W.I.S.E. INVE$TOR$ CLUB

Stock Study Guide

Sections 2 & 3

Created by: Marlene A. Jordan

Sections 2, 3, and 4 of the NAIC Stock Study Guide

Sec. 2 - EVALUATING MANAGEMENT Sec. 3 - PRICE-EARNING HISTORY

as an indication of the future

Sec. 4 - EVALUATING RISK and REWARD

Sec. 2 - EVALUATING MANAGEMENT

• Sec. 2A - The ratio of pre-tax profit to sales (or revenue)

• Sec. 2B - The ratio of net earnings to equity

Section 2A Using S&P

• Sales and Pretax income are reported under Income Statement Analysis on the S&P

• Divide Pretax Inc. by Sales (Revs.) and convert to a percentage

• Example: 1999 Ratio of Pretax Profit to Sales for Lucent is (5,443 ÷ 38,303) x 100 = 14.21%

Section 2A Using Value Line

Net Profit• Pretax Profit = 1 - Tax Rate

• Ratio of Pretax Profit to Sales = Pretax Profit Sales

Sec. 2A Using Value Line - (Values in Millions)

Row # Years 1994 1995 1996 1997 1998 1999 2000(E)

1 Net Profit 482.0 806.5 1054.0 1507.0 2287.0 3833.0 4775.0

2 Tax Rate 0.385 0.412 0.408 0.384 0.360 0.338 0.360

3 1 - Tax Rate 0.615 0.588 0.592 0.616 0.640 0.662 0.640

4 Pretax Profit (1÷3) 783.7 1371.6 1780.4 2446.4 3573.4 5790.0 7460.9

5 Sales (Revenues) 19765 21413 23286 26360 30147 38303 45000

6 Pretax Profit ÷ Sales

( 4 ÷ 5 rounded) 0.040 0.064 0.076 0.093 0.119 0.151 0.166

7 Pretax Profit as a %

of Sales 4.0% 6.4% 7.6% 9.3% 11.9% 15.1% 16.6%

A %Pre-tax Profit on Sales (Net Before Taxes ÷ Sales) 4.0 6.4

1991 1992 1993 1994 1995

LAST 5YEAR AVG. UP DOWN

7.6 9.3 11.9 15.1 16.6 12.1

1999 2000TREND

1996 1997 1998

Section 2A

Section 2B - The ratio of Net Earnings to Equity• A = L + OE

• ASSETS = LIABILITIES + OWNERS’ EQUITY

• BALANCE SHEET: A snapshot of a company’s financial status at a given point in time.

TERMS• ASSETS: everything that the company

owns at that particular moment.• LIABILITIES: everything that the company

owes at that moment.• Equity: the difference between the

assets and the liabilities. This is the net worth of the company at that moment.

• Book Value: the company’s equity divided by the number of shares of stock.

Section 2B - The ratio of Net Earnings to Equity

EPS% Earned on Equity = Book Value

per share x 100

• S&P … % Ret. on Equity • Value Line … Return on Shr. Equity

Section 2B - The ratio of Net Earnings to EquityB % Earned on Equity (E/S ÷ Book Value) 56.2

39.2 44.5 41.3 28.2 22.5 35.1

Sec. 2 - EVALUATING MANAGEMENT

A %Pre-tax Profit on Sales (Net Before Taxes ÷ Sales) 4.0 6.4B % Earned on Equity (E/S ÷ Book Value) 56.2

1991 1992 1993 1994 1995

LAST 5YEAR AVG. UP DOWN

7.6 9.3 11.9 15.1 16.6 12.1

39.2 44.5 41.3 28.2 22.5 35.1

1999 2000TREND

1996 1997 1998

Sec. 3 - PRICE-EARNINGS HISTORY

as an indicator of the future.• Present Price, High this year, & Low

this year.• Column A - High Common Stock

Prices• Column B - Low Common Stock Prices• Column C - Earnings per Share (EPS)• Column F - Dividends per Share

A B C D E F G HEarnings Dividend

per HIGH LOW per % Payout % High YieldHIGH LOW Share A ÷ C B ÷ C Share F ÷ C X 100 F ÷ B X 100

1 1996 13.3 7.4 0.41 0.042 1997 22.7 11.2 0.59 0.083 1998 56.9 18.4 0.87 0.084 1999 84.2 47.0 1.22 0.085 2000 84.18 49.81 1.50 0.106 TOTAL7 AVERAGE

8 AVERAGE PRICE EARNINGS RATIO 9 CURRENT PRICE EARNINGS RATIO

It is a bulding block for translating earnings into future stock prices.

PRESENT PRICE 58.31 HIGH THIS YEAR 84.18 LOW THIS YEAR 49.81

This show s how stock prices have f luctuated w ith earnings and dividends.

Year

PRICE Price Earnings Ratio

Sec. 3 - Columns A, B, C, and F

PRICE/EARNINGS RATIOS (P/E):COLUMNS D & E• P/E is the price of a share ÷ earnings

of a share• P/E is a way to measure what you

are getting for your money when you buy a stock

• Example: A P/E of 50.00 means investors are paying $50.00 for $1.00 worth of earnings.

PRICE/EARNINGS RATIOS (P/E):COLUMNS D & E• Column D - Compute HIGH P/E Ratio

by dividing high stock price (Column A) by EPS (Column C).

• Column E - Compute LOW P/E Ratio by dividing low stock price

(Column B) by EPS (Column C).

A B C D E F G HEarnings Dividend

per HIGH LOW per % Payout % High YieldHIGH LOW Share A ÷ C B ÷ C Share F ÷ C X 100 F ÷ B X 100

1 1996 13.3 7.4 0.41 32.44 18.05 0.042 1997 22.7 11.2 0.59 38.47 18.98 0.083 1998 56.9 18.4 0.87 65.40 21.15 0.084 1999 84.2 47.0 1.22 69.02 38.52 0.085 2000 84.18 49.81 1.50 56.12 33.21 0.106 TOTAL7 AVERAGE

8 AVERAGE PRICE EARNINGS RATIO 9 CURRENT PRICE EARNINGS RATIO

PRESENT PRICE 58.31 HIGH THIS YEAR 84.18 LOW THIS YEAR 49.81

Year

PRICE Price Earnings Ratio

COLUMNS D & E

Payout and High YieldColumns G & H

• PAYOUT - percentage of net income paid out in the form of cash dividends.

• YIELD - percentage of the purchase price one would receive in

dividends.• HIGH YIELD - yield one would have

received had he purchased the stock at the lowest price each year.

Payout and High YieldColumns G & H

• Column G - Compute payout by dividing Column F by Column C

(Dividend per share ÷ EPS). Multiply by 100 to convert to a percent.

• Column H - Compute High Yield by dividing Column F by Column B (Dividend per share ÷ low stock price). Multiply by 100 to convert to a percent.

Columns G & HA B C D E F G H

Earnings Dividend per HIGH LOW per % Payout % High Yield

HIGH LOW Share A ÷ C B ÷ C Share F ÷ C X 100 F ÷ B X 1001 1996 13.3 7.4 0.41 32.44 18.05 0.04 9.75 0.542 1997 22.7 11.2 0.59 38.47 18.98 0.08 13.56 0.713 1998 56.9 18.4 0.87 65.40 21.15 0.08 9.20 0.434 1999 84.2 47.0 1.22 69.02 38.52 0.08 6.56 0.175 2000 84.18 49.81 1.50 56.12 33.21 0.10 6.67 0.206 TOTAL7 AVERAGE

Year

PRICE Price Earnings Ratio

8 AVERAGE PRICE EARNINGS RATIO 9 CURRENT PRICE EARNINGS RATIO

PRESENT PRICE 58.31 HIGH THIS YEAR 84.18 LOW THIS YEAR 49.81

Compute the AveragesLines 6 and 7

• Line 6 - TOTAL - Add the 5 years of figures for columns B, D, E, & G

• Line 7 - AVERAGE - Calculate the averages of the same columns by dividing the totals by 5.

Compute the AveragesLines 8 and 9

• Line 8 - AVERAGE PRICE/EARNINGS RATIO Divide the sum of the High and Low P/E’s by 2, or ( 7D + 7E ) ÷ 2.

• Line 9 - CURRENT P/E RATIO Divide the present price

from the top of section 3 by the sum of the EPS’s for the most recent four quarters.

Sec. 3 - PRICE-EARNINGS HISTORY

CompletedA B C D E F G H

Earnings Dividend per HIGH LOW per % Payout % High Yield

HIGH LOW Share A ÷ C B ÷ C Share F ÷ C X 100 F ÷ B X 1001 1996 13.3 7.4 0.41 32.44 18.05 0.04 9.75 0.542 1997 22.7 11.2 0.59 38.47 18.98 0.08 13.56 0.713 1998 56.9 18.4 0.87 65.40 21.15 0.08 9.20 0.434 1999 84.2 47.0 1.22 69.02 38.52 0.08 6.56 0.175 2000 84.18 49.81 1.50 56.12 33.21 0.10 6.67 0.206 TOTAL 133.81 261.45 129.91 45.747 AVERAGE 26.76 52.29 25.98 9.15

8 AVERAGE PRICE EARNINGS RATIO 39.14 9 CURRENT PRICE EARNINGS RATIO 38.87

PRESENT PRICE 58.31 HIGH THIS YEAR 84.18 LOW THIS YEAR 49.81

Year

PRICE Price Earnings Ratio

WHAT DOES IT ALL MEAN?

• Price Trends• Price Volatility• Earnings per Share• P/E Ratios• Dividends• Payout• High Yield

End of Sections 2 and 3

QUESTIONS?