CH.9 EQUITY SECURITY ANALYSIS

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CH.9EQUITY SECURITY ANALYSIS
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Equity Security Analysis

• Equity security analysis is the evaluation of a
  firm and its prospects from the perspective of a
  current or potential investor in the firms stock
• Security analysis is the foundation for the
  second step of investment process, projecting
  future returns and assessing risk.

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Equity Security Analysis and Market Efficiency

• Efficient market hypothesis information would be
  reflected in security prices fully and
  immediately upon its release.
• Under this condition it would be impossible to
  identify mispriced securities on the basis of
  public information
• Efficient market hypothesis cannot represent an
  equilibrium in a strict sense

4
Market Efficiency and the Role of Financial
Statement Analysis

• Market agents could profit from digesting
  financial statement information
• The information would be useful to the select few
  who receive newly announced financial data,
  interpret it quickly, and trade on it within
  minutes
• The information would be useful for gaining
  understanding of the firm, so as to place analyst
  in a better position to interpret other news as
  it arrives
• Create trading strategies designed to exploit any
  systematic ways in which the publicly available
  data are ignored or discounted in the
  price-setting process

5
Approaches to Fund Management and Security
Analysis

• Active versus Passive Management
• Active relies heavily on security analysis to
  identify mispriced securities
• Passive serves as a price taker, avoiding the
  costs of security analysis and turnover while
  seeking to hold a portfolio designed to match
  some overall market index or sector performance

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Approaches to Fund Management and Security
Analysis

• Quantitative versus Traditional Fundamental
  Analysis
• Technical analysis attempts to predict stock
  price movements on the basis of market indicators
• Fundamental analysis attempts to evaluate the
  current market prices relative to projections of
  the firms future earnings and cash-flow
  generating potential.
• Supplemented traditional fundamental analysis
  with more quantitative approaches

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Approaches to Fund Management and Security
Analysis

• Formal versus Informal Valuation
• Formal method described in ch.7
• Informal method
• compare earnings projection with consensus
  forecast
• Recommend a stock because his or her earnings
  forecast appears relatively high in comparison to
  the current price
• Marginalist

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Performance of Security Analysts and Fund Managers

• Performance of Security Analysts
• Analyst earnings forecasts are more accurate than
  those produced by time series models that use
  past earnings to predict future earnings
• Stock prices tend to respond positively to upward
  revisions in analysts earnings forecasts and
  recommendations, and negatively to downward
  revisions
• Analysts play a valuable role in improving market
  efficiency

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Performance of Security Analysts and Fund Managers

• Performance of Fund Manager
• No consistent evidence that actively managed
  mutual funds generate superior returns for
  investors