Fundamental Analysis or Picking Stocks

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Fundamental Analysis or Picking Stocks

• Peter Lynch on picking stocks, "If you don't
  think you can beat the market, then buy a mutual
  fund and save yourself a lot of extra work and
  money.

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Fundamental Analysis or Picking Stocks

• Fundamental analysis refers to a process of
  investment evaluation whereby the investor makes
  an investment decision based on fundamental
  economic, industry, and company indicators.
• Basically, we are talking about informed stock
  picking.

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Fundamental Analysis or Picking Stocks

• We will examine three aspects of fundamental
  analysis
• Financial Statement Analysis
• Discounted Cash Flow Valuation
• Relative Valuation

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Financial Statement Analysis

• Goal is to identify good companies
• How do we do this?
• Examine financial statements
• Look for telling signs
• Ratio analysis
• Compare to other companies

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Analysis of Individual Companies

• Different types of companies
• 1. Slow grower
• Large, aging companies that grow slightly faster
  than GNP
• Pay high dividends
• Flat earnings and price appreciation
• 2. Stalwart
• Large corporation growing at a slightly faster
  clip than slow growers
• P.L. looks for a 30 - 50 return on a stalwart

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Analysis of Individual Companies

• Different types of companies
• 3. Fast grower
• Growing at 20-25 a year
• 10-bagger (earn ten fold on an investment, 900
  return)
• Fast growers do not have to be in fast growing
  industries
• 4. Cyclical
• Sales and profits rise and fall in regular
  intervals
• Riskier than a stalwart
• Timing is most important

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Analysis of Individual Companies

• Different types of companies
• 5. Turnarounds
• Little-problem-we-didnt anticipate
• Perfectly-good-company-inside-a-bankrupt-company
• Restructuring-to-maximize-shareholder-values
• 6. Asset plays
• Sitting on a valuable asset everyone else has
  missed
• Real-estate, cash, patents, name

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Analysis of Individual Companies

• Things to look for
• 1. You know something about the company
• If you dont understand what the company does,
  its hard to evaluate its performance
• 2. Percent of sales
• Know what impact a particular product may have on
  a company

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Analysis of Individual Companies

• Things to look for
• 3. P/E ratio
• Number of years it will take for the company to
  earn back your investment
• A P/E equal to growth in earnings is fairly
  priced
• (long-term earnings growth dividend
  yield)/(P/E) PE multiple
• P.L. suggests a ratio of 2 or higher
• 4. Cash
• May be a hidden asset
• May be spent

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Analysis of Individual Companies

• Things to look for
• 5. Debt position
• A company with no debt can not go bankrupt
• Types of debt
• Funded
• Bank
• 6. Dividends
• Cushion against falling prices
• Cant spend money foolishly

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Analysis of Individual Companies

• Things to look for
• 7. Diworseifications
• Generally, diversifying a company does not work
  well
• 8. Book value
• Large book value to market value is good

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Analysis of Individual Companies

• Things to look for
• 9. Free cash flow
• Cash flow is the amount of money a company takes
  in as a result of operations
• Free cash flow is cash flow net of normal capital
  spending
• 10. Inventories
• You dont want to see inventories piling up

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Analysis of Individual Companies

• Things to look for given specific company types
• Slow growers
• Dividends
• Payout ratio
• Stalwarts
• P/E ratio
• Diworseification
• Long-term growth
• Performance in recessions

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Analysis of Individual Companies

• Things to look for given specific company types
• Cyclicals
• Increasing inventories
• Shrinking P/E multiple
• Fast growers
• sales for new products
• 20 to 25 percent growth
• Duplicate successes
• Company still has room to grow
• P/E near growth rate
• Limited institutional ownership

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Analysis of Individual Companies

• Things to look for given specific company types
• Turnarounds
• Can company survive creditors
• What assets are left during/after bankruptcy
• How is the turnaround to occur?
• Are costs being cut
• Asset plays
• What is the value of the hidden asset?
• How much debt is being shouldered by these
  assets?
• Is there blood in the water?

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Analysis of Individual Companies

• Peter Lynchs Ultimate Company
• 1. It sounds dull or, even better, ridiculous
• 2. It does something dull
• 3. It does something disagreeable
• 4. Its a spin-off
• 5. The institutions dont own it and the
  analysts dont follow it
• 6. Rumors abound about the nature of the business

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Analysis of Individual Companies

• Peter Lynchs Ultimate Company
• 7. Theres something depressing about it
• 8. It a no-growth industry
• 9. Its got a niche
• 10. People have to keep buying it
• 11. Its a user of technology, not a creator
• 12. The insiders are buying
• 13. The company is buying back shares.