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Fundamental Valuation Concepts

Elementary Statistical Concepts Elementary Statistical Concepts Time Value of Money Understanding Financial Statements U d di Fi i lS Equity Research

Elementary Statistical Concepts y p
Mean ∑ Xi / N, where i =1,2,3…n Variance V i Geometric Mean
n

(1+r1)* (1+r2)* (1+r3)* ….(1+xn)

Standard D i ti St d d Deviation Positive sq root of variance, σ Covariance Cov (x,y) = { ∑ (Xi – X) (Yi – Y) } / N Normal Distribution x σ

σ2 = [ ∑(Pi * (xi – X)2 ) ]
Coefficient of Variation (σ / X) * 100 Correlation coefficient

ρ = Cov (x y) / (σx * σy) (x,y)

What is the average rate of return of XYZ if the returns during the previous three years are 20% 25% and 45% 20%,
Average Return = (20% + 25% + 45%) / 3 = 35% Correct answer is 30%

What is the expected return of XYZ if it has the probability of earning returns as given below? Probability (%) 20 30 50 Return(%) 10 12 15

(Since probability is assumed as a percentage, no need to divide by N) Expected return = { (20%*10%) + (30%*12%) + (50%*15%) } = 1300 = 13.10%

What is the annual percentage rate of increase in security prices if it increased @ 16% in 1999 8% in 2000 and 5% in 2001 ? 1999,
(1.16)* (1.08)* (1.05) Annual rate of increase = = 1.0956 First Multiply all = 9.56% three variables
3

Type 0.333 (i.e., 1/3 [since we want to find the cube root)]; then press =

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The return on the security A can be either 15% with 60% probability or 14% with 40% probability What is the variance of returns ? probability. σ2 = [ ∑(Pi * (xi – X)2 ) ]
= (0.15*0.60)+(0.14*0.40) = 0.146 = 14.60%

Therefore the variance is given by
σ2 ={ [ 0.60 * (15% - 14.60%)2 ] + [ 0.40 * (14%-14.60%)2 ] } ={ [ 0.60 * (0.4)2 ] + [ 0.40 * (-0.6)2 ] } ={ [ 0.096 ] + [ 0 144 ] } { 0 096 0.144 = 0.24 or 24%

Variance of the stock is 24%

Which amongst the following portfolio’s (A,B,C) are the most preferred and most risky Portfolio A B C Return (%) 15 10 14 Standard deviation (%) Coefficient of variation 12 9 7 = (12/15)*100 = 80 = (9/10)*100 = 90 = (7/14)*100 = 50

Therefore Portfolio B is more risky whereas portfolio C is the most preferred

A stock is at Rs. 800 on day 1. The total risk ‘σ’ of the stock is 2% per day. What range of prices would be observed on day 2 with 99% probability ?

For 99% probability the stock price can lie between + 3σ from the  mean
- 3σ 800 – (3 * 2% * 800) 800 - (48) 752 + 3σ 800 + (3 * 2% * 800) 800 + (48) 848

Hence the price will vary between Rs 752 to Rs 848 on the next day.

Time Value of Money y
Future value of a single cash flow

FV = PV (1+r)t

Present value of an single cash flow

PV = FV
(1+r)t

Future value of an Annuity

t FV = CF {(1+r) - 1 } r

Present value of an Annuity

Calculate the value 4 years hence of a deposit of Rs. 2000 made today if the interest rate is 15% by discrete and continuous compounding By discrete compounding FV = 2000 * (1+0.15)4 = 2000 * (1.749) = Rs. 3498 By B continuous compounding ti di FV = 2000 * e(0.15 * 4) = 2000 * e(0.6) = 2000 * 1.822 = Rs. 3644.23

Select Inv

Select ln Multiply by 2000 and press =

How much does a deposit of Rs. 3000 grow to at the end of 3 years, if the nominal rate of interest is 15% and compounding is done quarterly ?

Future value = 3000 * [ (1 + 0.15/4) (4*3) ] = Rs 4666 36 Rs. 4666.36

Suppose, you deposit Rs 1000 annually at the year end in a bank for 5 years and your deposit earn a compound interest rate of 15%. What will be the value of your investment after 5 years? ill b th l f i t t ft ?

= 1000 [ { (1 + 0.15)5 – 1 } / 0.15 ] = 1000 [ 6.7423 ] 6 7423 = Rs. 6742.3
If compounding is continuous then what ?

= 1000 [ ( e0.15*5 – 1 ) / 0.15 ] = 1000 [ 7.4466 ] 7 4466 = Rs. 7446.6

What is the present value of Rs. 50000 receivable after 4 years at a discount rate of 12% ?

PV = 50000 / (1 + 0.12)4 = 50000 / ( 1.5735 ) = Rs. 31775.9
If discounting is continuous then what ?

Present value = 50000 / [( e(0.12*4)] = 50000 / 1.616 = Rs. 30939.16

Understanding Financial Statements…
Balance Sheet
Balance Sheet shows the financial position of a business firm at a particular point of time. p p p

Understanding Financial Statements…
Profit & Loss account
Profit & Loss (abbreviated to P&L) Account/Income Statement reports the revenues and  expenses of a firm of an accounting period.

Understanding Financial Statements…
Comparative Financial Statements Financial statements which follow a consistent format but which cover different periods  of time. 

Common Size Statements A company financial statement that displays all items as percentages of a common base  figure. This type of financial statement allows for easy analysis between companies or  between time periods of a company.

Ratio Analysis…
Earnings per share The portion of a company's profit allocated to each outstanding share of common      h f ' f ll d h d h f stock. EPS serves as an indicator of a company's profitability. EPS = (Net Income + Dividend on Preferred Stock) / Average of Outstanding Shares. Dividend Yield A financial ratio that shows how much a company pays out in dividends each year  p yp y y relative to its share price. In the absence of any capital gains, the dividend yield is the  return on investment for a stock.  =Annual Dividend Per Year / Price Per Share Price to earnings ratio A valuation ratio of a company's current share price compared to its per‐share  earnings. earnings = Market Value Per Share / Earning Per Share(EPS) Return on equity A measure of a corporation's profitability that reveals how much profit a company  generates with the money shareholders have invested. =Net Income / Shareholder’s Equity

Ratio Analysis…
Debt to equity ratio
A measure of a company's financial leverage calculated by dividing its total  liabilities by stockholders' equity. It indicates what proportion of equity and debt the  company is using to finance its assets. = Total Liabilities / Shareholder’s Equity

Ratio’s for short term creditors
1. Current Ratio
An indication of a company's ability to meet short‐term debt obligations; the  higher  the ratio, the more liquid the company is. = Current Assets/ Current Liabilities

2.

Acid Test Ratio
ACID TEST RATIO is a stringent test that indicates whether a firm has enough  short‐term assets to cover its immediate liabilities without selling inventory.  short term assets to cover its immediate liabilities without selling inventory =   (Cash + Accounts Receivable + Short term Investments) Current Liabilities

Ratio Analysis… y
Ratio for Efficiency Ratio for Efficiency
INVENTORY TURNOVER RATIO      =    Cost of Goods Sold / Inventory. AVERAGE COLLECTION PERIOD      = Receivables / Avg. Sales per Day FIXED ASSETS TURNOVER RATIO   =  Net Sales / Fixed Sales. / GROSS PROFIT RATIO                        = Gross Profit / Net Sales NET PROFIT RATIO                            =   Net Profit / Net Sales.

Equity Research
Bhav Copy Database Bhav Copy Database NSE and BSE publish the bhav copies on there sites every day.  Bhav copy lists the prices of shares for the day. For every scrip bhav copy  contains four prices viz. open, high, low and close along with the volume. Index Database A database index is a data structure that improves the speed of operations  on a database table Order book snapshot Database p Shown next……. Trades Database Shown Next…………………….

O de oo S aps ot Order Book Snapshot

Trades Database

Queries & Clarification after reading the literature………