...Human Behavior and the Efficiency of the Financial System by Robert J. Shiller* Abstract Recent literature in empirical finance is surveyed in its relation to underlying behavioral principles, principles which come primarily from psychology, sociology and anthropology. The behavioral principles discussed are: prospect theory, regret and cognitive dissonance, anchoring, mental compartments, overconfidence, over- and underreaction, representativeness heuristic, the disjunction effect, gambling behavior and speculation, perceived irrelevance of history, magical thinking, quasimagical thinking, attention anomalies, the availability heuristic, culture and social contagion, and global culture. Theories of human behavior from psychology, sociology, and anthropology have helped motivate much recent empirical research on the behavior of financial markets. In this paper I will survey both some of the most significant theories (for empirical finance) in these other social sciences and the empirical finance literature itself. Particular attention will be paid to the implications of these theories for the efficient markets hypothesis in finance. This is the hypothesis that financial prices efficiently incorporate all public information and that prices can be regarded as optimal estimates of true investment value at all times. The efficient markets hypothesis in turn is based on more primitive notions that people behave rationally, or accurately maximize expected utility, and are able...
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...Is Skype worth $8.5 billion? An exercise in valuing young, growth companies Posted by Aswath Damodaran Wednesday, May 18, 2011 Last week, Microsoft announced that it would buy Skype for $8.5 billion. The reaction was fast, furious and very predictable. First, there was the search for reasons for the deal and technology mavens listed a few. Second, there was the reaction from investors and analysts, which was generally not very positive. Third, it was noted that Bill Gates, the face of Microsoft for so long, was strongly in favor of the deal (thus providing cover for Steve Ballmer). Ultimately, though, the discussion of the deal was lacking in one key respect: Is Skype worth $8.5 billion to Microsoft? A few of the analysts noted that the price paid was roughly ten times Skype's revenues in 2010, an undoubtedly rich price, but by itself proving nothing. After all, if you had been able to buy into Google at ten times revenues in 2003, you would be rich now. A great deal of attention was paid to whether Skype was the right company for Microsoft to buy and the strategic/synergistic fit of the two companies. It has always been my contention with acquisitions that it is not the strategic fit or synergistic stories that make the difference between a good deal and a bad one, but whether you buy a company at the right price. Put in more direct terms, buying a company that is a poor strategic fit at a low price is vastly preferable to buying a company that fits like a glove at the wrong...
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...comparable (or comp) same-store-sales in Q1 2013. This is the first such decline in 6 quarters of Walmart reporting comp increases. Based on a recent report published by Bloomberg, it appears Wal-Mart is struggling to keep its stores stocked with items that consumers are seeking. As seen in the below chart, Walmart’s tock, WMT, has been lagging behind its main competitors, Costco (COST) and Target (TGT). Given the weakness in global economies, and cautious consumer spending in the U.S. (WMT's biggest market), investors might be wondering whether Walmart stock is a good buy, sell or hold. Does WMT stock still make sense as a good investment or should investors seek better opportunities somewhere else? Let's analyze some of the valuation, fundamental and technical variables to better determine whether Walmart stock is a good buy, sell...
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...The company I pick from S&P 500 is Google Inc., which is a multinational corporation specializing in internet-related service and products. Google has been estimated to be a rapidly growing global technology leader focused on improving the way people connect with information, and its trading stock price is remained really high and still on the rise. The expected sales are given by Capital IQ from year 2014 to year 2018, and their values are listed below in the table. By calculating the average growth rate of sales over next five years, which is 12.8%, and have it compared with the one from the previous three years, which is 25.8%, it can be concluded that the projected sales value given by Capital IQ are reasonable. The average growth rate for the next five years represents a stable rate for a longer term, which should be lower than the short-term one when seeing the future performance of the company in a long-run view (Appendix A). Table1. Expected Cash Flows (in millions) | 2014 | 2015 | 2016 | 2017 | 2018 | Sales | 68,176 | 78,377 | 88,614 | 98,769 | 109,330 | The estimated EBITDA to Sales ratio is gained by calculating the average value of EBITDA margins from year 2011 to year 2013, which is 33.3%. Because the sales margins are acquired by Capital IQ from the market data as reliable source, we can use the average of the previous three years’ EBITDA margins as a constant multiple to project the future five years’ EBITDA. By assuming a constant EBITDA/Sales...
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...Memorandum TO: FROM: DATE: September, 27 2013 RE: One-Page Memo on JetBlue Case Study The purpose of this memorandum is to discuss the JetBlue case study, and review my answers to the specified questions. I will elaborate as to which price I believe JetBlue should choose for their initial public offering (IPO), and why JetBlue should choose that price. The first step in determining JetBlue’s IPO price is analyzing specific ratios of publicly traded competitors in JetBlue’s industry. I analyzed the Price-to-Earnings multiples, Cash Flow multiples, Total Assets multiples, and the Revenue multiples of the direct competitors of JetBlue. JetBlue’s direct competitors include; AirTran, Alaska Air, American West, MidWest, and Southwest. JetBlue’s relative stock prices are as follows: |JetBlue's Stock Prices Implied By Different Multiples | |Airline |P/E Multiple |CF Multiple |TA Multiple |Revenue Multiple | |AirTran |$36.41 |$23.71 |$45.20 |$9.24 | |Alaska Air |$47.23 |$27.64 |$30.69 |$8.92 | |American West |$29.04 |$30.82 |$26.24 |$8.39 | |MidWest |-$15.60 |-$11.42 |$39...
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...Warren Buffett Case Warren Buffett is the role model to all investors; therefore, I believe what he believed in is right (at least to him). However,we need to understand that not all of his rules work for everyone. Buffett's first rules is not to lose. The second rule is not to forget the first rule. He is absolutely right about this because risk management is always the key to success in investing. I think that valuing a share based on its relative performance to similar shares is a good strategy to make sure the return on your investment. The comparison of an investment against other returns available in the market was an important benchmark of performance is a good point. Moreover, Buffett also said that we should invest based on sound research and a detached emotional state and not to become an emotional slave to day to day price fluctuation. Buffett also has his points when he said that we should not believe in Efficient Market Theory because the market does have efficient sometimes doesn't mean the market always have its efficient. The intrinsic value is another point that inspired me because I agreed with him about we should focus on the firm's future output but not the historical input. However, I slightly disagree that accounting reality is useless. It is because we can't tell a firm's financial health by just looking at the economic reality. I also think that his heavy focus on economic reality relies too heavily on subjective evaluation of intangible assets and sometimes...
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...FINC 554 Investment Banking Names: Ali Geramian & Dinh Ton Assignment: Date : Google, Inc. February 11, 2013 Section (circle) ____30______31______32____ This assignment exclusively represents our own work. We have not discussed this case or this assignment with anyone and have done no outside research unless specifically authorized to do so. We have not discussed this work with any other students past or current nor have we reviewed any related work product prepared by such students. We have complied with the requirements of the Georgetown Honor System. Signed__________________________________________________________________ 1. Our review of the 4 analyst reports yields the following common themes: A) All reports are bullish on Google’s 2009 stock forecast; B) All use P/E ratio as part of their valuation method; and C) All EPS estimates, which exclude stock compensation, are in the range of $18.90 to $22.20. (Please refer to Exhibit 1 for more details). We will explore each report in more detail: Credit Suisse: Of the 4 reports, Credit Suisse achieves the most conservative price target at $400 per share based on a 5-year DCF analysis. Adverse macroeconomic factors are reflected in a comparatively high WACC of 13%. Terminal growth rate is responsibly estimated at 3%. Credit Suisse follows up with comparable P/E ratio analysis, which yields a price target of $339/share based on 17.9x ‘09 EPS of $18.9 and a 7.7x EV/EBITDA multiple. These estimates place...
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...Jorge Porres August 18, 2013 Investments Keiser University Week 3 Essays 1. Industry Life Cycle: Discuss the industry life cycle, how this concept can be used by security analysts, and the limitations of this concept for security analysis. The industry life cycle is made up of five stages: 1. Pioneer phase: This face is characterized by the high cost of production and the low demand of the product by the market. Mostly made up of start-ups. 2. Growth phase: When sales start to grow thanks to little competition. 3. Mature Growth phase: Companies begin to be affected by competition and as a result profit margins begin to diminish. 4. Stabilization /Maturity phase: this is typically the longest phase an industry will go thru, it is still affected by competition and starts growing by an average of the now fully created industry. 5. Deceleration / Decline phase: the falls in demand do to innovation in other products from other companies or industries. This life cycle can be effective to security analysis or to investors because they know when it is wise to invest, knowing that a company will grow, so will its market cap. It is not always 100% effective do that it is difficult to know when innovation will strike and one may not be prepared for the deceleration or decline phase. 2. P/E Ratio: The price/earnings ratio, or multiplier approach, may be used for stock valuation. Explain this process and describe how the "multiplier" varies from the one available...
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..."Which Valuation Metrics Work Best for Stock-Picking Within the Sector?" FIN630 Section 9044 Professor John Halstead October 30, 2011 Overview The article entitled “Which Valuation Metrics Work Best for Stock-Picking Within the Sector?” studies the effectiveness of several market valuation multiples in predicting outperformance of regulated utility stocks relative to the industry as well as the S&P 500 index from 1972 to 2010. The study that was conducted utilizes a database of financial information on publicly traded regulated utility stocks. “The initial source for the universe of firms was from FactSet, and consisted of all publicly traded stocks, that were classified as "Electric Utilities" under the Fact Set industry classification scheme.” FactSet is a company that provides computer-based financial data and analysis for financial professionals on global markets, public and private companies. The study started in 1972 with 80 publicly traded regulated utilities and ends in 2010 with 41 active regulated utilities. “This drop in the number of publicly traded regulated utilities over the last 40 years largely reflects the consolidation wave of the late 1990s and early 2000s, as well as the impact of deregulation during this period.” Black Book (2011). Methodology At the end of each month during the period of 1972-2010, we ranked the universe of regulated utility stocks were ranked on the basis of the following eight valuation metrics, and then sorted the...
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...1. Calculate RU a. Find the unleveraged Betas of Home Furnishings, Shipbuilding and Automotive divisions by using market segment competitors as a comparable. See Exhibit 9. b. βD is assumed to be 0.1-0.3 based on comparable S&P ratings and ratios of debt to total capital in Exhibit 10. c. Risk free rate given to be 9.5% and market risk premium is 8.6% d. Use historical proportion of operating income by segment in Exhibit 4 to aggregate Congoleum’s unlevered beta e. Calculate RU using the CAPM formula RU= RF + βU x MRP f. Alternatively, unlever Congeluem’s βE given in Exhibit 9 to get βE and Ru 2. Operating FCF Build discounted cash flow model with 5-year explicit forecast period from 1980-1984, as follows: a. Use projected Operating Income from Exhibit 15. b. From Exhibit 13, deduct corporate expenses and depreciation + amortization c. Less corporate taxes at 48% rate to get NOPLAT. d. Add back to NOPLAT the depreciation + amortization figures, less capital expenditure and changes in working capital. This gives the FCF to all capital 3. Calculate RD a. Due to the increased gearing of the Congoleum post LBO to >80%, the overall debt rate should effectively be higher than the bank senior financing of 14%. From Exhibit 10, such a debt rate corresponds to an S&P CCC rating. b. It is likely that the new senior and subordinated notes have lower interest rates because the “strips” issued to the insurance company investor includes preferred stock that pays additional...
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...Technical analysis involves identifying crowd behavior in order to join the crowd and take advantage of its momentum and direction. This is called the bandwagon effect. Here’s how a bandwagon works: A fresh piece of news comes out, a majority of traders interpret it as favorable to a security, and buying overwhelms selling so that the price rises. You profit by going with the flow. Then when everyone is jumping off the bandwagon, you jump, too. As market participants get excited about a security, they become increasingly bullish and either buy for the first time or add to positions, a phase namedenamed accumulation. When traders become disillusioned about the prospect of their security price rising, they sell, in a phase named distribution. To buy 100 shares of a stock is to enter a position. To buy another 100 shares for a total of 200 is toadd to your position. If you have 500 shares and sell half, you would be reducing your position. To sell all the shares you own is to square your position. When you’re square (also called flat), you have no position in the security. All your money is in cash. You’re neutral. After traders have been accumulating the security on rising prices, eventually the price goes too far.Too far is a relative term and can be defined in any number of equally valid ways, but basically it means any price extreme that’s wildly abnormal, statistically speaking. When a price has reached or surpassed a normal limit, it’s at an extreme....
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...JB Hi Fi Limited(JBH) | April 17 2011 | The following document is a complete valuation JBH based on DCF and Relative Valuation. All input justifications are provided and a final recommendation is presented. | | Business Summary JB Hi Fi (JBH) has experience unprecedented growth in the past few years in excess of 10% despite the Global Financial Crisis and weak consumer spending environments. JBH is likely to continue its strong growth (although below expectations) through a combination of recovering market conditions, a new era of smart products and with official interest rates likely to be placed on hold by the RBA until the end of 2011. (A) CHOICE OF MODELS ------------------------------------------------- 1. Discount Models Why FCFF Discount Model? DDM would not be a suitable model because JBH paid dividends which are significantly greater than or lower than FCFE to the firm between 2006 and 2010 thereby underestimating or overestimating the value of JBH (dividends less than 80% of FCFE or greater than 110% FCFE) . The debt to equity ratio has been volatile declining from 82.90% in 2003 to 23.73% in 2010 with a spike of 120.96% in 2006. Estimating future debt issues and repayments will prove to be difficult given that changes are expected because JBH has raised their senior debt facility by $105 million expiring by 2014 possibly to finance the roll out of up to 193 new stores by 2014 as well. The recent stock repurchases of $173 million and possible future...
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...Unit 3: Seminar Assignment MT480-01: Corporate Finance Alicia Turner Kaplan University Professor: S. Lacewell January 21, 2012 Seminar Assignment Unit 3 1.) What effects do changing interest rates have on bonds? The effects of changing interest rates on bonds would be the bond prices. If the interest rates tend to increase then the bond value will go lower and if the interest decreases then the bond value would be higher. In a case of purchasing a bond, the bond starts off with a fixed rate until it starts to mature. For example, if i were to purchase a bond at $5,000 with a 5% rate for 10 years, if the interest goes up to 6% then the value of the bond that I purchased would decrease and it would be beneficial for me to sell that bond at a discounted price. 2.) How are stocks prices related to expected dividends? Stock prices are related to expected dividends due the return that a person would receive on their stock. If the stock prices increase then your return would also increase. If the stock decreases then the expected dividend would remain the same as when the stock was purchased. 3.) How does the P/E ratio relate to the value of a stock? The P/E ratio is related to the value of stock due to the fact that it lets an investor/buyer know how much they are willing to pay per dollar of earnings. For instance, if a P/E ratio is 40 it would tell us that an investor is willing to pay $40 for every $1 of earnings that is generated by that company. References ...
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...process. Please let me know if you have questions or need further information. Yours truly, Brian Smith Enclosure Future analytical approach It is my opinion, that when dealing with future acquisitions, financial and accounting analysis is simply not enough. Therefore, it is my recommendation that an aggregate analytical approach include not just fundamental analysis, but also; corporate culture, synergy and customer analysis. Corporate Culture Analysis Future acquisitions need to carefully examine the morale and culture of the company being sought after. An overly dependent employee base that clings to its President and CEO presents a certain risk in production loss should the CEO exit the firm. As with the acquisition of Bainbridge House, morale dropped and attrition skyrocketed after Mr. Bainbridge’s passing. A high attrition rate and low morale has been shown to negatively affect production and overall efficiency. Therefore, a careful analysis needs to identify the independence and competitiveness of company employees. Synergy Analysis It is not enough to purchase a company based on fundamentals alone. If the company cultures of your firm and the firm being acquired are incompatible, valuable time will be lost looking for personnel replacements. Incompatibilities arise when the two companies have completely different goals and visions. As such, I recommend analyzing the takeover target’s mission statement, managerial goals, and obtaining an overall vision...
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...Advanced Fuel Corporation Kaize Lei Yu Wu Minh Nguyen 1. The type of financing largely depends on 3 factors: - Financial status of AFC - Amount of upside gain in a diversified portfolio - Record of past banking involvement in corporate venturing Advanced fuels Corporation is still at the early stage of formation, thus it is unlikely to break even in the future years and its probability of bankruptcy is high. Due to the difficulty in classifying loans to friends into either current or non-current liabilities, the exact ratio cannot be calculated. If the ratio is less than 1, then this means AFC will have trouble paying interest repayments if business suddenly fails. Investment banks cannot achieve their desired results by forming portfolios of risky debt securities because it cannot share fully in upside gains beyond the stated interest rate. 2. Planning: Finding out all the advantages and disadvantages of the proposal. This involves looking at all the components of the business plan to see if it is reliable and that the information is reasonable. Researching: Find out what Dr. Aplin’s work and education history to establish what his skills are and if the skills are related to the firm he proposes to start. Capitalist’s analysis: This can mean talking to other entrepreneurs who have started business with an innovative idea and have now established themselves as a mature company. 3. Liquidation Value The liquidation value is the value if the business is liquidated...
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