Module 7

Fundamental Analysis

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 Module 7 - Learning Objectives
• Define fundamental analysis.
• Differentiate between fundamental, technical and speculative analysis.
• Define income statement and its major components.
• Define balance sheet and its major components.
• Define cash flow statement and its major components.
• Analyze and evaluate key measures in a company’s income statement,
balance sheet, and cash flow statement.
• Evaluate a company’s products and market position.
• Evaluate a company’s management.
• Explain earnings estimates and how they can be used to evaluate a
company.
• Download financial statements from financial websites and evaluate an
investment.

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What Is Fundamental Analysis?

Fundamental analysis:
Looking for hidden value in
a company.
Technical analysis:
Discerning patterns in price
charts.
Speculative investing:
Playing the odds.
Some finance types believe
that none of these work. The
market is “efficient” and
stocks are priced at what
they’re worth.
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 How Do You Do Fundamental Analysis?

• SEC documents on the company

• Company websites
• Library (Value Line, Standard and Poor’s,
periodical databases)
• Business press (Wall Street Journal, New York
Times, Forbes, Fortune, and Business Week)
• Financial websites

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 What are you looking for?

• Growth in top line

• Growth in bottom line
• Upcoming products that might grow the
company
• New markets that may grow the company
• Management that is good at growing the
company
• In short, growth
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What can you find at a company website?

• Let’s try www.boeing.com

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 Product and Market

• Strong brand franchise in its market

• Market leader - largest share of sales
• Growth
• New products in the pipeline

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 Product and Market?

• AT&T
• EMC
• Amgen
• Time Warner

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 Management

• CEO, CFO, and COO

• Good management team
• Good track record
• Compensation
• Buying or selling company stock

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 Financial Statements
• Accounting is the language of business
• Companies are required to report their financials
according the accounting standards
• Publicly-listed companies need to file their financials
with the SEC
• The main financial statements:
– Income Statement
– Balance Sheet
– Cash Flow Statement

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 Income Statement
Activity for the year - revenues and expenses

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What’s your income statement?
Average Average You
Household Household
Under 25 Years 35-44 Years
1998 1998
Median Income (Revenues) $23,564 $48,451
Total Spending (Expenses) $19,436 $42,154
Food at home 1,518 3,314
Food Away from Home 1,557 2,439
Alcoholic beverages 311 328
Housing 6,151 14,181
Clothing 1,134 2,193
Transportation 4,149 7,873
Health care 445 1,688
Tobacco 186 344
Pensions and Insurance 1,040 4,415
Entertainment 974 2,215
Reading 64 162
Education 1,139 597
Donations 206 997
Other 562 1,407
Income Before Taxes $4,128 $6,297
Taxes 866 4,132
Net Income After Taxes $3,262 $2,165

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 Balance Sheet
Snapshot of financial situation

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 What’s your net worth?

Age Average Net Worth Median Net Worth

1998 1998
Under 35 65,900 9,000
35-44 196,200 63,400
45-54 362,700 105,500
55-64 530,200 127,500

Source: Federal Reserve

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How does it work for companies?

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 Evaluating Income Statements

• Merck is a major drug company. Here are its revenues, earnings

before taxes, and basic earnings per share for the past four years.
 Calculate the growth rates in sales
 Calculate the operating margin.
 Calculate the growth rates in earnings per share.
• What does each of these tell you about Merck?

$ Millions 2000 1999 1998 1997

Revenues or Sales 40,363.10 32,714.00 26,898.10 23,636.90

Pre-Tax Income 9,824.00 8,619.50 8,133.10 6,462.20

Basic EPS 2.96 2.51 2.21 1.92

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Calculate growth in debt and equity for
American Home Products now part of
Pfizer. What do your findings show?

$ Millions 2000 1999 1998 1997

Short-Term Debt 58.7 1,912.50 79.6 89

Long-Term Debt 2,394.80 3,668.60 3,859.10 5,031.80

$ Millions 2000 1999 1998 1997

Total Equity 2,818.10 6,214.70 9,614.70 8,175.30

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Calculate Pfizer’s growth in operating cash
flow. What does it tell you about the
company?

$ Millions 2000 1999 1998 1997

Operating Cash Flow 6,195.00 3,056.00 2,929.00 1,629.00

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Earnings Projections
• Forecast or prediction of what
the company will do in the next
two years
• Detailed analysis of the company
• Create a financial model
(income statement, balance sheet
and cash flow statement) for the
company
• Basis of where analysts think
stock price will be in the next
two years.

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 Pfizer’s Earnings Estimates

Pfizer Earnings Estimates Quarter Year

March-01 Dec-01 Dec-02

Current Mean 0.31 1.30 1.59
Number of Brokers 19 25 22
Median 0.31 1.30 1.60
Current High 0.32 1.34 1.65
Current Low 0.31 1.27 1.56
30 Day Ago Mean 0.31 1.30
Next Report Date Apr 16, 2001

Reported Actuals
Quarter Year
Year Ago Actual EPS 0.25 1.02
Current vs. Year Ago 24% 27%

Consensus Recommendations Long-Term Growth Rates

Next 5 Years -
Current Mean 1.8 23.0%
Median
High 3.0 Number of Brokers 14
Industry Growth
Low 1.0 16.2%
Rate
Previous Mean 1.8
Number of Brokers 24
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