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1、Investment Returns, Equity Value, and Financial Statements,PART I,Gaining the Understanding to do Fundamental Analysis,Chapter 3,Investment Returns,Investment Returns,What you will learn in this chapter,How investment returns are calculated The difference between normal and abnormal returns What an
2、efficient market price means What an arbitrage opportunity is The difference between active and passive investment The difference between an alpha and a beta How asset pricing models work (in outline) How screening strategies work (and dont work) What a contrarian strategy is How fundamental analysi
3、s differs from screening and contrarian analysis How various stock selection strategies have worked in the past,For a terminal investment: For an investment in equity: For a one-year equity investment Payoff: Return: Rate-of-Return: Expected Return: Expected Rate-of-Return: Required Payoff per dolla
4、r: Required Rate-of-Return: The required return is also called the normal return or the cost of capital,The Structure of Investment Returns,Hewlett-Packard: Returns for 1991,If the price paid for a stock is (expected payoff discounted at the required payoff per dollar, r), the stock is appropriately
5、 priced: the market price is efficient Or, price is efficient if it equals the expected return capitalized at the required rate-of-return: Or, todays price (P0) must be such that the required rate-of-return, r-1, will equal the (expected) rate-of-return :,The No Arbitrage Condition (NA),Required Rat
6、e-of-Return,Expected Rate-of-Return,Arbitrage Trading Strategies,If NA holds, the market is efficient in that stock: there is no arbitrage opportunity Any discrepancy between expected and required rate-of-return, is an arbitrage opportunity that, if exploited, will profit the arbitrage trader An arb
7、itrage opportunity arises if If then BUY If SELL The difference is called the expected abnormal return and the rule can be restated as: BUY if the expected abnormal return is positive, and SELL if negative. If it is zero, do nothing (HOLD),Types of Arbitrage,Risk 1. Pure (Risk-Free) Arbitrage You ge
8、t something for nothing, for sure 2. Expectational Arbitrage You have a better chance of an abnormal return than not Location of prices 1. Cross-sectional Arbitrage Different prices for the same commodity at the same point in time 2. Intertemporal Arbitrage Different prices for the same commodity at
9、 different points in time,These concepts apply to an investment for more than one period with two modifications: The multiperiod rate-of-return will be the compounded annual rate. For a T-year period and a flat term structure, the required payoff is: For a changing term structure it would be Dividen
10、ds for the intermediate years can be reinvested at r. The accumulated value at year T of reinvested dividends is called terminal value of dividends at T Adding the selling price will give the cum dividend payoff or cum-dividend terminal price: And the T-period cum dividend return will be,Multiyear E
11、quity Investments,Hewlett-Packard 1990-95: Payoffs,1994,1995,1993,1992,1991,1990,d4=0.55,P5=84,d3=0.45,d2=0.36,d1=0.24,d5=0.90,P0=13,Terminal Value of Dividends,0,1,2,3,4,5,d,1,d,2,d,3,d,4,d,5,d,2,x,r,-2,d,3,x,r,-3,d,4,x,r,-4,d,5,x,r,-5,d,1,r,-1,d,2,r,-2,d,3,r,-3,d,4,r,-4,d,5,r,-5,(Year 0 value),(Ye
12、ar 5 value),1,2,3,4,5,d,1,d,2,d,3,d,4,d,5,(Year 5 value),(Year 0 value),0,( ),r,5,d,t,r,-,t,t,=,1,5,HP 1990-95: Terminal Dividend Payoff,HP 1990-95: Five-Year Return,Terminal value of dividends in 1995 2.76 Price payoff in 1995 (PT) 84.00 Total Payoff 86.76 Purchase price in 1990 (P0) 13.00 Five-yea
13、r return 73.76 Five-year-rate-of-return 567.38% *Normal rate of return (12% p.a.) 76.23% Abnormal rate of return 491.15% * Normal rate of return = (1.125 - 1) = 76.23 %,The NA condition for a multiyear investment is now Or Or,Multiyear Equity Investment: NA,Expected rate-of-return,Required rate-of-r
14、eturn,Dividends and Capital Gains,T-period return components: For one period:,Capital Gain Component,Dividend Component,+,-,1,0,1,d,P,P,Capital Gain Component,Dividend Component,Intrinsic Values,Intrinsic value is calculated by forecasting payoffs from the information about them and applying the dis
15、count rate Two ways to calculate intrinsic values (V0): 1. Present value of the expected payoff V0 = Expected payoff / rT 2. Capitalized expected returns V0 = Expected returns / (rT -1) Always two ingredients: Expected payoffs and discount rates Intrinsic values at different points in time always obey the no arbitrage condition (NA): =,Beta technologies: Calculates the normal return Ignores any arbitrage opportunities This is the denominator issue in valuation Alpha technologies: Tries to gain abnormal returns by exploiting arbitrage opportunities This involves the numerator issue in val
