This article briefly outlines the basic factors in determining equity value as well as roles and techniques associated with Portfolio Management.

Determining Equity Value

Equity value involves four basic issues:

1. the characteristics of the stock as a financial security
2. the financial and business prospects of the issuer of the stock
3. the relative valuation of the particular stock versus other stocks
4. the valuation of financial securities in general and the stock market in particular

Portfolio Management Basics

Sector Pickers

“Stock pickers” focus on the characteristics of the particular stock as a financial security and the financial and business prospects of the particular issuer. They believe that they should value the stock and analyze the prospects for the issuer independent of market and economic changes. With their focus on individual securities, they believe that they are “buying companies” that will prosper over a longer period of time and reward investors because of their success. Value investors try to buy “good companies at cheap prices” when these companies are out of favour with other less-disciplined and more fad-oriented investors. Growth investors strive to find companies with business strategies and products that will allow them to achieve high levels of growth. Both value and growth investors try to ignore the future path of the market or economy. They are confident that the prospects for the individual securities they are buying will overcome other factors and do not try to “time the market”. If they cannot find individual stocks that are attractive, they might leave some monies in cash. This reflects their ability to find attractive investment ideas rather than representing a call on the market.

Sector Rotators

“Sector rotators” focus on the relative equity value compared to other stocks and the overall prospects for the stock market in general. Using historical methods, they assess the relative valuation of individual stocks and move between stocks and industry groups when they are cheap by comparison. They also assess the overall valuation of the market by using aggregate data on earnings, price and other historical accounting measures and comparing these to historical norms. Another valuation yardstick is a comparison to other financial assets, such as bonds or money market securities. Much emphasis is given to the relative levels of bond and money market yields and the market dividend yield. The stage of the economic cycle is important, as stock industry groups have differential performance over the course of a market and economic cycle. If their valuation measures suggest that the market is expensive, they sell stocks and raise cash to defend their portfolios from a potential market setback.

The average investment manager combines stock picking and sector rotation, maintaining their portfolio similarly to their index benchmark and to those of other managers. This type of manager will make industry and security “bets” in their portfolio weightings, moving into defensive stocks and cash in overvalued markets and weighting stocks and industries that are relatively attractive.

Fundamental Valuation Techniques

Fundamental equity value analysis relies on historical financial data and an assessment of the business prospects of an issuer. The historical data demonstrates the “track record” of the company and its management. The assessment of the business prospects of an issuer involves a study of the conditions and environment under which a company operates.

Related Article

The financial analysis of the company examines trends in its profitably, efficiency in employing capital, financial capability and other factors that the analyst considers important. These are assessed by calculating the applicable financial ratios and patterns of sales and profit growth. Important ratios to consider include: gross and net margin, sales and inventory turnover, financial and operating leverage, interest coverage, current, and quick ratios. Valuation yardsticks would include price/earnings, book value per share, earnings yield, dividend yield, and return on equity.

Beyond a Standard Assessment of Equity Value

A more “in-depth” review would include interviews with senior management of the company, both telephone and in person, and even discussions of the company’s prospects with suppliers, regulators (where applicable) and even competitors’ personnel.

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