Lecture 1

Introduction to Equity Security Analysis


Class Organization


Overview of Financial Markets


What is Equity Security Analysis?


Formation of Groups

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 Class Organization
Review of Course Syllabus


Discussion of Course Objectives


Course Text and Reading Materials
Most Useful Text is
“Security Analysis and Investment Strategy” (SAIS);
Also: Valuation of Equity Securities (VES); Equity Capital (EC)


Evaluation of Grade

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 Overview of Security Markets
Reading: SAIS, Sec. 1.1
What is a Security?
 Various possible definitions:
 Legal Definitions, e.g., Securities Act (1933)
• The Act does apply to certain types of securities
 Graham and Dodd (1934) definition
• Only covers corporate securities
 Functionality approach (Poitras 2004)
• What is commonly used and covered in the press
– Publicly traded Stocks and govt. and corp. bonds

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Definition of a “security” in the US Securities Act (1933) as
amended 2018 (Title 1, Sec. 2(1))
(1) The term ‘‘security’’ means any note, stock, treasury stock,
security future, security-based swap, bond, debenture, evidence of
indebtedness, certificate of interest or participation in any profit-
sharing agreement, collateral-trust certificate, preorganization
certificate or subscription, transferable share, investment contract,
voting-trust certificate, certificate of deposit for a security, fractional
undivided interest in oil, gas, or other mineral rights, any put, call,
straddle, option, or privilege on any security, certificate of deposit,
or group or index of securities (including any interest therein or
based on the value thereof), or any put, call, straddle, option, or
privilege entered into on a national securities exchange relating to
foreign currency, or, in general, any interest or instrument
commonly known as a ‘‘security’’, or any certificate of interest or
participation in, temporary or interim certificate for, receipt for,
guarantee of, or warrant or right to subscribe to or purchase, any of
the foregoing.
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Canadian Approach to Defining Securities
See Mcmillan reading on webpage

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 The Securities Universe

Priority of Claim
 Debt vs. Equity
 Relevant for Corporate Securities
 Examine Home Depot Balance Sheet (next page)

Type of Issuer
 Government vs. Corporate
 Government Securities are debt
 Domestic vs. Foreign

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 The US Regulators

Securities Laws require regular filing of information about publicly
traded securities
 In the US: (Available on company sites)
 Annual Filing 10-K
 Quarterly Filing 10-Q


Information is filed with the US Securities and Exchange
Commission (www.sec.gov)
 Securities Act (1933)
 Securities Exchange Act (1934)
 Other laws see SEC website About link


FINRA – US exchanges, NYSE and NASDAQ also have self-
regulatory oversight, Financial Industry Regulatory Authority was
the result of a 2003 merger of the exchanges’ oversight functions

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SEC website, for FINRA and other websites see Links page

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 Canadian Regulators

Canada does not have a national regulator, works by
agreement between provincial security regulators
 Ongoing attempts by federal government to get agreement by
provinces to launch a national regulator; Alberta and Quebec
usually opposed

Most important Canadian regulator is the Ontario
Securities Commission as this is the jurisdiction with the
TSX
 See Links page for link to OSC website
 Canada has similar requirement that publicly traded securities be
subject to regular filings
 Filings are less structured than in US

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Ontario Securities Commission Website

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 Distinctions between Debt and Equity

The origins of debt and equity are ancient and
specific characteristics of each depend on
historical context

In general, Debt is a contractual relationship
between a lender and borrower
 Failure to fulfill the contractual obligations results in
sanctions, e.g., forced bankruptcy

Equity involves a more complicated relationship
binding contributors of capital  consequently
equity organization can take a variety of forms,
e.g., partnership, LLP, LLC, LC
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 Basics of Debt Securities

The Bond Indenture
 The bond indenture is a legal document, monitored and
enforced by a trustee, that contains the terms and
conditions governing that issue.
 Where applicable, the indenture contains information
about
 coupon payment schedules,
 protective provisions and covenants,
 priority of claim relative to other bond issues,
 conversion conditions, sinking fund payment schedules
and the like.

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 Types of Debt Securities

Debt issues can be secured by specific property,
such as mortgage bonds

Debentures are unsecured issues that do not have
a lien against a specific asset identified in the
indenture.

When a number of debentures are issued by a
corporation, the issues are usually further classified
as senior, senior subordinated and subordinated
debentures to reflect the associated priority of claim.
(See Boeing Financials, Tables 1.2 and 1.3)

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 Examples of Debt Securities

US Treasury and Govt. of Canada securities
 Table 1.9 in SAIS and Bloomberg/GI websites

Corporate Bonds
 Investment Grade vs. High Yield
 Table 1.10 in SAIS + websites

Tax-Exempt (State and Local)
 Table 1.11 in SAIS

Mortgage-Backed Securities
 Table 1.12 in SAIS + issuer websites

Foreign Bonds

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 Equity Securities

Key feature of modern equity securities is
limited liability
 In the event of bankruptcy shareholders are only
liable to the extent of the amount that was paid
for the shares.

Equity securities are composed of common
stock, preferred stock and claims against
equity such as warrants
(Examine Boeing Financials on webpage)

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 Legal Character of Equity Claims

Under general registration, at the time of incorporation,
a corporate charter which contains the articles of
incorporation is filed with the appropriate company
registry office (typically state or province, some
federal).
 There are a variety of methods that can be used to organize
equity claims, such as the LLC, unit trust and LLP, but almost
all publicly traded equity claims are organized as corporations.


The corporation law of the jurisdiction of incorporation
will determine the legal character of equity claims
 Many states and provinces have similar legal requirements
 Companies are required to provide regular filings to the
registry office, in BC through BC Registry and Online Services

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Website for BC Registry Services

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 The Corporate Charter

The corporate charter usually provides information about:
 the methods by which the articles of incorporation can
be amended;
 the classes of stock and the par values;
 features protecting the preferred stock;
 voting rights for the stock;
 powers and composition of the board of directors;
 rules for retiring common stock;
 dividend payment provisions;
 rights of prior security holders in the event of new
issues;
 merger and reorganization procedures.

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Examples: Equity Securities

Preferred Stock
 Table 1.4 in SAIS + GI website
 Observe that the yields on preferred stock are
comparable to bond yields

Common Stock
 Table 1.5 in SAIS + many websites
 Examine the information that is provided in
the price quotes

Exchange Traded Funds (ETFs),
Closed End Funds and Mutual Funds
 Not all ETF’s are ‘Equity Securities  some ETFs
have returns derived from positions in Derivative
Securities, e.g., some Bitcoin ETFs and Gold
ETFs
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Source: WSJ US Data
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Is Bitcoin an Equity Security?

Key Distinction in Cryptocurrency Creation:
Proof of Work vs. Proof of Stake
 Proof of Work  involves the ‘mining’ coins to add to and
verify the blockchain, i.e., ‘creating’ cryptocurrency  Bitcoin
and early versions of Ether are Proof of Work
 Equity securities for proof of work mining are associated

with ‘mining’ stocks, e.g., RIOT, HIVE, BitMining (BTCM)

 Proof of Stake  recent evolution of crypto involves
dedicating crypto tokens in wallets for a specific period to
participate in blockchain governance and earn ‘interest’
 Stakes are comparable to GICs (CD is US)
 Stablecoins  digital assets are designed to maintain a stable value relative
to a national currency to facilitate trading, lending, or borrowing of other digital
assets  backed by some form of stable reserves

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 What is Equity Security Analysis?

Reading: SAIS, sec. 2.3


Graham and Dodd (1934) defined security
analysis to mean ‘the use of fundamental
analysis to value securities issued by publicly
traded corporations.’
 This has led to the mantra: “All security analysis
involves the use of financial statements”
 This ignores government securities and
emphasizes valuation of equity securities

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 Themes of Equity Security Analysis
Constant themes in the realm of security analysis
 The relevance of the distinction between
investment and speculation

 The emphasis on the use of financial

statements to form opinions

 The problems raised by the vagaries of market

pricing

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The Scope of Equity Security Analysis
Graham and Dodd identify three functions of
Security Analysis

Selective -- deciding “whether a given issue
should be bought, sold, retained, or exchanged for
some other”

Critical -- evaluating the terms and conditions of a
particular security issue

Descriptive – preparing reports and the like

This course covers aspects of all three

functions, emphasizing the Selective function

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Benjamin Graham (1894-1976)
With a former student combined to
produce
Security Analysis (1934)
Fourth and Final edition in 1962
with Dodd and Cottle

“One thing badly needed by

investors – and a quality they rarely
seem to have – is a sense of
financial history”
The Intelligent Investor (1949)

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Valuation of Tesla 2018: Not a Value Stock! (Note: ir.tesla.com)

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Valuation of Tesla: 2021 Earnings (2020-3 10Q)

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Not an accruals problem! Negative Cash From Operations

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Dramatic changes in Cash From Operations: 2020-3 10Q

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Tesla was a capital consumption machine –
and the stock price keeps going up!

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The end of Tesla equity issuance: 2020-3 10-Q

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 What about Market Efficiency?
Market Efficiency: a Cornerstone of Modern Finance
Weak form of Market Efficiency


 Aimed at Technical Analysis (Lecture 9)

Semi-Strong Form


 Aimed at Fundamental Analysis

 Equity security prices accurately and rapidly
encompass publicly available information
 Objective of equity security selection is to achieve
risk minimization by holding combination of market
portfolio and riskless asset (2 Fund Separation)
More Detail on this in Lecture 5
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Formation of Groups

See Group formation Link on class webpage
 http://www.sfu.ca/~poitras/417-groups_20-2.pdf

Presentation link for past presentations
http://www.sfu.ca/~poitras/links417.htm


Groups are formed by instructor based on preferences
expressed in email – announced in Week 2


Note that the .ppt’s on the Presentations link are for
417-4  417-3 presentations will be shorter (2 per 170
minute class vs. 1 per 110 minute class)

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