

Vary; return on assets and return on equity

Leverage Ratios measure ____.

a company's level of debt

P/E is best for comparing relative value of stocks to ____. Alone, it is not good basis for ____.

an industry, choosing stocks

In stage 3, sales and earnings continue expanding, but ___

at a decreasing rate

The economy expands and contracts through a ___ process.

business cycle

Fundamental Analysis

every security has an intrinsic value that is determined by using future expectations about a company

One way of maintaining growth when domestic markets have become saturated is to ____

expand into markets overseas

As world population ages, __ for drugs will grow

demand

Industries can be classified into groups that may exhibit similar behavior during ___

different phases of the business cycle

Buffet believes the reason for taking the time to evaluate manager is that it gives you ____

early warning signs of eventual financial performance

Graham and Dodd suggest investor should not buy a stock with a P/E higher than 12 for "___ investing." Low P/E strategy is known as "___ Investing"

value; Contrarian

Trailing 12-month P/E

what you are paying for $1 of last years earnings