Fundamental Analysis

Question 1

What is the opposite of an “excellent” business?

Answer 1

A “commodity type” business.

A commodity is:

• a product that is the same from manufacturer to manufacturer
• the primary consumer purchase motivation is price

Question 2

What traits do commodity type businesses have in common?

Answer 2

• absence of brand loyalty: when brand loyalty exists, the company can charge a premium (which increases profit margin)
• multiple producers: too many companies making the same product, or supplying the same service, translates into intense price competition (they have to lower their prices)
• excess capacity: if there is the presence of excess production capacity throughout the industry, companies are usually forced to compete on price.

These three traits translate into:

• low profit margins
• low returns on equity
  (Two attributes of companies that investors like to avoid)

Question 3

Profitability ratios

Answer 3

Metrics that measure the profit-generating ability of a company relative to sales, assets, and equity.

• you can’t simply use one profitability ratio. You have to use many, over time.
• they’re a good way to judge a company’s performance.

They are used in fundamental analysis.

They are:

• gross profit margin (GPM)
• net profit margin (NPM)
• return on equity (ROE)
• return on investment (ROI)
• return on assets (ROA)

Question 4

ROE

Answer 4

Return on equity

• profitability ratio that analyzes management’s ability to earn a fair return on the shareholder’s investment.
• Each company has “shareholders equity”, the amount of cash received from shareholders in exchange for shares.
• each company also has “net income” (or “net profit”) for the full fiscal year.
• you would divide net income by shareholders equity to get the percentage.

Question 5

What are the two companies to consider buying?

Answer 5

1) . Stocks of businesses that we understand.

2) . Businesses that are “excellent” and have expanding value.

Question 6

Intrinsic value

Answer 6

Examining a stock (which will carry risk) versus a benchmark (like a treasury) that offers a risk-free return.

If it can’t beat the treasury, it isn’t worth the investment.