STUDY SESSION 14

ANALYSIS OF EQUITY INVESTMENTS:

Industry and Company Analysis

READING ASSIGNMENTS
Reading 59 An Introduction to Security Valuation
Reading 60 Industry Analysis
Reading 61 Equity: Concepts and Techniques
Reading 62 Company Analysis and Stock Valuation
Reading 63 Technical Analysis
Reading 64 Introduction to Price Multiples

T his study session focuses on industry and company analysis and describes the
tools used in forming an opinion about investing in a particular stock or group
of stocks.

This study session begins with the essential tools of equity valuation: the
discounted cash flow technique and the relative valuation approach. These
techniques provide the means to estimate what a reasonable price for a stock
should be. The readings on industry analysis are an important element in the
valuation process, providing the top-down context crucial to estimating a
company’s potential. Also addressed is estimating a company’s earnings per share
by forecasting sales and profit margins.

The reading on technical analysis introduces the basic philosophy and

underlying assumptions relied on by technicians to forecast trends in individual
stocks as well as the entire stock market. The most widely used technical indica-
tors, trading rules, and charts are described, and their application illustrated.

The last reading in this study session focuses on price multiples, one of the
most familiar and widely used tools in estimating the value of a company, and
introduces the application of four commonly used price multiples to valuation.

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LEARNING OUTCOMES

Reading 59: An Introduction to Security Valuation

The candidate should be able to:
a. explain the top-down approach, and its underlying logic, to the security valuation
process;
b. explain the various forms of investment returns;
c. calculate and interpret the value of a preferred stock, or of a common stock,
using the dividend discount model (DDM);
d. show how to use the DDM to develop an earnings multiplier model, and explain
the factors in the DDM that affect a stock’s price-to-earnings (P/E) ratio;
e. explain the components of an investor’s required rate of return (i.e., the real
risk-free rate, the expected rate of inflation, and a risk premium) and discuss
the risk factors to be assessed in determining a country risk premium for use
in estimating the required return for foreign securities;
f. estimate the implied dividend growth rate, given the components of the required
return on equity and incorporating the earnings retention rate and current stock
price;
g. describe a process for developing estimated inputs to be used in the DDM,
including the required rate of return and expected growth rate of dividends.

Reading 60: Industry Analysis

The candidate should be able to describe how structural economic changes
(e.g., demographics, technology, politics, and regulation) may affect industries.

Reading 61: Equity: Concepts and Techniques

The candidate should be able to:
a. classify business cycle stages and identify, for each stage, attractive investment
opportunities;
b. discuss, with respect to global industry analysis, the key elements related to
return expectations;
c. describe the industry life cycle and identify an industry’s stage in its life cycle;
d. interpret and explain the significance of a concentration ratio and a Herfindahl
index;
e. discuss, with respect to global industry analysis, the elements related to risk, and
describe the basic forces that determine industry competition.

Reading 62: Company Analysis and Stock Valuation

The candidate should be able to:
a. differentiate between 1) a growth company and a growth stock, 2) a defensive
company and a defensive stock, 3) a cyclical company and a cyclical stock, 4) a
speculative company and a speculative stock and 5) a value stock and a growth
stock;
b. describe and estimate the expected earnings per share (EPS) and earnings
multiplier for a company;
c. calculate and compare the expected rate of return (based on the estimate of
intrinsic value) to the required rate of return.
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Reading 63: Technical Analysis

The candidate should be able to:
a. explain the underlying assumptions of technical analysis and explain how
technical analysis differs from fundamental analysis;
b. discuss the advantages and challenges of technical analysis;
c. identify examples of each of the major categories of technical indicators.

Reading 64: Introduction to Price Multiples

The candidate should be able to:
a. discuss the rationales for the use of price to earnings (P/E), price to book value
(P/BV), price to sales (P/S), and price to cash flow (P/CF) in equity valuation and
discuss the possible drawbacks to the use of each price multiple;
b. calculate and interpret P/E, P/BV, P/S, and P/CF.