Fundamental Analysis

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  • Created by: OBrett96
  • Created on: 06-05-17 09:47
What is the goal of Fundamental Analysis?
Identify under priced assets
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How does fundamental analysis reconcile with the EMH?
violates the semi strong form
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What do fundamental analysts analyse?
Publicly available financial data - P/E ratio, book to market etc
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What is the key belief of fundamental investors?
market prices will eventually adjust to reflect a securities intrinsic value
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What does Basu (1977) state?
presence of disequilibria - lag in the incorporation of publicly available information in stock prices
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What are the two approaches to valuation?
Top Down and Bottom Up
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What are the stages of top down analaysis?
Global macro/domestic macro, sector analysis, company analysis
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What type of industries are particualrly sensitive to the state of the economy?
Cyclical industries
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Give an example of a cyclical industry
Durable goods e.g. automobile industry
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When do cyclical industries derive there greatest return?
the trough of the economy
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Give an example of defensive industries
Food producers, pharmaceuticals, utilities
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What is sector rotation?
Idea of shifting a portoflio more heavily into indsutries or sector groups that expected to perform on assesment of the business cycle
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What is a criticsm of sector level analysis?
Difficult to divide companies into groupings Chan et al., (2007)
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Who notice significant indsustry effects?
McGahan and Ported (1997) in the US
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What is the "economic moat"?
buffet - threat to entry, rivalry, substitutes etc
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What is the focus of bottom up?
Stock picking - identifying under priced assets irrespective of sector
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Who finds that bottom up approach outperforms top down?
Gallagher (2003) in Australia
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What is the issue with testing top down v bottom up?
Hard to distinguish what investors are - may not be just one
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What models are used to value a security?
Discounted Cash Flow (DCF) or relative valuation
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What are the issues surrounding DCF valuation?
how to determine time patterns of cash flows, estimate of discount rate, WACC assumed constant over time
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What is the view of Penrose (1992)
DCF is uninformative as it is concerned with the distribution of wealth
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What are the different DCF models?
1. Present Value of Dividends (DDM) 2. Present Value of Operating Cash Flow 3. Present Value of Free Cash Flow
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What are the different relative valuation techniques?
1. P/E, P/CF, P/BV, P/S
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What are the issues surrounding relative valuation?
Accounting data is historical, no guidance on whether it is still appropraite
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What does a high P/E ratio indicate?
A growth stock
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What does P/E depend on?
i. Estimated dividend pay out ratio 2. Estimated required rate of return on the stock 3. Expected growth rate of dividends
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Who found that returns are affected by size and BM?
Fama and French (1996)
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What is the advantage of P/CF
Cash flow is less prone to manipulation
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What is the relationship between BM and excess returns?
Inverse - Fama and French
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When is P/S used?
When a firm pays no divideds
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Who found financial statements to be useful?
Ou and Penman (1989)
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Who found excess returns between 4.3% and 9.3%?
Holthausen and Larcker (1992)
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Who found that returns from 'strong' high B/M firms can be increased by 7.5% annualy?
Piotroski (2000)
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What are the issues associated with accounting data?
1. arbitrary accounting rules 2. can underrepresent true values 3. earnings management
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What is value investing?
Sub section of fundamental analysis
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Who is value investing attributed to?
Graham (1934)
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What did Graham argue?
mathematical formulas underlying valuation models can convey a false sense of precision
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what are the 3 characteristics of the market upon which value investing relies?
1. prices are subject to significant movement 2. financial assets have fundamnetal value which is relatively stable and can be measured 3. Buy when intrinsic valye is low will produce superioir returns in the long run
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What is the margin of safety?
should always be a significant difference between estimated intrinsic value and market price
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Who argues that true value investors are in the minortiy?
Greenwald et al., (2001)
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What are Domodaran (2003)'s 3 types of value investors?
1. passive screeners 2. contrarian investors 3. active value investors
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What type of value investor is the "tradition" one?
passive screeners (Greenwald et al., 1934)
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What is the basis of contrarian stratergy?
Stocks have overreacted
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What do activist value investors seek to do?
Unlock the value of poorly managed firms, change the firm
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What are the benefits of Value Investing?
Signals easy to interpret and implemetn (Piotrski, 2000), Makes practicaly use of economis and statistics (Greenwald et a., 1934)
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What does empirical evidence show?
That value stocks give greater return than growth stocks
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Who finds the existence of a value premium?
Fama and French (1992, 1998), Lakonishok et al., (1994), Chan et al., (1991), Black and MacKinlay (1991)
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What is the debate over such a value premium?
Extra risk or market under pricing?
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Who argues excess return is compensation for increased risk?
Fama and French (1993)
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Who finds that returns are driven by mispricing rather than systematic risk/
Crawford et a., (2016)
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Who argues that value premium may have been eliminated?
Bodie et al., (2014)
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Who notes that we have witnessed a decade whereby returns for growth investing have outperformed value investing?
Hall (2016)
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How does fundamental analysis reconcile with the EMH?

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violates the semi strong form

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Card 4

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What is the key belief of fundamental investors?

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Card 5

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What does Basu (1977) state?

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