Tuesday, 7 January 2020

Unit 3: Introduction to Security Analysis

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Unit 3: Introduction to Security Analysis

Security analysis comprises of an examination and evaluation of the various factors affecting the value of a security.

Security analysis is about valuing the assets, debt, warrants, and equity of companies from the perspective of outside investors using publicly available information.

While there is much overlap between the analystical tools used in security analysis and those used in corporate finance, security analysis tends to take the perspective of potential 106    Security Analysis and Portfolio Management Notes investors, whereas corporate finance tends to take an inside perspective such as that of a corporate financial manager.

The equity value of a firm is simply its market capitalization, that is, market price per share multiplied by the number of outstanding shares.

Two types of approaches to valuation are discounted cash flow methods and financial ratio methods.

The “cash flow to equity” approach to valuation directly discounts the firm’s cash flow to the equity owners.

Free cash flow (FCF) is cash flow available for distribution among all the securities holders of an organization.

In general, each project’s value will be estimated using a discounted cash flow (DCF) valuation, and the opportunity with the highest value, as measured by the resultant net present value (NPV) will be selected.

This requires estimating the size and timing of all of the incremental cash flows resulting from the project.

Any outstanding warrants must be considered when valuing the equity of the firm.

Buyback is reverse of issue of shares by a company where it offers to take back its shares owned by the investors at a specified price; this offer can be binding or optional to the investors.

Goodwill is considered to be one of the largest intangible assets, the value of which companies want to reflect correctly in their financial statements.

Accounting for this asset, poses many challenges for accountants, as it is an unidentifiable intangible asset.

Amortisation: The process of increasing, or accounting for, an amount over a period of time.

Asset: Economic resources owned by business or company.

Intrinsic Value: The difference between the exercise (strike) price and the underlying stock price.

Warrants: Securities that entitles the holder to buy stock of the company that issued it at a specified price, which is usually higher than the stock price at time of issue.

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