Financial Analyst :

A person who analyses securities and makes recommendation

Tools for Analysis : to determine a particular security is worth
buying, holding or selling
i) Fundamental Analysis: Tools like future Earnings, Dividends and assess
intrinsic value .
ii) Technical Analysis: Study of Past prices and volumes to
determine the direction of price movement
To find out Mispriced securities through Fundamental Analysis
i) Estimating Intrinsic value and comparing the same with
prevailing market prices
ii) Estimating a security’s Price expected return and Intrinsic value
and the comparing it with the ‘appropriate’ return for securities with
similar characteristics
Study of financials
 Study of a company is a part of Three step approach
 It includes , Macro economic analysis , Industry analysis and company

analysis
 Company Analysis:

 i) Study of Financials
 Ii) Study of other factors

Practical methods for valuation of stocks:

i) Dividend discount models
ii) Balance sheet Model
iii) Earnings Multiplier
Note: In practice Earnings Multiplier is the most popular method
Key questions addressed by
Earnings multiplier method
 What is the expected EPS
 What is the reasonable P/E ratio given Growth prospects, risk exposure,

and other characteristics of the firm

To answer above questions Analyst start with historical analysis of the
following :
- Earnings
- Dividends
- Growth
- Risk
- Valuation
Key Financial metrics
I . Earnings and Dividend level
To assess Earnings and Dividend level, Analyst look for different
metrics like
1. Return on Equity : Equity earnings/ Equity
ROE decomposes in to three factors,
Net Profit Margin X Assets turnover X Leverage
PBIT/ Sales Sales / Assets Assets /Equity
ROE decomposes in to Five factors:
PBITefficiency x Assets turnover x Interest Burden x Tax burden x Leverage
PBIT/sales Sales/ Assets : PBT/ PBIT : PAT/PBT ; Assets/ Net
worth
Key Financial metrics

2. Book value per share : Paid up equity capital

+ reserves & surpluses
No. of outstanding shares
3. Earnings per share : Equity earnings/ No. of outstanding shares
4. Dividend payout ratio : Proportion of equity earnings which is paid out as
dividends : Equity dividends/ Equity earnings
5.Dividend per share : Dividend declared per share
: DPS stated based on paid up value per share
: EPS x D/P ratio
Key Financial metrics
II. Growth Performance:
To measure Historical growth ,
The compounded Annual growth rate (CAGR) of sales ,
( sales for 2007/sales for 2002) 1/5 - 1
CAGR EPS : ( EPS for 2007/EPs for 2002) 1/5 – 1
CAGR DPS : ( DPS for 2007/DPs for 2002) 1/5 – 1
Sustainable growth rate : ROE x b ( retention ratio)
Key Financial metrics
III. Risk Exposure:
Measure of Risk:
i) Beta : CAPM, How sensitive a stock return to variation in the
market return
ii) Volatility of ROE : Range of ROE over n years / Avg. ROE over n years

Range : Simplest measure of dispersion

: value of highest data point – value of lowest data point
Key Financial metrics
IV . Other factors:
Value Multiples:
i) P/E ratio ii) Price to Book value Ratio (PBVR)
i) P/E ratio : It reflects the price investors are willing to pay for every
Birr of EPS
a) Retrospective manner : Price per share at the end of the year n
EPS for year n
b) Prospective Manner : Price per share at the beginning of the year n
EPS for year n
Note: Prospective P/E ratio is more widely used
Key Financial metrics
ii) Price to Book Value Ratio (PBVR)
a) Retrospective manner : Price per share end of the year n
BVPS for year n
b) Prospective manner : Price per share at the beginning of the year n
BVPS for year n

Note: Retrospective manner is more commonly used

Favorable Factors & Unfavorable factors
Favorable factors:
Earnings level : High BVPS
: High ROE
Growth rate : High CAGR in sales and EPS
: High sustainable growth rate
Risk exposure : Low volatility of ROE
: Low Beta
Un favorable factors:
Earnings level : Low BVPS
:Low ROE
Growth rate : Low CAGR in sales and EPS
: Low sustainable growth rate
Risk exposure : High volatility of ROE
: High Beta
Going beyond Numbers
 Qualitative in nature, Past structures, Prospects, quality of its
management;
 Availability and cost of inputs
 + Raw materials, power, fuel, cost advantage, dis advantage
 Order position ( Months/Year of production)
 Regulatory frame work
 Technological and Production capabilities
 Marketing & Distribution
 Finance and Accounting ,
 + External financing ,
+ Accounting policies ( Depreciation policies
+ Efforts to manage Bottom line ,
 Human Resources and Personnel ( competency, overstaff, under staff,
Employee turnover, absenteeism)
 Evaluation of Management
 Experts opinion on Evaluation of Management
 According to Warren Buffett :
 “ The key to investing is not assessing how much an industry is going to affect
society , or how much it will grow, but rather determining the competitive
advantage of any company and above all, the durability of that advantage”
 According to Peter F. Drucker: 1
 “ The performance of business today largely a result of the performance, or
lack of it, of earlier management of years past”
 “ Good Management means doing a good job in preparing today’s business for
the future”
 According to Theodore Leavitt:
 “ The mark of good management is not simply how its business but how well it
changes them”

 References:
 P.F.Drucker : A new score card for management “ the wall street journal ,
September , 1976
 Theodore Levitt : “Dinosauras among the Bears and Bulls” HBR, Jan-Feb ,1975

Estimation of Intrinsic value
 i) Estimate the Expected EPS
 Assumptions about future prospects :
 ( Normal, optimistic and pessimistic)
 Demand growth,
 Market share,
 Raw materials Price
 Import duties
 Product prices
 Interest rates
 Assets Turnover ratio
 Income tax rate
 Cash flow per share ( PAT+ Dep. / No. of shares )
Estimation of Intrinsic value
ii) Establish P/E ratio:
a) Dividend discount model : D/P ratio
r-g
b) Cross section analysis: similar firms P/E ratios in the industry take
a view
c) Historical Analysis : Historical P/E ratio of the company and take
a view ( consider recent changes in capital market)
d) Weighted P/E ratio :
+ P/E ratio based on DDM
+ P/E ratio based on Historical analysis
+ Assign weight age to each one
+ Find out weighted P/E ratio
Estimation of Intrinsic value

iii) Determine Value Anchor and Value Range:

Value Anchor : Projected EPS X Appropriate P/E ratio
Value Range : Highest and Lowest value of stock

Decision Rule : for instance

As per value Anchor is 35/-
Value range is 30 to 38
Market price Decision Rule
Market price < 30 Buy
Market Price >38 Sell
Between 30 and 38 Hold
Tools for judging under valuation
or over valuation of stocks
1. PBV –ROE Matrix ( Price to Book value – Return on Equity )

Over valued Fair price

High

Price to
Book value
Ratio

Fair price Under valued

Low

Low High

Return on Equity
 Tools for judging under valuation
or over valuation of stocks
2. Growth Duration Matrix:

High Under valued

Promises of
Expected growth
5 year
EPs Growth

Over valued
Dividend
Low cows

Low High

Duration (1/ Dividend yield)

Note: Duration of equity stock is inverse of Dividend yield : MPS/DPS
Tools for judging under valuation
or over valuation of stocks
3. Expectations Risk Index (ERI)
- Developed Alfred Rappaport
- It reflects the risk in realizing the expectations surrounded in the
current market price
Two important inputs to estimate ERI:
a) what proportion of stock’s price depend on future value–creating
growth
b) How difficult will it to be achieve the growth rate expected by market
For instance : Estimation of ERI
The price per share of ABC company is 150/- Birr,
ABC company operating cash flow per share is 10/- Birr
Cost of equity of the company is 15%
The company’s after tax ‘cash’ operating earnings grow by 20% over
past 3 years
The market expects to grow 50% over next 3 years

ABC ‘s base line value : Cash flow per share / cost of equity
: 10/0.15 = 66.7
For instance : Estimation of ERI
a) Proportion of stock price coming from investor expectations of the future growth
opportunities : Market price – Base line price
Market price
150 – 66.7/150 = 55.6%
b) ABC ‘s Ratio of expected future growth rate to recent growth ( Acceleration ratio)
Acceleration Ratio : Expected future growth rate / Recent growth rate
: 1.50/1.20 =1.25
ERI is defined as
= Proportion of stock price coming from investors x Acceleration ratio
0.556 x 1.25 = 0.695 or 69.5%
NOTES:
Lower ERI , the greater chance of achieving expectations, and higher expected
return for the investors
Higher ERI , the smaller chance of achieving expectations, and Lower expected
return for the investors
Equity research in Ethiopia
 Institutional Investors :
 Ethiopian Insurance Corporation ,
 Commercial Bank of Ethiopia
 Ethiopian Airline ( Asky – 25% stake – 24 million $)
 Equity culture ( the shylvia pankhurst Educational & training
 institute – Floated public shares)
 FFIS : ( Foreign Financial Institutions )
 The Private Multi National Bank ( ECOBank)
 The Economic community of West African states
( ECOWAS)
 Bank of Investment and Development
 African Development Bank
Equity research in Ethiopia
 Corporate consulting :
 Access Capital , Zemen Educational and Training Institute
 African Investment Bank ( 170 Million USD ) – Libya ( Tripoli)
 African Monetary Fund – Central Africa
 African Central Bank – Nigeria
 New Generation Business centre – MOCB,German govt. , OTITB, and
New generation University college
 ECX launch coffee trading in January 2009
 ECX CEO – Dr.Eleni Crebre-Medhin - New initiation in coffee trading
and research in derivative markets in Ethiopia
 UN –under secretary general –ECA stated that “ several african
countries have experienced volatility in their stock market and exchange
rates since outset of global financial crisis