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
