A firm with the management ability and the opportunities to consistently make investments that yield rates of return greater than the firm’s required rate of return.
A stock with a higher expected rate of return than other stocks in the market with similar risk characteristics.
Future earnings are likely to withstand an economic downturn.
One would expect them to have relatively low business risk and not excessive financial risk.
(fast food chains or grocery stores—firms that supply basic consumer necessities.)
Rate of return is not expected to decline during an overall market decline, or decline less than the overall market.
A stock with low or negative systematic risk (a small positive or negative beta), because its returns are unlikely to be harmed significantly in a bear market.
Sales and earnings will be heavily influenced by aggregate business activity.
(steel, auto, head machinery)
Changes in rates of return greater than changes in overall market rates of return.
Stock of any company that has returns that are more volatile than the overall market (high-beta stocks that have high correlation with the aggregate market and greater volatility.)
Assets involve great risk but that also has a possibility of great gain.
High probability of low or negative rates of return and a low probability of normal or high rates of return.
(Overpriced, leading to a high probability that during the future period when the market adjusts the stock price to its true value, it will experience either low or possibly negative rates of return.)
Appear to be undervalued for reasons other than earnings growth potential.
Low price-earning or low price-book value.
Defensive Competitive Strategy
Positioning the firm to deflect the effect of the competitive forces in the industry.
(Investing in fixed assets, technology)
Offensive Competitive Strategy
Attempts to use its strengths to affect the competitive forces in the industry.
Strength (internal) - customer service, quality products, brand, reputation, R&D, loyalty
Weaknesses (internal) - competitors have potential to exploit the firm
Opportunities (external) - growing market, shrinking competition, favourable exchange rate shifts
Threats (external) - slow economy, regulations, new entries, new technology
Favourable Assets (Lynch)
- The firm’s product is not faddish; it is one that consumers will continue to purchase over
The company has a sustainable comparative competitive advantage over its rivals.
The firm’s industry or product has market stability. Therefore, it has little need to innovate or create product improvements or fear that it may lose a technological advantage.
Market stability means less potential for entry.
The firm can benefit from cost reductions (e.g., a computer manufacturer that uses technology provided by suppliers to deliver a faster and less-expensive product).
The firm buys back its shares or management purchases shares, which indicates that its insiders are putting their money into the firm.
Firm’s expected rate of growth of earnings per share
Stock’s required rate of return
Firm’s dividend-payout ratio.
Inconsistency Between Growth and P/E Ratio
- A major difference in the risk involved (the low P/E high-growth company is much
- Inaccurate growth rate estimates. You may want to reexamine your growth rate estimate
- for the firm with the higher P/E ratio; that is, could it be higher or should the growth esti-
- mate for the low P/E stock be lower?
- The stock with a low P/E ratio relative to its expected growth rate is undervalued. (Before
- you accept this possibility, consider the first two factors.)
- The stock with a high P/E and a low expected growth rate is overvalued. (Before this is
- accepted, consider both its risk and your estimated growth rate.)
Earn Above Average Returns
The analyst must have expectations that differ from the consensus
The analyst must be correct.
Estimating Intrinsic Value Approaches
The present value of cash flow
The analysis of relative valuation ratios.
Assumptions of Technical Analysis
- The market value of any good or service is determined solely by the interaction of supply
- and demand.
- Supply and demand are governed by numerous rational and irrational factors. Included in these factors are those economic variables relied on by the fundamental analyst as well as
- opinions, moods, and guesses. The market weighs all these factors continually and
- Disregarding minor fluctuations, the prices for individual securities and the overall value of
- the market tend to move in trends, which persist for appreciable lengths of time.
Prevailing trends change in reaction to shifts in supply and demand relationships. These shifts, no matter why they occur, can be detected sooner or later in the action of the market itself.
Problems with Accounting Standards
They lack a great deal of information needed by security analysts (information related to sales, earnings, and capital utilized by product line and customers.)
- According to GAAP, corporations may
- choose among several procedures for reporting expenses, assets, or liabilities. (Notably,
- these alternative procedures can produce vastly different values for expenses, income, return on assets, and return on equity, depending on whether the firm is conservative or aggressive)
Many psychological factors and other non quantifiable variables do not appear in financial statements.
Mutual Fund cash positions
Credit balances in brokerage accounts
Investment advisory opinions
Chicago Board Options Exchange (CBOE) Put-Call ratio
Futures Traders Bullish on Stock-Index futures
Follow the Smart Money
T-Bill Eurodollar Yield Spread
Debit balances in brokerage accounts (margin debt)
Breadth of market
Stocks above their 200-day moving average
Stock Price and Volume Techniques
Importance of Volume
Support and Resistance Levels
- Relative strength
- Bar charting
Dow described stock prices as moving in trends analogous to the movement of water.
- Major trends that are like tides in the ocean
- Intermediate trends that resemble waves
- Short-run movements that are like ripples.
Technical Trading Rules (Categories)
Stock price and volume techniques