Investments Ch 7- Analyzing Common Stocks

security analysis

consists of gathering information, organizing it into logical framework, and then using the information to determine the intrinsic value of common stock

intrinsic value

provides a measure of the underlying worth of a share of stock

intrinsic value depends on several factors:

1. estimates of the stock's future cash flows
2. discount rate used to translate those future cash flows into a present value
3. risk associated with future performance

Efficient market asserts the following:

1. securities rarely, if ever, substantially misplaced in the marketplace
2. no security analysis is capable of identifying mispriced securities with a frequency greater than that which might be expected by random chance alone

fundamental analysis

looks at the financial condition and operating results---the "fundamentals"---of a specific company

economic analysis

consists of a general study of the prevailing economic environment---often on both a global and domestic basis

business cycle

behavior of economy is captured in business cycle; reflects changes in total economic activity over time (measures are GDP and industrial production)


market value of all goods and services produced in a country over a given period

industrial production

indicator of the output produced by industrial companies

industry analysis

deals with the industry within which a particular company operates; looks at the overall outlook for that industry and at how companies compete against each other in that industry; also helps investor assess the riskiness of a company and therefore define

steps in industry analysis

1. establish the competitive position of a particular industry in relation to others
2. identify companies within the industry that hold particular promise

stages in growth cycle

1. initial development
2. rapid expansion
3. mature growth
4. stability/decline

balance sheet

statement of the company's assets, liabilities, and equity

income statement

provides a financial summary of the operating results of the firm; shows the amount of revenue generated over a period of time, the costs and expenses incurred over the same period, and the company's profits

statement of cash flows

provides a summary of the firm's cash flows and other events that caused changes in its cash position

ratio analysis

study of the relationships between various financial accounts

liquidity measures

concerned with firm's ability to meet its day-to-day operating expenses and satisfy its short term obligations as they come due (current ratio, net working capital)

activity ratios

compare company sales to various asset categories in order to measure how well the company is utilizing its assets (accounts receivable turnover, inventory turnover, total asset turnover)

leverage measures

look at the firm's financial structure; indicates the amount of debt being used to support the resources and operations of the company (debt-equity ratio, times interest earned)


relative measure of success (net profit margin, return on assets, return on equity

common stock ratios (market ratios)

tell investor exactly what portion of total profits, dividends, and equity is allocated to each share of stock (price/earnings ratio, dividends per share, payout ratio, book value per share)