Summarily, the author seeks to establish the extent to which accounting approach to fundamental corporate financial statement analysis can be used in the process of predicting value received by the stock investors.
This way, he describes the research approaches which are normally applied to ensure that the information generated in not only value-based but also relevant. As such, the approaches include association studies, which are based on presumed market efficiency such that all the information derived from the market are solely relevant, and the predictive studies that is intrinsic oriented and uses the historical figures derived from the financial statements.
The article focuses on the fundamental analysis, as the best approach to determine stock values as reflected by the financial statements. the target variables are the corporate portfolio based on their market and book values. As such, the article illustrates how investors can enhance their return on investments through the objective selection of investment vehicles, which is guided by the type of firm invested in. based on the study, the author argues that a proactive choice of a portfolio, that is guided by a firm’s fundamental and historical figures analysis would help to determine a would be the winner or loser in investment. It is therefore argued that the historical figures can be used to develop fundamental market signals, from which earnings and performances can be correlated and the potential winning portfolios chosen.
Specifically, the article looks into the various analyses of the financials statements that can be adopted to establish a firm’s value, basis his review on various components of binary variables. As such, the author looks into inventory, accounts receivable, investments, gross margins, liquidity, leverage, cash flow, asset turnover as some of the variables that should be analyzed to obtain relevant information on a firms value and stock returns
The article succeeds in showing how historical data, drawn from the financial statements can help determine stock’ returns. According to relevant historical information can be to used ‘to eliminate firms with poor future prospects from a generic high BM portfolio’ (Piotroski, 2002). The major argument is that the fundamental strategy helps to get relevant information on stock signals so as to separate possible winners from losers. In stock evaluation, it is critical that the analyses focus on the past data as they may offer a predictive pattern of stock growth. At the same time, it is critical to carry out industry comparisons but take into account the size of the firms under review is given that the size, based on revenues affects the behaviours of the analysis of the financial statements (Michael, John & Steven, 2000).
Though the author supports fundamental strategy in the analysis of financial statements, he fails to give the possible failures of the concept. The argument presented is that the variations are normally cancelled out with time as the fluctuations tend to converge at given fundamental values. However, there are instances when the historical data may not be indicative of future performance. For example, a change of law may render the most valuable source of cash flow illegal thus leading to fall in inflows and overall firms’ value. As such it is critical to analyze all the firm’s disclosures. For example, the income statements normally have more information transitory the disclosures only made on the footnotes (Riedl & Srinivasan, 2007).
The supposition that inventory valuation that shows a quicker than sales increase is not good for the firm as it is a negative signal is true. This is because inventory is one of the most critical assets that generate revenue and should be turned as often as possible. As such, the higher rate of stock turnover is key to earnings so that the share prices go up through the signaled revenue growth.
Review of the firms leverage is also critical in the process of deducing a firm’s stock value and the possible growth in its market performance. As established by the author, it is critical that an investor looks into the analysis of a firm’s leverage, more so debt to equity ratio. If the leverage has been growing over time, it is important that an investor avoid such firms. This is because such instances present a dangerous situation such as possibility of hostile takeovers in event of default or involuntary liquidation. It also results into restrictive debt covenants and tying of firms attached asset, use as collateral, to specific use.
Analysis of a company cash flow
Cash Flow, Investment and Derivative Use: An Empirical Analysis of New Zealand Listed Companies by Reynolds
In summary, the article looks into the ways in which firms manage their cash flows by investing on financial hedges. As such, the study addresses the research gap that seeks to establish the major reasons behind attempts to limit as much as possible internal cash flow deviations. According to the article, it is critical that both external and internal cash flows be managed well, and none should be overrated or overlooked. This is because any hiccups in the external cash flows would have a negative impact on in the internal cash flow and deter the achievement of a firm’s financial management goals. As such, through hedging, it is possible that investors can be attracted because of the motivation provided by the low risk and low default rate feature of the firm and stronger leverage.
According to the article, the literature reviewed show that a good internal cash flow management, with specific reference to use of derivatives, helps to reduce liquidity constraints. It is therefore desirable that derivatives be used not only as a risk management strategy but also as away of saving on cash outflows. This strategy also helps to limit investments volatility. In the data analysis, the author deduces how to cash flow can be measured. Accordingly, cash flow from investments can be measured through the utilization of cash that has bee internally generated and available for investment. Specifically, two approaches are used to measure this kind of cash flow. First is the lagged value of cash flows. This measure is based on the principle that the current investment will depend on the cash flows from the previous year. The second measure is based on free cash flow. In this measure, the authors argue that the focus is on the net cash flows after tax. As such, the cash flow available for investment is one that has not been distributed to the equity investors. Based on the study, the authors deduced that investment volatility can be solved through hedging. This is because there will be cash savings and low risks associated with debt capital. However, the cash available for such investment should be objectively identified so that al the stakeholders get their claim on the revenues.
The argument that investment volatility can be effectively managed through proper management of internal cash flow is very significant. This is because, cash flows need to be maintained at optimum levels so that the investors get their dividends while the reserves are used to meet growth opportunities. Hedging is, therefore, a good cash saving approach that would guarantee investors the safety of their capital.
In carrying out cash flow analysis, it is critical to evaluate the factors that influence the firm’s cash flows and its magnitude. For example, one of the identified factors, investment opportunities, is very critical. If there are many viable investment opportunities, and the firm committed funds to them, it is likely that there will be more cash outflows. On the other hand, lower level of investment opportunity will imply that investment will be limited while the idle assets disposed of. This way, the level of cash outflow will be lower. It is therefore correct to argue that assets that are not in use need to be employed elsewhere to generate cash inflows.
The result of the study shows that the firms analyzed rely more on internally generated cash to take advantage of investment opportunities. The motivation to use the internal cash sources as opposed to external ones may be varied. Probably, the firms need to limit the use of external cash source such as loans because of the restrictions on their use, complexity in the process of getting loans or poor market conditions. Similarly, reliance more on internal sources of cash may because of high borrowing interest rates or restrictive monetary lending policies set by the central bank. This argument is supported by Jensen (1986), who argued that proper control and management of debt is offers a good way to generate larger volumes of cash flows. As a matter of fact, the author established that small firms find it hard to attract external cash flows for investing activities due to the associated steeper costs and accessibility challenges.
Net Present Value with Uncertainty by Xeni K. Dimakos , Neef & Aas
The article stipulates that organizations can use many methods to evaluate the viability of a project before committing funds into it. One of such techniques is the Net Present Value approach. This is similar to an argument by Gollier (2009) which has that an organization should only invest in a project with a positive NPV, after discounting the cash flows using a given rate. According to the article, the NPV relates to the difference between the discounted net values of expected cash inflows and the initial can outlay of investment. To ensure that a good risk analysis is carried out, it is vital that issues relating to market changes and uncertainties be factored in before money can be committed. As such, the article establishes that NPV approach offer one of the best means of evaluating an investment project as it takes into account the uncertainties. Different, the traditional methods do not take these factors into account, thus may be misleading. The major argument in support of NPV in the appraisal of an investment is that by discounting the cash flows, the risks elements of a project can be recognized and minimized.
The article, however, goes beyond the conventional NPV method that only looks for a positive NPV figure to approve an investment to incorporate a simulated approach to the concept. As such, the cash flows are simulated based on the different scenarios after the NPV is calculated. In the process, the simulation-based NPV approach would help to come up different risk scenarios so that the more risky projects are rejected.
By taking into account uncertainties in the process of NPV analysis, the project’s evaluators are able to recognize more risk factors that may affect the investment choice. Similarly, Gollier (2009) argues that NPV method works well with risk averse investors. Analytically, the authors recognize that their model does not take into account all the risk factors that may affect the value of NPV. This shows that the article may not be fully relied on in the process of project evaluation. As such it is critical that a good fitting model be developed to guide an analyst in the choice of the project risk factors. It is however critical that a good investment appraisal tool take into account the fundamental factors that may affect the capital budgeting decision, more with respect to risks as well as the related relevant costs and benefits (Bierman, 2007).
Based on the authors’ results, the model NPV ∗b, b = 1,…,B, can be used to supplement the ordinary NPV method. This way, it is possible to obtain information relating to a project’s uncertainty and risk. According to Gollier (2009), it is critical that the risks kinked to the various financing strategies must be taken into account’ to ensure a successful project appraisal. This argument is very critical in investment appraisal as the aim of such process is to come up with valuable information that can guide the investors in the process of decision making, and its understanding of the investment’s impacts on a company net worth. Emphatically, White and Miles (1998), argues that NPV provides the best tool for understanding the impact of investment on shareholders’ net worth. Impliedly, the article seeks to reinforce the fundamental importance of NPV in determining the projects’ risks in a ranked manner so that the investors can make his or her choice based on the financial capacity and the relationship among the projects. According to experts, a good evaluation is necessary as firms have limited funds (Elumilade, Asaolu & Ologunde, 2006). As suggested by the authors, it is important that the evaluator rank the projects in order of the associated risks to aid in making the choice. This is referred to as a ranking based on ‘worst-case scenarios’. The incorporation of simulation thus improves quality of decision making more so in mutually exclusive projects. In such projects, it is likely that two projects that are competing for funds may have same NPV figures, making the appraiser to be indifferent. However, with the improved NPV method, it is very possible to use the probability analysis and simulation to separate projects based on NPV and uncertainties
Valuation of stock and stock portfolios
The Capital Asset Pricing Model: Theory and Evidence by Eugene F. Fama and Kenneth R. French
The article analyses the different ways through which firm’s stock can be evaluated. Specifically, the author looks at the development and application of Capital Asset Pricing Model (CAPM) in the process of evaluating the stocks performances and returns. The major advantage of employing CAPM , based on the literature reviewed by the authors, is that gives a very objective way of measuring stock risks and the return that is excepted from a portfolio. As a portfolio approach to risk assessment, the article suggests that offers a more comprehensive assessment of portfolio and the ways to diversify risks. However, the study findings show that the principle should not be relied on fully as it has certain subjective assumptions.
The article outlines the CAPM model as a stock portfolio valuation model in which a risk adverse investor would come up with the best portfolio choice that minimizes risks but maximizes returns. In overall, the concept is based on the desire to come up with “mean-variance-efficient” (Fama &French, 2004).
The author then proceeds to test the reliability of the model in stock valuation. Based on several past tests, the author established that CAPM logic that risk premium beta is a positive figure. In the rest of the article, the author criticizes the CAPM based on the many assumptions that it makes and the failures to incorporate different factors that may also affect stocks other than the beta. For example, various stock rations like EPS which guide in stock valuation are blatantly ignored by the model. As such there should be no over-reliance on the CAPM betas as they fail to capture all the relevant market information. At the same time, CAPM weakness emanates from the fact that it ignores behavioral aspects of investment. Some investors are influenced by psychological factors and opinion shapers thus may make investment decisions on such clumsy grounds.
In conclusion, the article looks at the various application of CAPM model. Such areas include analysis of stocks, mutual funds and other portfolios. However, the empirical tests have many times faulted CAPM. As such, the authors warn against undue reliance on CAPM as it may not give better predictive values of stocks and portfolios.
By arguing that CAPM’s simplicity and intuitiveness made it very popular in portfolio analysis despite the many shortcomings, the author attempts to show that a theoretical model should not be fully relied on in stock valuation. However, Sigrist (2000) argues that the model can be used by market players to establish or not stock price has been ‘over- or underpriced’. The author thus calls for the incorporation of other models in the portfolio analysis so that the investors can make more informed choices. One of such factor is stock ratios such as the EPS. Earnings per Share are a superior stock valuation model as it has more updated and recent market information.
On the other hand, Michailidis, Tsopoglou, Papanastasiou and Mariola, E. (2006) assert that the model has ‘measurement and model specification errors’ that emanate from the fact that it utilizes proxy variables as opposed to ‘actual market portfolios’. The authors also argue that the CAPM ignore the proposals put forward by the behaviourists that other factors just as beta also determine the investment decisions. For example, the model does not give a better stock valuation due to mis-pricing. As such, the best model should one that recognizes risks in the market and also incorporates the market signals in relation to stock performance. This would be a more rational approach as it would capture the portfolio risks and also factor in the emerging issues in the market that are critical in price-setting such as results’ announcement or mergers.
Use the Internet to identify the journal articles.
Review the journals and provide a summary for each in about 200 words. Follow APA guidelines for writing style, grammar, spelling, and citation of sources.
Elleuch, J. (2009). Fundamental Analysis Strategy and the Prediction of
Stock Returns. International Research Journal of Finance and Economics. Retrieved August 17, 2010, from http://www.eurojournals.com/irjfe_30_08.pdf.
Elumilade, D., O., Asaolu, T., O. & Ologunde, A., O. (2006). Capital Budgeting and
Economic Development in the Third World: The Case of Nigeria. International Research Journal of Finance and Economics. Retrieved August 17, 2010, from http://www.eurojournals.com/IRJFE%202%2010%20Elumilade.pdf.
Fama, E., F. & French, K. R. (2004). The Capital Asset Pricing Model:
Theory and Evidence. Journal of Economic Perspectives. . Retrieved August 17, 2010, from http://www-personal.umich.edu/~kathrynd/JEP.FamaandFrench.pdf.
Gollier, C. (2009).Expected net present value, expected net future value, and the Ramsey
rule. Toulouse School of Economics (LERNA and IDEI). . Retrieved August 17, 2010, from http://www.scor.com/www/fileadmin/uploads/ChairSCOR/ChairSCOR_ExpectedNetPresentValue_062009_EN.pdf.
Jensen, M. (1986). Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers.
Harvard Business School. . Retrieved August 17, 2010, from http://www.bmibourse.org/Report%5CFiles%5Cagency%20costs%20of%20free%20cash%20flow%20corporate%20finance%20and%20takeovers.pdf.
Michailidis,G., Tsopoglou, S., Papanastasiou, D. & Mariola, E.(2006). Testing the
Capital Asset Pricing Model (CAPM): The Case of
the Emerging Greek Securities Market. International Research Journal of Finance and Economics . Retrieved August 17, 2010, from www.eurojournals.com/IRJFE4%207%20grigoris.pdf.
Michael, P. John, V. & Steven, A. ().A behavioral comparison of financial ratios for
Different size privately-held retail and service Businesses. Journal of Behavioral Studies in Business. Retrieved August 17, 2010, from http://www.aabri.com/manuscripts/08070.pdf.
Piotroski. J. (2002). Value Investing: The Use of Historical Financial Statement
Information to Separate Winners from Losers. Retrieved August 17, 2010, from http://www.chicagobooth.edu/faculty/selectedpapers/sp84.pdf.
Reynolds, P., M. (2009). Cash Flow, Investment and Derivative Use: An Empirical
Analysis of New Zealand Listed Companies
International Research Journal of Finance and Economics. Retrieved August 17, 2010, from
Riedl, E.& Srinivasan, S.(2007). Signaling Firm Performance Through Financial
Statement Presentation: An Analysis Using Special Items. Harvard Business School. Retrieved August 17, 2010, from http://www.hbs.edu/research/pdf/09-031.pdf.
Sigrist, D. (2000). CAPM and Methods to Determine the Market Portfolio. Winterthur.
Retrieved August 17, 2010, from http://www.sbf.unisg.ch/org/sbf/web.nsf/0/481f0d21e81c4f84c1256ba3002bb747/$FILE/Capm.pdf.
White, J. & Miles, M. (1998). The managerial imperative of evaluating
Non-capital expenditures within A capital budgeting context
Journal of Financial and Strategic Decisions. Retrieved August 17, 2010, from
Xeni K. Dimakos, X., K., Neef, R., L. & Aas, K. (2006). Net Present Value with
Uncertainty. Retrieved August 17, 2010, from http://publications.nr.no/samba0506.pdf.
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