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York University
Administrative Studies
ADMS 4501

Advanced Portfolio Management ADMS 4501 – Winter 2012 – Lois King Lecture 7 – Chapter 8 – Economic and Industry Analysis – Feb 16 An Overview of the Valuation Process - Two general approaches o Top-down, three-step approach. o Bottom-up, stock valuation, stock picking approach. - The difference between the two approaches is the perceived importance of economic and industry influence on individual firms and stocks. - Both of these approaches can be implemented by either fundamentalists or technicians. - Three-step top-down process o First examine the influence of the general economy on all firms and the security markets. o Then analyze the prospects for various global industries with the best outlooks in this economic environment. - Cone-shaped diagram: o Top layer  Analysis of alternative economies and security markets • Objective: decide how to allocate investment funds among countries and within countries to bonds, stocks and cash. o Middle layer  Analysis of alternative industries • Objective: based upon the economic and market analysis, determine which industries will prosper and which industries will suffer on a global basis and within countries. o Bottom layer  Analysis of individual companies and stocks • Objective: following the analysis of the industries, determine which companies within these industries will prosper and which stocks are undervalued. Why a Three-Step Approach? - General economic influences o Fiscal policy initiatives, such as tax credits or tax cuts, can encourage spending. o Monetary policy though controlling money supply growth or interest rate therefore affects all segments of an economy and that economy’s relationship with other economies. o Inflation causes changes the spending and saving behaviour of consumers and corporations. o Other events such as war, political upheavals in foreign countries, or international monetary devaluations exert strong effects on the economies. - Industry influences o Identify global industries that will prosper or suffer in the long run or during the expected near-term economic environment. o Different industries react to economic changes at different points in the business cycle. o Alternative industries have different responses to the business cycle. o Demographic factor and international exposure will also have different impacts on different types of industries. - Company analysis o The purpose of company analysis to identify the best companies in a promising industry (or worst companies). o This involves examining a firm’s past performance, but more important, its future prospects. o Compare the estimated intrinsic value to the prevailing market price of the firm’s stock and decide whether its stock is a good investment. o Compare estimates relative value to other firms in the same industry. o The final goal is to select the best stock within a desirable industry and include it in your portfolio based on its relationship (correlation) with all other assets in your portfolio. Does the Three Step Process Work? - Studies indicate that most changes in an individual firm’s earnings can be attributed to changes in aggregate corporate earnings and changes in the firm’s industry. - Studies have also found a relationship between aggregate stock prices and various economic series such as employment, income, or production. Economic Analysis: Understanding Business Cycles - Leading indicators o Economic series that usually reach peaks or troughs before corresponding peaks or troughs in aggregate economy activity. - Leading indicators for Canada o Average work week, manufacturing. o Housing index. o United States composite leading index. o Money supply. o New orders, durable goods. o Retail trade, furniture and appliances. o Durable goods sales excluding furniture and appliances. o Shipment to inventory ratio, finished products. o Stock price index, S&P/TSX. o Business and personal services employment. - Coincident indicators o Economic series that have peaks and troughs that roughly coincide with the peaks and tro
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