Background

• Most important assets are Bonds and Stocks/Shares

• Companies raise capital issuing Shares
– IPOs
– New Issues
• Investors get a return via…
– Dividends (only if there is a profit)
– Change in Prices

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 Background
• Shares are riskier than Bonds
– Unknown Return
– Shareholders are the last ones to be paid in case of default
(e.g. first employees and bond holders)
• Common Stock (also known as ordinary share)
– Right to vote (i.e. to elect directors)
– Get dividends after Preferred Stock holders are paid
– In case of default, they are paid after Preferred Stock holders are
paid
• Preferred Stock
– Might have the right to vote
– Get dividends first
– In case of default, they are paid first

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 Fundamental Analysis
– Methodology
• Top-down
– Start with macroeconomic environment
– Global Economy (GDP, inflation, IR, FX)
– Region\Industry level (prices, sales, market)
– Local level
» How much to specific sectors, how much to money markets
• Bottom-up
– Specific stocks
» Market and Competitors
» Competitive Advantages
» Financial Statements
• Does the company have enough liquid assets compared to
liabilities?
• Does the company have good profitability?

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 Financial Statements
• Consider publicly traded firms
– Managers goal is to maximize the value of the stock/share
– The stock value is (in some way) based on the CFs the firm
will generate in the future
– How to estimate future CFs?
– Need to understand publicly available information
• Financial Statements
– Balance Sheet
– Income Statement
– Statement of Cash Flows

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 Balance Sheet
• Snapshot of financial position on the last day of each
year
Assets = Liabilities + Equity
– Book Values
• When assets are purchased or liabilities issued
– Assets
• Listed in order of liquidity
– Liabilities
• Listed in the order they can be claimed

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 Income Statement
• Reflects performance during a period of time
– Earnings Before Interests, Taxes, Depreciation and
Amortization (EBITDA)
• Net Sales – Operating Costs
• Excluding Depreciation and Amortization
– Annual charges that reflect costs of the assets used up
– Depreciation: applies to tangible assets
– Amortization: applies to intangible assets

– Net income (or Accounting Profit or Earnings)

• Income available to common shareholders
– Revenue less expenses (e.g. interests), taxes and preferred dividends

– Earnings Per Share (EPS)

• Dividing Net income over number of shares outstanding

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 Net Cash Flow
• Net income – Noncash revenues + Noncash charges
– Noncash revenues
• Subscriptions
– Company collects cash at purchase but spreads the reported revenues

– Noncash charges
• Depreciation and Amortization
• Deferred taxes

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 Statement of Cash Flow
• Summarizes changes in cash position
• Net income can be used to:
– Pay dividends
– Increase inventories
– Invest in fixed assets
– Reduce debt
– Buy-back stocks
– Not only kept as cash!

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 Statement of Cash Flow
• Company´s cash position will be affected by:
– Operating Activities
• Increase inventories
– Investing Activities
• Invest in fixed assets
– Financing Activities
• Pay dividends
• Reduce debt
• Buy-back stocks

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 Ratio Analysis
• Class is divided in 3 groups
• Choose a person to write
• Choose a person to present
• Read the paper provided
• As a team:
• Write the formula to calculate the
corresponding ratio
• Explain how the information provided by this
ratio can be used

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 Ratio Analysis
• Liquidity: short-term capacity to pay short-term debts
– Current Ratio

– Acid (Quick) Ratio

• Asset Management
– Inventory turnover ratio

– Days Sales Outstanding or Average Collection Period (ACP)

– Total Assets Turnover Ratio

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 Ratio Analysis
• Debt Management: long-term capacity to pay debts
– Debt-to-equity ratio

– Time-Interest-Earned Ratio

• Market Value Ratios

– EPS

– P/E ratio

– Market-Book ratio

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 Ratio Analysis
• Profitability Ratios
– Net profit margin

– Operating profit margin

– ROA

– ROE

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 Ratio Analysis
• Basic tools
– Compare with the industry or region
• Strengths and weaknesses
• Against competitors
– Compare against historical data
• Is it getting better or worse?

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 Technical Analysis
• Focus on price movements
– Tracking trends in Historical Prices

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 Technical Analysis
– Moving Averages
• To cut out noise and show direction
• Simple Average: same weight to all data
• Exponential Average: more weight to recent data
– Reacts sooner
• Change in direction when the price crosses the moving
average
– Bollinger Bands
• Bands move according to volatility
• Moving Average ±𝛼𝜎
• Change in volatility pattern expected

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 Technical Analysis
– Bollinger Bands

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 Equities

Use fundamental analysis to identify stocks and then

technical analysis to set a good time to buy.

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 Big Data and Machine Learning
• Big Data
– Increase in the amount of data available
• Smart phones
• Satellites
– Increase in computing capacity
• Parallel computing
• Storage capacity
• Machine Learning
• Methods used to analyse data
– Based on statistics

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 Big Data and Machine Learning
• Machine Learning Techniques
– Supervised Learning (e.g. Regression)
• Input and output variables are provided and the algorithm
tries to find the relationship that has the best predictive
power.
– Unsupervised Learning (e.g. PCA)
• The algorithm examines the data and identifies relationships
between variables and their common drivers.
• The algorithm does not know which variables are input and
which variables are output.
– Deep Learning (e.g. Neural Networks)
• Analyze data by passing it through multiple layers of non-
linear processing units.

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 Big Data and Machine Learning
• Trading
– Big Data
• Credit card transactions
• Twitter messages
• Buying satellite data to check number of cars parked
outside Walmart

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 Equity Indices
• Market indicators
– Based on all stocks traded at a exchange
• NYSE Composite Index
– Based on a selection of stocks
• S&P 100, S&P 500

– In general, the weight given to each stock is based on market

capitalisation

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 Market Efficiency
• Theory introduced in the 60´s
• Actively-managed funds do not outperform passively
managed funds
• There is no advantage of having a super asset manager
• To consistently outperform others, super manager
should know something the others do not know
– Public
INFORMATION
– Private
• Actually, there are some super asset managers!
– Taleb and the Black Swan

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 Market Efficiency
• Types
– Strong: all information is already reflected in prices

Only way to increase returns is to increase risk

• Lawmakers do not believe in strong efficiency… insider trading is a crime

– Semi-strong: all public information is already reflected in prices
• No room for fundamental analysis
– Weak: all historical price information is already reflected in prices
• No room for technical analysis
• Market participants believe in temporary inefficiencies
– Short window

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