• Involves assessing the short-, medium- and long-range prospects of different industries and companies.
• It involves studying everything, other than the trading on the securities markets, which can have an effect on a security’s value: macroeconomic factors, industry conditions, individual company financial conditions, and qualitative factors such as management performance.
• Most important factor: the actual or expected profitability of the issuer, thus fundamental analysis pays attention to:
o Debt-equity ratio, profit margins, dividend payout, earnings per share
o Interest and asset coverage ratios
o Sales penetration, market share, product or marketing ...view middle of the document...
It also assumes people have access to necessary information and will use it intelligently in their own self-interest. Past mistakes can be avoided by using the information to anticipate change.
• The efficient market hypothesis, the random walk theory and the rational expectations hypothesis all suggest that stock markets are efficient: at any time, a stock’s price is the best available estimate of its true value.
• Evidence suggests that capital markets are not entirely efficiently priced (ex. Investors can consistently outperform index averages)
Better understanding of how macroeconomic factors, industry factors, and company factors influence stock valuation should lead to better investment results. These three factors all help to determine changes in interest rates and in the actual or expected profitability of companies.
Macroeconomic analysis looks at factors under 4 categories: fiscal policy, monetary policy, flow of funds and inflation.
The Fiscal Policy Impact
The two most important tools of fiscal policy are levels of government expenditures and taxation, which are usually disclosed in federal and provincial budgets.
• By changing tax levels, governments can alter the spending power of individuals and businesses. An increase in sales or personal income tax leaves individuals with less disposable income, which curtails their spending; a reduction in tax levels does the opposite.
• Corporations are similarly affected by tax changes. Higher taxes on profits, generally speaking, reduce the amount businesses can pay out in dividends or spend on expansion. On the other hand, a reduction in corporate taxes gives companies an incentive to expand.
Limiting effectiveness: time lag for parliamentary approval for tax legislation, and lag between fiscal action and when the economy is affected.
→GOVERNMENT SPENDING and POLICY:
• On the simplest level, an increase in government spending stimulates the economy in the short run, while a cutback in spending has the opposite effect.
• Fiscal policies can also be designed to achieve government policy goals. For example, the dividend tax credit and the exemption from tax of a portion of capital gains were designed to encourage greater share ownership of Canadian companies by Canadians.
• Savings by individuals can be encouraged by measures such as Registered Retirement Savings Plans (RRSPs) and Tax Free Savings Accounts (TFSAs). Such policies increase the availability of cash for investments, thereby increasing the demand for securities.
• After peaking in 1996-97, net Canadian federal debt declined for more than a decade. Recently, net Canadian federal debt has increased.
• The main problem with a large government debt is that it restricts both fiscal and monetary policy options. With high levels of government and consumer indebtedness, the government’s ability to reduce taxes or increase government spending is impaired.