## Financial Management Assignment

Stock Reporting

To familiarize you with stock market reporting, I would like you to follow your stock, its comparable firms, and its market index for the course of the semester. The stock you should pick should not be financial firms, real estate firms, or utility firms because they have to comply with different regulations I would like you to take the closing adjusted price of your stock, your comparable firms, and stock FIN 4010/7010 Financial Management 9 market at least for the past 3 years on a daily basis.

At the end of the semester, you will graph both the price and returns of your stock, the market index and comparable firms and see how they perform. That is, the graphs will exhibit both time-series and cross-sectional analyses. To choose comparable firms or competitors, pick firms that have business revenue (same industry), technology, age, and size. Size can be captured by total assets or market capitalization. Age is a number of years since IPOs.

Market index is the market where your stock is traded. If your firm is traded in NASDAQ, compare your stock returns with the returns of NASDAQ. If your firm is traded in NYSE, compare your stock returns with the returns of NYSE. You can find stock price data from Yahoo! Finance or Google Finance. Financial Statement Analysis You will use your company to do a financial statement analysis.

Choose quarterly financial statements to do analyses for the past 5 quarters. You need to download the financial statements, obtain the date, and calculate all ratios by yourself. Which ratios should you compute? You don’t need to compute all of the ratios we’ve learned in class. Use your own judgment.

For instance, inventory turnover is not important for Google, but important for Amazon and Walmart. Asset turnover ratio is not important for Netflix, but important for Caterpillar.

For biotech firms, innovation and human capital are the key value drivers. Which ratios capture them? We will learn in class. Compare those ratios of the industrial average and those of your comparable firms. Show both cross-sectional analysis and time-series analysis.

Interpret the outcome carefully. For industry ratio, you can get the data here https://csimarket.com/Industry/industry_Financial_Strength_Ratios.php?s=1300&hist=8 In your Excel file, you need to show the original data and explain how you generate them.

Each number needs to have formula embedded and show the cells that you take the numbers. For instance, if you compute the profit margin in the first quarter of 2019. First, you need to have a balance sheet and income statement in your spreadsheet. Then, for profit margin in the 1st quarter of 2019, I need to be able to tell where you get net income and sales from your income statement and balance sheet of the 1st quarter of 2019, respectively. You will be considered as cheating if you fail to justify the sources of data and/or just copy and paste the financial ratios/beta provided by other sources than you.

In other words, you need to calculate all output numbers by yourself. Please do the financial ratios of your company on your own; although, they are available through the public domain.

From my experiences, the numbers reported in the public domain are inaccurate and not trustworthy. There is no description of how those websites calculate the financial ratios (which frequency, which financial report, which formula).

For competitors and industry, you can use the numbers from those websites; although, it is better to calculate on your own for consistency. To name a few, the websites providing financial ratios of companies include http://www.morningstar.com/, http://www.reuters.com/, and http://finance.yahoo.com/. FIN 4010/7010 Financial Management 10 PART TWO In this part, you are going to try out some of the things you have learned this semester. In this part, all of the data has to be daily for the past three years. I recommend daily data because we are going to do a regression analysis to estimate CAPM.

The more frequent data you use, the more info you incorporate in your analysis. Second, when you use more data, you will increase the statistical power of your analysis. Stand Alone Risk Convert your and your comparable firm’s price series into a return series by calculating Returns = [(Pricet − Pricet) + Dividendst] / Price −1. Calculate the mean, standard deviation, variance, and coefficient. Also, calculate the correlation between your stock’s, comparable’s and the stock market index’s returns. You should use the functions in Excel to do this, and your Excel worksheets should show those functions and equations. Market Risk Estimate the beta of your stock by regressing your stock’s returns (as the dependent variable) on the returns to your index (as the independent variable).

Do the same for your comparables. The beta of a stock is simply the slope coefficient of a regression line (assuming that your stock market index is the market portfolio).

Run a regression based on the instruction I posted on Canvas. Please do not give me your company’s beta from any public domain as it is not reliable.

Systematic and Unsystematic Risk Total risk of a stock (variance of stock returns) can be seen as the sum of systematic and unsystematic risk. That is, Total risk = Systematic risk + Unsystematic risk = Market risk + Diversifiable risk This equation can also be expressed in a mathematical form as follows: σ 2 for a stock = β2 × (σ 2 of the market portfolio) + σ 2 of the regression error term. Based on this equation, calculate your stock’s market and diversifiable risk. Also, determine the proportion of the total risk that is nondiversifiable (market risk) and diversifiable. What does it mean? Offer the suggestion on how to diversify your portfolio that has only your stock and another portfolio that has only your competitor’s stock. Estimate the Required Rate of Return on a Stock (or the Cost of Equity) 1. The CAPM or SML Estimate the parameters of the CAPM or the SML (see chapter 5). Find an estimate of the current risk-free rate based on Treasury bill rates and the market rate of returns from Ken French’s website here. FIN 4010/7010 Financial Management 11 http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html Scroll down and choose “Fama/French 3 factors”. Click “CSV” to get the data. Pick daily data as mentioned above. See the PDF “How to run a regression” posted in the same folder on Canvas. CAPM formula is the following: Ri = Rf + beta (Rm-Rf) where Ri = cost of equity of stock I Rf = risk-free rate Rm = market rate of return If you want a challenge and want to earn bonus points, you should do a robustness check and compute cost of equity from 3-FF factor, and/or 5-FF factor models. 2. Constant Growth Dividend Valuation Model Estimate the required rate of return or cost of equity using the constant growth dividend valuation model, rs = (D1/P0) + g. For g, use analysts’ forecasts of earnings growth for the next 5 years (also available in many websites such as Yahoo!Finance). If your company does not pay a dividend, then required the return of the stock = g. 3. Compare with your benchmark and the industry Analysis:

§ Make sure you explain everything you did, the source of data, and any assumptions you made.

§ How does your beta compare to the total risk measures you have calculated – variance or standard deviation?

What is each statistic measuring? Does your stock appear to have a strong or a weak correlation with the market index?

§ How does your computed beta compare to the reported beta in the websites?

Why do you think they differ? Which one do you think is a better estimate of the market risk of your stock?

§ Does your company appear to have a lot of company-specific (unsystematic or diversifiable) risk or little? Is it possible for a company to have lots of company-specific risks and little market (systematic) risk? Explain.

How do your two estimates of required returns compare? Why do they differ? Which one do you feel is the more realistic estimate?

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