Question

a. Enumerate four (4) factors to consider in analyzing the domestic economy as part of fundamental analysis.
b. Distinguish between time limit orders and Limit orders
c. Explain the following Investment ratios and indicate how they are computed:
Earnings per share (EPS) and Price/Earnings ratio (P/E).
d. What is market efficiency? Differentiate between weak and semi strong form efficiency
e. Next Pharmacy Ltd, an all equity finance company has started the production of a vaccine against COVID-19. The popularity of the vaccine is such that it expects to pay its shareholders dividends of ȼ150 which grows steadily at 10%. The company has a beta of 1.75. The risk-free rate is 5% and the expected return on the market is 18.34%.
Required: Calculate the stock’s required rate of return and price per share.

Answer 1

a) Fundamental analysis is the test of the underlying forces that affect the well being of the economy, industries and companies. As with most analysis, the goal is to derive a forecast and profit from future price movements. For the domestic economy, fundamental analysis might focus on economic data to assess the present and future growth of the economy. General Steps to analyzing the domestic economy would be:

1. Economic Forecast - First and foremost in a top-down approach would be an overall evaluation of the general economy.

2. Group Selection -  then certain groups are more likely to benefit than others. As an investor can narrow the field to those groups that are best suited to benefit from the current or future economic environment.

3. Narrow Within the Group - Once the industry group is chosen, an investor would need to narrow the list of companies before proceeding to a more detailed analysis.

4. Company Analysis - With a shortlisted companies, an investor might analyze the resources and capabilities within each company to identify those companies that are capable of creating and maintaining a competitive advantage.

b) Time limit order- in this order, Customer order that sets the time limit during which the order can be executed and after which it is cancelled. Also called time order. whereas

Limit order - is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. A limit order is not guaranteed to execute.

c) Earning per share - It is common for a company to report EPS that is adjusted for extraordinary items and potential share dilution. The higher a company's EPS, the more profitable it is considered.

EPS = [ Net Income − Preferred Dividend (+or−) Extraordinary Items​ ] / Weighted Average Common Shares

Price/ Earning Ratio - this ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company's earnings. This is why the P/E is sometimes referred to as the price multiple because it shows how much investors are willing to pay per dollar of earnings.

P/E Ratio = Share Price / Earning per share

d) Market efficiency - defines to the degree to which market prices shows all available and relevant information. If markets are efficient, then all information is incorporated into prices, and so there is no other way to beat the market because there are no undervalued or overvalued securities available in the market.

Weak-form efficiency - future prices cannot be predicted by analyzing prices from the past.

Semi-strong-form efficiency - is a type of efficient market hypothesis, which holds that security prices adjust quickly to newly available information, thus eliminating the use of fundamental or technical analysis to achieving a higher return.

e) Rate of return = risk free return + beta (market return - risk free return)

= 5% +1.75( 18.34% - 5% )

= 28.345%

Stock price = Dividend per share / (Required Rate of Return – Dividend Growth Rate)

=150 / (28.345% - 10%)

= 817.66