Class Note 8-S2010_1 - RSM 330 - Investments Class 9...

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RSM 330 - Investments Class 9 – Fundamental Analysis August 3, 2010 Maureen Stapleton, CFA 1
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Plan for Today Assignment 2 is due on Tuesday, August 10 in class Fundamental Analysis – Class Note 8 Equity Valuation – 2 approaches – Discounted cash-flow – Dividend Discount Models – Relative valuation – Price/Earnings Ratios Earnings Forecasts - Estimate Growth rates and Opportunities Readings: Posted on Blackboard 2
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Your Project 8 to 12 pages excluding cover page, graphs & tables which are in the appendix Double spaced, 12 point font Spend time thinking about what you want to say & writing your report Include: Cover page with full name and student number of all group members and group name of your Rotman Portfolio Manager Account Table of Contents Executive Summary key points about what you did and what you learned – high level, very important, ½ page Body - Rationale, methodology, lessons learned, results/findings Cite the sources of your ideas and/or data Conclusion Appendix- tables etc References 3
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Fundamental Analysis - What is it? The process of finding the intrinsic value of a security. • Intrinsic value is related to the firm’s characteristics such as - growth prospects of cash-flows (earnings and dividends) - risk profile . Market price (MP) of securities can vary from their intrinsic value (IV) - Under-priced or over-priced Profitable trading opportunities - Buy if MP < IV (this stock is underpriced) - Sell if MP > IV (this stock is overpriced) Typical Analytical Procedures: Top Down analysis – Economic & Industry Analysis; Company Analysis; Equity Valuation; forecast stock price Bottom up analysis - Starts with the company 4
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1. Dividend Discount Models (DDMs): use discounted cash flow The value of a stock is the present value of expected dividends . - Gordon Constant Growth Model (also called Gordon Growth model) – If future dividends are assumed to grow at a constant rate g, – If T increases to infinity, OR This constant growth model was named after Myron J. Gordon (U of T professor ). 5 T T T T r P r g D r g D r D Value ) 1 ( ) 1 ( ) 1 ( ..... ) 1 ( ) 1 ( 1 1 1 2 1 1 + + + + + + + + + + = - g r D Value - = 1 g r g D Value - + = ) 1 ( 0
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An example: Apply the Gordon model to estimate the values of three utility stocks : Bell Atlantic, Bell South, and Cincinnati Bell. Step 1 : Use CAPM to estimate the discount rate for each stock. - Assume a market risk premium of 5% and a risk-free rate of 6%. - Your estimates of the betas are 0.90, 0.80, and 0.95, respectively - Next, apply the formula E(r i ) - r f = β i [E( ˜ r M ) - r f ] So the cost of equity (or the discount rates) for each stock is: Bell Atlantic : r = 0.06 + 0.90(0.05) = 0.1050 Bell South : r = 0.06 + 0.80(0.05) = 0.1000 Cincinnati Bell : r = 0.06 + 0.95(0.05) = 0.1075 6 Recall that the discount rate for a stock r i = r f + β i times the market risk premium r M - r f
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This note was uploaded on 07/16/2011 for the course COMMERCE 330 taught by Professor Stapleton during the Fall '10 term at University of Toronto- Toronto.

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Class Note 8-S2010_1 - RSM 330 - Investments Class 9...

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