Download Equity Investments Analysis Notes
CIFA INTERMEDIATE LEVEL
COURSE OUTLINE
GENERAL OBJECTIVE
This paper is intended to equip the candidate with the knowledge, skills and attitudes that will enable him/her to value and analyse equity investments.
LEARNING OUTCOMES
On successful completion of this paper, the candidate should be able to:
- Undertake industry and company analysis
- Determine the value of equity securities
- Apply various models in valuing equity investments
- Calculate and interpret equity valuation multiples
- Undertake valuation of private companies
- Apply the concepts of equity market equilibrium.
CONTENT
Overview of equity markets and structure
- Structure of the equity market: Financial system and intermediaries
- Primary and secondary markets for securities; types of orders
- Trading equity securities
- Types of equity securities; ordinary shares and preference shares, private versus public
- Investing in foreign equity securities
- Risk and return characteristics of different types of equity securities
- Market value and book value of equity securities
- Comparison of a company’s cost of equity, accounting rate of return and investors’ required rate of return
- Equity security and company value.
Fundamental analysis
- Introduction to fundamental analysis
Overview of company analysis
- Elements that should be covered in a thorough company analysis; forecasting of the following costs: cost of goods sold, selling general and administrative costs, financing costs, and income taxes
- Comparing estimated values and market prices; information efficiency and efficient market hypothesis
- Approaches to balance sheet modeling
- Growth companies and growth stocks; defensive company and stocks; cyclical companies and stocks; speculative companies and stocks.
Download Equity Investments Analysis Notes
Overview of industry analysis
- Relationship between industry and company analysis
- Approaches to grouping companies: Industry classification systems; factors that affect the sensitivity of a company to the business cycle
- Elements that need to be covered in a thorough industry analysis.
- Principles of strategic analysis of an industry; competitive forces that shape strategy; effect of competitive forces on prices and costs
- Effects of barrier to entry, industry concentration, industry capacity, and market share stability on pricing power and return on capital.
- Product and industry life cycle models; Classification of industry as to life cycle phases (embryonic, growth, shakeout, maturity and decline); limitations of life- cycle concept in forecasting industry performance
- Comparison of representative industries from various economic sectors
- Demographic, governmental, social and technological influences on industry growth, profitability and risk
Technical analysis
- Overview of technical analysis: definition, assumptions, advantages and disadvantages
- Dow theory: overview ; assumptions; interpretation
- Elliott wave theory: overview ; assumptions; interpretation
- Chart types used in technical analysis
- Trend analysis
- Technical indicators, rules, momentum indicators, pure price and volume techniques; relationships between market efficiency and technical analysis; application of behavioural finance in technical analysis
- Forecasting methodology: conditional forecasting, economic forecasting
The equity valuation processes
- The scope of equity valuation: definitions of value, valuation and intrinsic value, sources of perceived mispricing
- Valuation and portfolio management
- Valuation concepts and models: Valuation of speculative stocks; capital asset pricing model, asset valuation, market capitalisation, shareholder value
- Performing valuations: the financial analyst’s role and responsibilities
- Alternative to traditional analysis techniques: cash flow return on investment (CFROI)
- Effects of inflation on the valuation process
Discounted dividend valuation
- Valuation model of common stock: dividend discount model (DDM)
- Gordon growth model; underlying assumptions; implied growth rate of dividends using growth model and current share price; calculation and interpretation of present value of growth opportunities; strengths and weaknesses of Gordon model
- Valuation of non-callable fixed rate perpetual preferred shares
- Zero-growth model
- Constant growth model
- Multiple growth model
- Multistage dividend discount models: valuing a non-dividend-paying company, first- stage dividend ,H-model, three-stage dividend discount models
- Finding rates of return for any dividend valuation model
- Terminal value in a dividend valuation model
- Determination of whether a stock is overvalued, fairly valued, or undervalued by the market based on a DDM estimate of value
- The financial determinants of growth rates: sustainable growth rate, dividend growth rate, retention rate, and return on equity (ROE) analysis
- Financial models and dividends
- Investment management and DDM
Free cash flow valuation
- Free cash flow to firm (FCFF) and free cash flow to equity (FCFE) valuation approaches: defining free cash flow, present value of free cash flow, single-stage FCFF and FCFE growth models
- Appropriate adjustments to net income, earnings before interest and taxes(EBIT),earnings before interest, taxes, depreciation, and amortisation (EBITDA),and cash flow from operations(CFO) to calculate FCFF and FCFE
- Forecasting free cash flow: computing FCFF from net income(NI), computing FCFF from the statement of cash flows, noncash charges
- Computing FCFE from FCFF, finding FCFF and FCFE from EBIT or EBITDA: Single- stage, two-stage, and three stage FCFF models; calculating terminal value in a multistage valuation model
- Uses of sensitivity analysis and scenario analysis in FCFF and FCFE
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Valuation Multiples
- Overview of valuation multiples: definition and importance; rationale and drawbacks for using valuation multiples
Price multiples
- Method of comparables and the method based on forecasted fundamentals as approaches to using price multiples in valuation
- Alternative price multiples and dividend yield in valuation; fundamental factors that influence alternative price multiples and dividend yield
- Normalised earnings per share(EPS) and its calculation
- Measures of relative value: Price-to-earnings (P/E) ratio, Price-to-book (P/B) ratio, Price-to-cash flow ratio and Price-to-sales (P/S) ratio
- Predicted P/E regression
Enterprise value multiples
- Alternative definition of cash flow
- Enterprise value multiples and its use in estimating equity value
- Momentum indicators and their use in valuation
- Sources of differences in cross boarder valuation comparisons
Residual income valuation
- Residual income; economic value added(EVA) and market value added(MVA)
- The residual income valuation model: uses of residual income models; fundamental determinants of residual income ;calculation of intrinsic value of common stock using the residual income model
- The general residual income model: residual income valuation in relation to other approaches(single-stage residual income valuation, multistage residual income valuation)
- Comparison of residual income model to divided discount and free cash flow models
- Determination of whether a stock is overvalued, fairly valued, or undervalued by the market based on a residual income model
Private company valuation
- Public and private company valuation comparison
- Reasons for private company valuation
- Private business valuation: definition of value and how different definitions of value could lead to different estimates of value; income, market, and asset–based
approaches to private companies valuation and factors relevant to the selection of each approach
- Cash flow related to private company valuation; valuation of a private company using free cash flow, capitalised cash flow and/or excess earnings methods
- Factors that require adjustment when estimating the discount rate for private companies
- Valuation of private company using capital asset pricing model (CAPM), market approach methods and asset-based approach
- Role of valuation standards in valuing private companies
Equity market equilibrium
- Justification for the short term and long term equilibrium
- Grinold-Kroner model
- Yardeni model
- Tobins q
- Short term valuation methods
- Stock market diversity and its measure (entropy)
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