Introduction to Investing

and Valuation

Prepared By: Md. Golam

Sharoar
Chapter 1 Lecturer, Finance & Banking
BSMRSTU Gopalganj.
Introduction
Financial Statement Analysis is the method by which users
extract information to answer their questions about the firm.
Users: Common Questions:
1. Investors: Primary Users 1. Whether the company has a sound
2. Government: Social and Economic financial position or not?
Policy Making 2. Whether the business is legit or doing
3. Regulators: To control business any suspicious activity to attain
Activities abnormal gain.
• Antitrust Authorities: 3. Is the firm doing really well or it has
• Financial Market Regulators: fabricated it’s Financial Statement?
• Bank Inspectors: 4. Is the firm performing
4. Employees: Wage negotiations Window Dressing to amplify it’s profit?
5. Senior Managers: To evaluate 5. Is the firm capable enough to pay it’s
Subordinates long term debt obligations?
6. Court and Expert Witnesses: To 6. Is the firm making enough gross profit
assess damages in Litigations. to satisfy it’s employees financial
obligations?
7. Are the subordinates contributing
enough to company’s profitability?
Concept Checks
- The shareholders (both investors and traders) are concerned with
profitability, the bondholder with default, and financial statement
analysis aids in evaluating both.
- Intuitive Investors- Rely on their own instincts.
- Passive Investors- When you invest your money in an
instrument, but do not handle it directly. If you buy a mutual
fund, you are passive because it leaves the handling to the
investment manager. [Such as, Investment in mutual fund].
- The P/E (price-to-earnings) ratio is the ratio for valuing a company
that measures its current share price relative to its earnings
per share (EPS). The price-to-earnings ratio is also sometimes
known as the price multiple or the earnings multiple.
- A high P/E ratio could mean that a company's stock is
overvalued, or that investors are expecting high growth rates in
the future.
Concept Checks
- A simple (and popular) scheme says "buy firms with low P/E
ratios and sell firms with high P/E ratios.
- Selling Dell, with a high P/E in 2000, would have worked. But
buying General Motors or Ford, with low P/E ratios of 8.5 and 5.0,
respectively, would not; General Motors' stock declined from $80
per share in 2000 to $4 in 2008 (and then went bankrupt), and
Ford's declined from $29 to $3 over the same period.
- Fundamental Investor: The investor who relies on fundamental
analysis.
- The Active Investor uses fundamental analysis to discover
mispriced stocks that might earn exceptional rates of return.
- Intrinsic value of a share is the worth of an investment that is
justified by the information about its payoffs.
Bubble, bubble, toil and trouble.
- Bubble is an economic cycle that is characterized by rapid
escalation of market value, particularly in the price of assets.
[Stocks in stock market].
- This fast inflation is followed by a quick decrease in value, or a
contraction that is sometimes referred to as a ‘crash’ or a ‘bubble
burst’.
Noble Laureate Robert Schiller’s Definition of a Bubble-
- A news of price increase spurs investors enthusiasm.
- It spreads by psychological communication from person to
person.
- A process starts stories to justify the price increase.
- It draws the attention of wider class of investors.
DSE 30 index- Bubble Explained
Stages of Bubble
• Stages take place when investors start to notice a new paradigm, like a
Displ
ace
new product of technology; or historically low interest rate. This can be
men
t
basically anything to get their attention.
• Prices start to rise even more momentum as more investors enters into
Boo
m
the market with their savings.

• Investors liquidate their slow return holding assets [like FDR] and bring
Eup
hori them to stock market.
a

Profi • Figuring out the burst period that might hit and anyone who identify the
t
Taki
ng
early warning they will sell the positions and exit from the market.
and
Exit

• Everyone start selling their stocks and stock price dramatically fall. And
Pani
c
bubble bursts.
Stock Market Bubbles History

Please Read: Asset Bubbles Through History: The 5 Biggest

The Setting: Investors, Firms, Securities, And
Capital Markets
- Investors invest in firms to give up cash and with a hope of
higher return.
- They invest in shares, bonds or contingent assets (like-
Convertible bonds, options and derivatives)
- These investments creates a claim for the firm to the investors.
- Common shareholders are the primary claimants which
investments are referred as Owners Equity or Shareholders Equity.
- But they are having the residual claim after other claimants
have been satisfied.
- Bondholders make loans in exchange of interest payments
whereas shareholders contribute cash in exchange of equity,
and the right to receive dividends and capital gain.
- Usually their return are divided into two parts- Dividend/interest
yield and Capital Gain (HPR).
The Setting: Investors, Firms, Securities, And
Capital Markets
The Investors: The Claimant on
The Firm: The Value Generator Value

Cash from Loans Cash from Secondary

Debtholder
Sale of Debtholde
s
Interest & Loan Debt r
Repayments
Operatin Investin Financin
g g g
Activities Activities Activities Cash from Share
Issues Shareholde Cash from Secondary
rs
Sale of shareholder
Dividend and Cash Shares s
from Share
Repurchase
Enterprise Value/Value of the Firm
Enterprise Value/Value of the Firm = Value of the Debt + Value of the
Equity
Depends on the 3 factors-
• Financing activities: Are the transactions with claimants for raising cash for
the business in exchange for equity and debt claims and returning cash to
claimants.
- These activities are investing activities for the claimants but financing activities
for the firm.
• Investing activities: Use the cash raised from financing activities and
generated in operations to acquire assets to be employed in operations.
These assets may be physical assets, like inventories, plant, and equipment,
or knowledge and intellectual assets, like technology and know-how.
• Operating activities: Utilize the assets in which the firm has invested to
produce and sell products. Operating activities combine assets with labor and
materials to produce products and services, sell them to customers, and collect
cash from customers. If successful, the operations generate enough cash to
reinvest in assets or return to claimants.
The Analysis of Business: The Professional
Analyst
Investing in Firms: The Outside Analyst:
As there are two main types of business claims (Debt & Equity);
these lead to 2 types of business analysts-
1. Credit analysts: Such as-
- Bond Rating Agencies (Standard & Poor's, Moody's Investors
Service, and Fitch Ratings for example)
- Bank Credit Risk Management Officers, evaluate the riskiness-
and thus the value- of business debt.
2. Equity Analysts: Such as-
- Buy-side analysts perform equity research as money managers,
within mutual funds, hedge funds, and other investment vehicles.
- Sell-side analysts provide the research to support retail investors
through their brokers.
The Analysis of Business: The Professional
Analyst
Investing Within Firms: The Inside Analyst:
Business begins with Ideas “A Strategy”. These strategies may
involve-
- Developing new products.
- Exploring new markets.
- Adopting a new production technology.
- Beginning an entirely new line of business.
Strategy may call for acquiring another firm, spinning off a
division, or entering into alliances.
To evaluate their ideas, business managers, like outside investors,
need to analyze the value that their ideas might generate. Such an
evaluation is called strategy analysis.
The Analysis of Business: The Professional
Analyst.
Value-Based Management: Investing and managing with valuation
analysis is called value based management.
- Valuation analysis not only helps in go/no go decision but also
helps to formulate a concrete plan and execution with absolute
dollar value.
- It forces the planner to examine alternative ways of doing things.
- The CFO is responsible to coordinate analysis for management.
However, Inside and outside analysts differ in one respect: Inside
analysts have far more information to work with. Outside analysts
receive the published financial statements along with much
supplementary information, but they are typically not resistant to "inside
information.
[All we are going to study is to be an outside analysts]
Watch: Shark Tank India
The Analysis of Business
What!! Why !! & How!!
Business Valuation:
Start your valuation with- Business Model/ Business Concept/
Business Strategy or Business Dynamics.
Start with the following Question-
-What is the firm aiming to do?
-Why the firm is operating? What areas does it serve?
- How does it see itself to be generating value?
- And what are the consequences of the strategy?
Mastering the Details of Business Valuation
1. Know the firm's products.
a. Types of products.
b. Consumer demand for the products.
c. Price elasticity of demand for the products. Does the firm
have pricing power?
d. Substitutes for each product. Is the product differentiated?
On price? On quality?
e. Brand name association with products.
f. Patent protection for products.
Mastering the Details of Business Valuation
2. Know the technology required to bring products to
market.
a. Production process.
b. Marketing process.
c. Distribution channels.
d. Supplier network and how the supply chain operates.
e. Cost structure.
f. Economies of scale.
Mastering the Details of Business Valuation
3. Know the firm's knowledge base.
a. Direction and pace of technological change and the firm's grasp
of it.
b. Research and development program.
c. Tie-in to information networks.
d. Ability to innovate in product development.
e. Ability to innovate in production technology.
f. Economies from learning.
Mastering the Details of Business Valuation
4. Know the competitiveness of the industry.
a. Concentration in the industry, the number of firms, and their sizes.
b. Barriers to entry in the industry and the likelihood of new entrants and
substitute
products. Is there brand protection? Are customer switching costs large?
c. The firm's position in the industry. Is it a first mover or a follower in the
industry?
Does it have a cost advantage?
d. Competitiveness of suppliers. Do suppliers have market power? Do labor unions
have power?
e. Capacity in the industry. Is there excess capacity or under capacity?
f. Relationships and alliances with other firms.
Mastering the Details of Business Valuation
5. Know the management.
a. What is management's track record?
b. Is management entrepreneurial?
c. Does management focus on shareholders? Do members of
management have a
record of serving their own interests? Are they empire builders?
d. Do stock compensation plans serve shareholders' interests or
managements'
interests?
e. What are the details of the ethical charter under which the firm
operates, and do managers have a propensity to violate it?
f. How strong are the corporate governance mechanisms?
Mastering the Details of Business Valuation
6. Know the political, legal, regulatory, and ethical environment:
a. The firm's political influence.
b. Legal constraints on the firm, including antitrust law, consumer law,
labor law, and
environmental law.
c. Regulatory constraints on the firm, including product and price
regulations.
d. Taxation of the business.
These features are sometimes referred to as the economic factors that
drive the business.

"One does not buy a stock, he buys a business." And it goes on: "If you are
going to buy a business, know the business.“
The Key Question: Sustainability Of Competitive
Advantage

How durable is the firms competitive advantage?

Financial Statements: The Lens on the Business.
- We might recognize that a firm has "market power," but what
numbers would support this attribution?
- We might recognize that a firm is "under the threat of
competition," but how would this show up in the numbers?
- Where accounting measurement is defective, analysis
corrects.

“Numbers Never Lie”

Practice Question
Concept Questions:
C1:1, 3,4, 5, 6, 7, 8
Drill Experiences: 1,2,3,4, 5, 6(Easy Mode)
The End
Assignment:

Hindi Series- “Scam 1992” - Watch at least 2 Episodes of

Shark Tank India

Summarize Your Experience with this chapter considering the facts-

Bubble- Bubble Toil and Trouble and Value Based Management.