mid-term study guide
mid-term study guide FINE-7670-01
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This 7 page Study Guide was uploaded by YUQING XU on Saturday April 2, 2016. The Study Guide belongs to FINE-7670-01 at Tulane University taught by Pan, Xuhui in Fall 2015. Since its upload, it has received 111 views. For similar materials see Risk Mgmt and App to Enrg Firm in Finance at Tulane University.
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Date Created: 04/02/16
The Little Book that Beats the Market, Joel Greenblatt 1. What are the elements of this author’s “magic formula?” Paying a bargain price when you purchase a share in a business, that means, you buy the stock that have higher earning yield is better than a lower one. The second element is to buy a share of a good business is better than a bad one, which means businesses that earn a high return on capital are better than a low one. So, the formula list 3,500 largest companies available for trading on one of the major U.S. stock exchanges according to both earning yield and return on capital—the higher the better. Finally, the formula combines the rankings and looks for the companies that have the best combination of those two factors. The big picture is that we want to make sure we earn a lot more from our other investments than we could earn without taking any risk. 2. What do you perceive as the strengths and weaknesses of using this formula to “beat the market?” The strength of this formula is that it can win in long run. The weaknesses is that you might loss in short term. The Little Book of Valuation, Aswath Damodaran. 1. What is the difference between intrinsic valuation and relative valuation? Relative valuation is all about comparing how the market prices different companies, with the intent of finding bargains. In relative valuation, you value an asset based on how similar assets are priced in the market. The three essential steps in relative valuation are: 1. Find comparable assets that are priced by the market. 2. Scale the market prices to a common variable to generate standardized prices that are comparable across assets 3. Adjust for differences across assets when comparing their standardized values. Relative valuation can be done with less information and more quickly than intrinsic valuation and is more likely to reflect the market mood of the moment. The intrinsic value of a company reflects its fundamentals. Estimates of cash flows, growth, and risk are all embedded in that value, and it should have baked into it all of the other qualitative factors that are often linked to high value, such as a great management team, superior technology, and a longstanding brand name. There is no need for garnishing in a well-done intrinsic valuation. The differences in value between discounted cash flow valuation and relative valuation come from different views of market efficiency or inefficiency. In discounted cash flow valuation, we assume that markets make mistakes, that they correct these mistakes over time, and that these mistakes can often occur across entire sectors or even the entire market. In relative valuation, we assume that while markets make mistakes on individual stocks, they are correct on average. In other words, when we value a new software company relative to other small software companies, we are assuming that the market has priced these companies correctly, on average, even though it might have made mistakes in the pricing of each of them individually. Thus, a stock may be overvalued on a discounted cash flow basis but undervalued on a relative basis, if the firms used for comparison in the relative valuation. 2. What are Free Cash Flows? Free Cash Flows can be break down into to two kinds. First is free cash flow to equity. The free cash flow to equity measures the cash left over after taxes, reinvestment needs, and debt cash flows have been met. The second one is free cash flow to the firm. The cash flow to the firm is the cash left over after taxes and after all reinvestment needs have been met, but before interest and principal payments on debt. 3. Explain each of the “value drivers” for: a. Startup firms Young companies can range from idea companies that have no revenues and products, to startup companies that are testing out product appeal, small revenues and increasing losses, to second stage companies that are moving on the path to profitability, growing revenues, move toward profit. Revenue growth, target margin, survival probability b. Growth companies Growth firms get more of their value from investment that they expect to make in the future and less from investments already made. Scaling growth, margin sustainability c. Mature companies Easy to value because they have long periods of operating and market history, with established patterns of investment and financing. Get the bulk of their value from existing investments. Operating slack, financial slack, probability of management change. d. Declining companies Have little in terms of growth potential and even their existing assets often deliver returns lower than their cost of capital Common characteristics: Stagnant or declining revenues Shrinking or negative margins Asset divestitures Big payoutsdividends and stock buybacks Financial leveragethe downside Going concern value, default probability, default consequences e. Financial Services firms Pay large and stable dividends, and they were regulated. They fall into four groups depending on how they make their money. Bank/insurance company/investment bank/ investment firms Equity risk, quality of growth (return on equity), regulatory capital buffers. f. Cyclical and/or Commodity companies Cyclical: earnings that track overall economic growth Commodity: derive their earnings from producing commodities that may become inputs to other companies in the economy or be desired as investments in their own right. Normalized earnings, excess returns, long term growth g. Firms with intangible assets The most successful companies of our generation have been technology and service companies, with much of their value coming from assets that have no physical presence such as brand name, technological skills and human capital. Nature of intangible assets, efficiency of investments in intangible assets. 4. Explain the author’s “10 Rules for the Road” that he lists at the close of his book. Do not let experts and investments professionals intimidate you. All too often, they are using the same information that you are and their understanding of valuation is no deeper than yours. 1. Feel free to abandon models, but do not budget on first principles 2. Pay heed to markets, but do not let them determine what you do 3. Risk affects value 4. Growth is not free and is not always good for value 5. All good things, including growth, come to an end. Nothing is forever. 6. Watch out for truncation risk, many firms do not make it. 7. Look at the past, but think about the future. 8. Remember the law of large numbers. An average is better than a single number. 9. Accept uncertainty, face up to it and deal with it. 10. Convert stories to numbers. 这这这这 rules这 这这这这这这这这 explain这这这这这这这这这这这 OK 这 这这这这这这 One Up on Wall Street, Peter Lynch 1. List and explain the six (6) categories that the author uses to aid in his investment analysis. (page 75) Slow growers(sluggards) They started out as fast growers and eventually pooped out, either because they had gone as far as they could, or else they got too tired to make the most of their chances. When an industry at large slows down (as they always seem to do), most of the companies within the industry lose momentum as well. 这 这 这 may has no hill slow grower pays regular and general dividend Stalwarts Most huge companies. not excited to hold too long. Unusual to get tenbagger(这这这 这这) . always offer good protection in recessions. fast growers expand within a slowgrowing company; make expansion ; plenty of risks: becasuse some younger companys that tend to be over zealous and underfinanced. Larger growing company risks a rapid devaluation when they begin to falter. Cyclicals Company’s sale and profits rise and fall in regular; business expands and contacts again and again; cyclical flourish in a vigorous economy;这这这这这这这 policy这most understood(这这)这 very differ from Stalwats, timing is everything, u must detect the early sign whether business falls off or picks up. asset plays company sitting on valuable but wall strt overlooks; Asset opportunities are everywhere. Sure they require a working knowledge of the company that owns the assets, but once that’s understood, all you need is patience. turnarounds potential fatality; may never come back; the advantage of investing turnaround is that stock direction is least related to market 2. What is a “tenbagger?” In wall street parlance a tenbagger is a stock in which you have made ten times your money. 3. What does Lynch mean when he says that there are advantages to “dumb money?” Summary: Smart money is money plus the promise of help that’s worth paying for, dumb money is money plus hidden harm where the smart money isn’t so smart, and the dumb money isn’t really as dumb as it thinks. Dumb money is only dumb when it listens to the smart money. In fact, the amateur investor has numerous built-in advantages that, if exploited, should result in his or her outperforming the experts. 3 reasons to ignore Peter: maybe he is wrong; don’t know when he change his policy; better resource all around u. 4. What is the author’s opinion about “spin off” companies? A spinoff is the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company. A spinoff is a type of divestiture Spinoff often results in astoundingly lucrative investment because 1. the spinoffs normally have strong balance sheets and are well-prepared to succeed as independent entities. 2. Large parent companies don’t want to see spinoffs get into trouble and bring embarrassing publicity that would reflect back on the parents. once these companies are granted their independence, the new management, free to run its own show, can cut costs and take creative measures that improve the near-term and long-term earnings. Investors often are sent shares in the newly created company as a bonus or a dividend for owning the parent company. These are favorable omens for the spinoff stocks. So take immediate investment and buy more! 5. What are the types of stocks that the author would avoid? The hottest stock in the hottest industry(the one everyone hears in the car pool, the one gets mostly favorable punlicity). Hot stocks can go up fast, usually out of sight of any of the known landmarks of value, but since there’s nothing but hope and thin air to support them, they fall just as quickly. Avoid diworseification because profitable company always do foolish acquisition. Not only acquisitions produce synergy, it should be related business. There is a strong tendency for companies that are flush with cash and feeling powerful to overpay for acquisitions, expect too much from them, and then mismanage them. Diworsification is investing in too many assets with similar correlations that will result in an averaging effect.decrease the potential potfolio return. Diworseifier seeks out merchandise that is overpriced and beyond his realm of understanding. Be aware of next something. In fact, when people tout a stock as the next of something, it often marks the end of prosperity. When the company was called next something, u could imagine the company goes through a terrible time. 6. In the Chapter on “Getting the Facts,” what advice is given to the reader? Getting the most out of the broker, use the broker as an advisor. Ask the broker to give you the two-minute speech on the recommended stocks. Ask them for analysts’ reports, chart of price versus earnings, p/e ratios, etc. Calling the company. Ask broker for investor relation’s phone number. Prepare questions but be careful about what you want to ask. If you do not have specific questions, you may ask “what are the positives/negatives this year.” Visiting the headquarters. Investor relations in person. Get into informal annual meetings to develop useful contacts. You can sense something about the company representative that gives you a feeling about the company’s prospects. Wandering through stores and tasting things. Example: go to the store and ask the customers, stay at a hotel to experience it. Reading the reports. If you do not want to read through the financial statements, you can start with value line reports. 7. Read and understand the Chapter called, “The Final Checklist.” Stock in general: p/e ratio, the percentage ofinstitutional ownership(lower is better), insider stock transactions, strong financial results, cash position Slow growth: Check dividend payout ratio and frequency. If it’s a low percentage, then the company has a cushion in hard times. It can earn less money and still retain the dividend. If it’s a high percentage, then the dividend is riskier. Stalwarts: Check long-term growth rate and diworseification,whether momentum Cyclicals: Keep a close watch on inventories, and the supply- demand relationship. Watch for new entrants into the market, which is usually a dangerous development. If u know the cyclical, u have advantages I figuring cycle. Fast grower: whether expanding is speeding up; whether the product that’s supposed to enrich the company is a major part of the company’s business; Whether the stock is selling at a p/e ratio at or near the growth rate. Turnround: debt structure, can the company survive through a raid by creditor. Asset plays: whether have new debt to make asset less valuable;if have hidden asset Bottom line is, you need to KNOW a lot about your company before investing. E&P Industry Lectures 1. Review the lecture notes / presentation materials that were posted online for the four days Prof. Carroll lectured on the E&P Industry. 2. Understand E&P Industry Math (converting from daily /quarterly /annual production rates, BOE / Mcfe, etc…) Freeman Reports Construction 1. General modeling skills that have been presented in class may be tested. 2. If you have participated in class discussion and taken time to review the materials posted on the course website, you should be successful with this part of the quiz. Format of Quiz / Rules 1. Multiple Choice 2. Short Discussion 3. Calculations 4. You will have 75 minutes to complete the quiz 5. The Honor Code, as always, is in effect. Until final grades are received, any discussion of the quiz is a violation of the Honor Code.
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