CHAPTER13

STOCKMARKETANALYSIS

1.Althoughcorporateearningsmayriseby12percentnextyear,thatinformationbyitself

isnotsufficienttoforecastanincreaseinthestockmarket.Themarketlevelisaproduct

ofbothcorporateearningsandtheearningsmultiple.Theearningsmultiplemust

likewisebeprojectedsinceitisnotstableovertime.

2.StudentExercise

3.Theinvestorcanimprovehisnetprofitmarginestimatebyworkingfromthegross

margindowntothenetprofitmargin.Bythisprocedure,theinvestorexplicitlyconsiders

eachmajorcomponentthataffectsthenetprofitmargin.Thislevelofanalysisprovides

insightsintothecomponentswhichdonotbehaveconsistentlyovertime.Also,thegross

profitmarginshouldbeeasiertoestimatesinceithasthelowestlevelofrelative

variability.

4.Theeffectofadeclineincapacityutilizationshouldbeadeclineintheaggregateprofit

margin,allelsethesame,becauseitwillmeangreateroverheadanddepreciationperunit

ofoutput.Alsomorefixedfinancialchargesperunit.

5.Theincreaseinhourlywagesof6percentwill,allelseheldequal,causetheoperating

margintodecrease.Inadditiontotheestimateofthechangesinthehourlywagerate,an

estimateoftheproductivityratechangeisalsoneededtoforecasttheunitlaborcost

change.Therelationshipis:

%AHourlyWages-%AProductivity=%AUnitLaborCost

6.7.0-5.0=2.0%increaseintheunitlaborcost.Theunitlaborcostisnegativelyrelatedto

theprofitmargin.Thisincreasewould,holdingotherfactorsconstant,decreasethe

aggregateprofitmargin.Becauseitisalowrateofincrease,theeffectontheprofit

marginshouldbesmall.

7.

7(a).AnincreaseintheROEwithnootherchangesshouldcauseanincreaseinthemultiple

becauseitwouldimplyahighergrowthrate.Animportantquestionis,howwasthe

increaseinROEaccomplished?Ifitwasduetooperatingfactors(higherassetturnover

orprofitmargin)itispositive.Ifitwasduetoanincreaseinfinancialleverage,there

couldbesomeoffsetduetoanincreaseintherequiredrateofreturn(k).

7(b).Increase,becausethiswillincreaseearningsgrowthbyraisingequityturnover.Itcould

alsocauseadecreasebecauseitwillincreasethefinancialriskand,thus,therequiredk.

7(c).Decrease,becausethiswillincreasegrowthandthereforeraisetherealRFR.Itcouldalso

reduceinflation,whichwoulddecreasethenominalRFR,causingthemultipliertorise.

7(d).Increase,becauseadecreaseinthedividendpayoutrateincreasestheretentionrate,

raisingthegrowthrate.Itcouldalsocauseadecreasebecauseitreducesthenextperiod's

dividends.

8.Boththepresentvalueofcashflowapproachesandtherelativevaluationratiosapproach

requiretwofactorsbeestimated:(1)requiredrateofreturnonthestock,becausethisrate

becomesthediscountrateorisamajorcomponentofthediscountrate,and(2)growth

rateofthevariableusedinthevaluationtechniques,suchas,dividends,earnings,cash

flowsorsales.

9.TheDDMassumesthat(1)dividendsgrowataconstantrate,(2)theconstantgrowthrate

willcontinueforaninfiniteperiod,and(3)therequiredrateofreturn(k)isgreaterthan

theinfinitegrowthrate(g).Therefore,theinfiniteperiodDDMcannotbeappliedtothe

valuationofstockfbrgrowthcompaniesbecausethehighgrowthofearningsforthe

growthcompanyisinconsistentwiththeassumptionsoftheinfiniteperiodconstant

growthDDMmodel.Acompanycannotpermanentlymaintainagrowthratehigherthan

itsrequiredrateofreturn,becausecompetitionwilleventuallyenterthisapparently

lucrativebusiness,whichwillreducethefirm'sprofitmarginsandthereforeitsROEand

growthrate.Therefore,afterafewyearsofexceptionalgrowth(aperiodoftemporary

supernormalgrowth)afirm'sgrowthrateisexpectedtodecline.Eventuallyitsgrowth

rateisexpectedtostabilizeataconstantlevelconsistentwiththeassumptionsofthe

infiniteperiodDDM.

10.NominalGDPgrowthisequaltorealGDPgrowthplustherateofinflation.From

Exhibit13.27,wefindnominalGDPfortheUnitedKingdomfor2003canbeestimated

as2.8%(realGDP)+2.6%(inflation)=5.4%.ForJapan,theestimateis1.0%+(-0.7%)

=0.3%.

11.Thenominalrateofinterestisapproximatelytheexpectedrealrateofinterestplusthe

expectedrateofinflation.Further,therealrateofinterestcanbeapproximatedbythe

expectedrealgrowthrateinGDP.FromthenumbersinExhibits13.27and13.29,wesee

thattheUnitedStateshasahigherrealgrowthrate,bothcurrentlyandforecasted,aswell

asahigherexpectedrateofinflationthanJapan.Bothfactorshelpexplainthehigher

currentinterestrateintheU.S.relativetoJapan.

CHAPTER13

AnswerstoProblems

1.Usingonlythegraphanddrawingalineoverfromtenpercenttothelineofbestfitand

downtothehorizontalpercentchangeindicatesanestimateofslightlyunder10%forthe

S&Pseries.Alternatively,ifyouapplythefollowingregressionequation:

%AS&PIndustrialsSales=-.024+1.16(%AinNominalGDP)

=-.024+1.16(0.10)

=-.024+.116

=.092or9.2%

Exhibit13.10wasbaseduponananalysisthatencompassedtheperiod:1975-2000.The

overallaverageGDPpercentagechangewas7.4%,with6.3%changeinS&PIndustrials.

Duringthe1990s,thepercentagechangeinGDPwaslowerthantheaverageoverthe

period(approximately5.5%)andlowerthanthe10%proposedintheproblem.

Therefore,onecouldarguethatbaseduponrecentobservations,thepercentagechangein

S&P400Salesshouldalsobelower:

%AS&PIndustrialsSales=-.024+1.16x.055

=-.024+.0638

=3.98%

2(a).60

P/E=-------------=.60/.06=lOx

.13-.07

2(b)..50

P/E=-----------=.50/.06=8.3x

.13-.07

2(c).60

P/E==.60/.07=8.57x

.16-.09

2(d).60

P/E=-----------=.60/.04=15x

.10-.06

3.CFAExaminationI(1985)

3(a).Overall,bothmanagersaddedvaluebymitigatingthecurrencyeffectspresentinthe

Index.Bothexhibitedanabilityto“pickstocks"inthemarketstheychosetobein

(ManagerBinparticular),ManagerBusedhisopportunitiesnottobeinstocksquite

effectively(viathecash/bondcontributiontoreturn),butneitherofthemmatchedthe

passiveindexinpickingthecountrymarketsinwhichtobeinvested(MangerB,in

particular).

MANAGERAMANAGERB

STRENGTHSCurrencyManagementCurrencyManagement

StockSelection

UseofCash/BondFlexibility

WEAKNESSESCountrySelectionCountrySelection

(toalimiteddegree)

3(b).Thecolumnrevealstheeffectonperformanceinlocalcurrencytermsafteradjustmentfor

movementsintheU.S.dollarand,therefore,theeffectontheportfolio.Currency

gains/lossesarisefromtranslatingchangesincurrencyexchangeratesversustheU.S.

dollaroverthemeasuringperiod(3yearsinthiscase)intoU.S.dollarsfortheU.S.

pensionplan.TheIndexmixlost12.9%tothedollar,reducingwhatwouldotherwise

havebeenaveryfavorablereturnfromthevariouscountrymarketsof19.9%toanet

returnofonly7.0%.

4(a).Growth=.60x.12=.072=7.2%

4(b)..40

P/E==14.29x

.10-.072

4(c).Themarketpricewillriseto:Price=14.29x$53=$757,37

757.14-950+30

4(d).RateofReturn==-17.14%

950

5(a).$850x352$129,20(operatingprofitmargin)

$129.20-$38$91.20(depreciation)

$91.20-$16$75.20(interest)

$75,20x(1-32)$51.14(EstimatedEPS)

5(b).Optimistic:

$850x.155$131,75(operatingprofitmargin)

$131.75-$38$93.75(depreciation)

$93.75-$16$77.75(interest)

$77.75x(1-.32)$52,87(EstimatedEPS)

Pessimistic:

$850x.149$126.65(operatingprofitmargin)

$126.65-$38$88.65(depreciation)

$88.65-$16$72,65(interest)

$72.65x(1-,32)$49,40(EstimatedEPS)

6(a),GrowthRates:Requiredreturn:

High=(1-0.45)x0.16=.088High=0.08+0.03=0.11

Low=(1-0.65)x0.10=.035Low=0.10+0.05=0.15

Consensus=(1-0.55)x0.13=.0585Consensus=0.09+0.04=0.13

P/ERatios:

High=0.45/(0.11-0.088)=0.45/.022=20.4545

Low=0.65/(0.15-0.035)=0.657.115=5.6522

Consensus=0.55/(0.13-0.0585)=0.55/.0715=7.6923

Pnce:

High=52.87x20.45451081.43

$

Low=49.40x5.6522=279.22

$

一

Consensus=51.14x7.6923一393.38

6(b).High=(1081.43/1600)-1=-.3241

Low=(279.22/1600)-1=-.8255

Consensus=(393.38/1600)-1=-.7541

Giventhatlargelossesareexpected,oneshouldunderweighttheU.S.stocksinaglobal

portfolio.

7.

7(a).FCFEo=$40

FCFEi=$40x(1.09)