Corporate Finance IIStock Market
Read and model this dialog between a Financial
Planner, Luke Ahead (LA) and a new investor, Wary Moneybag
(WM). LA: Hello Wary. What can I do for you?
WM: Thanks for making time to talk to me today. The U.S. stock markets have done very well in 1995 and 1996. I want to try making equity investment choices myself. Can you give some ideas? LA: Some people are successful at this, but it takes discipline. There are many approaches to equity markets. Personally, I am a value investor. That means I generally look for stocks that are relatively inexpensive for some reason. WM: How can I get started? LA: In one meeting, I will have to oversimplify. You should understand that stock picking is more complicated. I will show you how to find price information so you can track a stock. WM: You mean you have to know the stock's ticker symbol and which market it trades on: the New York (NYSE), American(AMEX) or the NASDAQ. LA: That's right. Then you need to get an analysis of the company and examine several important financial measures. WM: Do you get these from the three key financial statements, the Income Statement, Balance Sheet and Cash Flow Statement? LA: You know more than you let on. One important measure is the Price to Book Value ratio. The company's book value is total assets minus total liabilities and divide this by the number of shares of common stock outstanding. Divide this into the current stock price and you will have it. We look for Price to Book Value of less than 1. WM: What does this tell me? It gives a relationship between the current price and what the company is worth, theoretically, if it were to sell all assets. LA: Another important measure is the Price to Earnings Ratio. We use the Earnings Per Share from the Income Statement and divide it into the current price. This is more art than science. We look for values of less than 20. For high tech companies it may be OK to go to 25 or 30. WM: Why is this important? LA: It shows the relationship between price and earnings. Earnings are the results of operations and measure the company's success. Without this capability a company will go out of business. Generally, the lower the ratio, the better. WM: I hear a lot about trends. Why are they important? LA: For certain investors they are more important than for others. All investors will agree that momentum is very important. You can measure the momentum of many measures. Three of the most important are: Revenue growth, earnings growth and stock price. You can compare these measures over the same period for a number of years. WM: Do you interpret these measures uniformly? For example, if a measure is increasing, is it always a good thing? LA: Revenue and earnings growth are good. If a company is not growing revenues with a corresponding increase in earnings, good financial management will not be able to produce good results. These two measures are found on the Income Statement. WM: What about stock price momentum? LA: It is not so easy to generalize here. Many related factors must be considered. Remember the classical investor wisdom: "Buy low and sell high." If the stock price has risen recently, there must be very good reasons to expect it to continue to rise. Often a stock will fall after a rise because the market believes that it has become too expensive. WM: That makes sense. I am going to track some companies. Can we talk again next week. LA: Certainly. It always pays to compare notes with a savvy analyst. Listen to Part One Listen to Part Two Listen to Part Three LinksStock Picking
General Investing
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