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UGBA133Lecture 8-Security Analysis

UGBA133Lecture 8-Security Analysis - LECTURE 8 SECURITY...

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LECTURE 8: SECURITY ANALYSIS CHAPTER 18: EQUITY VALUATION MODELS CHAPTER 19: FINANCIAL STATEMENT ANALYSIS CHAPER 18: THIS CHAPTER FOCUSES MORE ON BALANCE SHEETS AND THEN LOOKS AT TWO WELL KNOWN FORMS OF “FUNDAMENTAL ANALYSIS.” THOSE TWO FORMS ARE DIVIDEND VALUATION MODELS AND PRICE TO EARNINGS RATIOS. THE OTHER PRICE RELATED RATIOS (AND I CONTEND MORE USEFUL) RATIOS WILL BE DISCUSSED IN CHAPTER 19. BALANCE SHEET ANALYSIS: BOOK VALUE: The popularity of the concept “book value” seems to rise and fall in an inverse relation to the market’s direction. As stock market values rise, book value is perceived to be less relevant, and you will begin noting articles in the WSJ that are critical of book value => to me it is one of the first signs that the market is becoming over priced and due for a downward move. It is only a warning, not a precise timer. Book value is simply the total liabilities subtracted from the total assets of any given company. The text is correct about the concept of book value NOT being a “floor” valuation of a company. If there is/are one or more preferred stock issues outstanding, the preferred stocks would also be subtracted from the assets to produce a net figure labeled “common equity book value.” The key is to eliminate everyone but the common shareholders. Book value is one of the original ratios created, perhaps 100 or more years ago. Until the 1960s, most of the stocks traded in the United States markets were of manufactur- ing entities that sold tangible products built and assembled in factories on land owned by the company. That means the predominant assets of a company were things that had tangible value; factories could be sold, land could be sold, etc. Book value meant something then. As our economy became more service oriented, and more “products” were intangible, book value lost much of its meaning as a “floor” value. So the concept of book value was then linked to another measure, liquidating value . 1
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LIQUIDATING VALUE: VARYING DEFINITIONS—THE TEXT DEFINES IT AS THE PROCEEDS FROM THE SALE OF THE ENTIRE SET OF ASSETS (NOTE I AM MAKING THE DISTINCTION OF THE ASSETS, NOT THE SALE OF THE COMPANY AS AN ONGOING ENTITY). In spite of the presumed increased irrelevance of book value, it continues to be identi- fied as a major source of financial strength. Twenty years ago, Barr Rosenberg wrote an often cited paper which, to his surprise, revealed that price to book was a signific- ant variable in the valuation process. Ten years ago, Eugene Fama and Ken French wrote another paper realizing the same result…do not trivialize book value. The means by which it is used as in a comparison to the current price of the stock. That ratio is called: PRICE TO BOOK VALUE…the book value is divided by the number of shares of common stock outstanding and that is compared to the current stock’s price. Ana- lysts usually refer to the ratio as P / B but in doing any sort of econometric analysis, you have to invert the ratio to B / P to finesse problems with companies that have very low book values, close to or equal to zero.
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