Since there are a few investment bankers on here and I am really bad at anything predictive… I have heard that there are simple analytical techniques that are used by IB to predict what a stock should be?
Would anyone care to give a brief outline of the methodology?
People use various methods to determine the true valuation of a stock. From a simple P/E determination and aligning it with historical and then projecting hte future value to more scientic, EVA (Economic Value added) and the DCF (discounted cash flow) projections to measure the true worth of the company.
Re: Oh ye investment bankers!
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*Originally posted by hmcq: *
Since there are a few investment bankers on here and I am really bad at anything predictive..... I have heard that there are simple analytical techniques that are used by IB to predict what a stock should be?
Would anyone care to give a brief outline of the methodology?
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the financial statements should also give you a clear idea of where they stand...also look at their financial ratios compare them with industry averages..
^ that’s deep. 
^ aahhh thanks matsui…are you trying to make up for the bashing u get on other threads…?
waisay EVA & DCF are real deep though :k:
Matusi and lussi (names seem kinda similar - an IB thing?)... I was seeking a more detailed post as in:
P/E ratio means----? and for a stock say Intel you would use it in the following manner.... simply stating P/E ratio is like telling me the plane flies... I know it flies... but how?
Price to earnings ratio is one of the ways investors gauge the stock by comparing the same ratio to industry avgs, as lussi mentioned.
market cap/annualized revenue: Limitation here is that this doesn't take into account the varying rates of revenue growth and balance sheet strength.
market cap/pre-tax income: this way you can take into account the different levels of oeprating expenses as well as hidden charges
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*Originally posted by hmcq: *
P/E ratio means----? and for a stock say Intel you would use it in the following manner.... simply stating P/E ratio is like telling me the plane flies... I know it flies... but how?
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P/e ratio is simply a stock market price divided by earnings per share (earnings per share is company's operational income divided by the value of stock). Simply put, this ratio indicates the amount of confidence external market has on the company. A word of caution, this measure is affected by the general macroeconomic conditions in the country eg during the late 90's tech companies had extremely high PE's.
If you are not comfortable in analyzing financial statements then you can buy research reports about the company that you’re interested in. One very good source is Value Line, which is available in libraries or you can buy it through the net.
Also, keep a check on any news regarding the company because they affect the stock price fairly quickly. An easy of doing this is to go to Yahoo Finance, enter the company's symbol and then click the 'News' link. A benefit of using Yahoo is that it serves as an integrating point, collecting news from multiple sources.
P/E ratio is no way to value a stock. A brand new company would have negative earnings but still have a positive market cap. How are you going to compare it to companies with positive P/E? With divine intervention?
Any metric based on earnings is easy to manipulate and will hide the true picture. For example, one-time write-offs and depreciation can swing net earnings wildly.
The only intelligent way to value a stock is to project its free cash flow and discount it at its cost of capital that reflects the going forward riskiness of the complany.
Many investment bankers are trash-talking dumbasses prone to throwing around jargon and applying formulas like monkeys with no sense of what the implications of those formulas are. Don't trust them.
Negative. We look for such one-timers and base valuations for such multiples exclusive of these distorters.
Positive. Though i would not necessarily agree with the ‘only’ part. Yes, it is the most-used and dependent upon analysis. There are a lot of variants of the generic DCF approach such as the Free Cash Flows to Equity (FCFE) and the Free Cash Flows to Firm (FCFF) which take into account the impact of various growth phases of a company (Kareem: especially true for your high-growth companies or startup ventures).
hmcq: As we say…a financial model used for valuation is only as good as the assumptions behind it. In essence we do what Kareem has said. We look at:
All of the above are then translated into hard numbers which form the core assumptions of the financial model.
More than the core model itself, we IBs fancy the scenarios which we build with the financial model. Typically speaking we form a minimum of three scenarios: one reflecting a base case (distress situation) , a realistic scenario and an ambitious (rosy picture) scenario. The only difference in the three models is for the inputs we feed in our assumptions sheet which obviously result in different projected financial statements and the resulting valuations of the company.
As you may have figured, it is not an exact science…one analyst’s assumptions most certainly will be different from the others and both may be right in their own world. It’s about taking a viewpoint for the future and justifying it with your reasoning.
I am not too sure what answer you were looking for. You, in your own capacity can buld a rough, back-of-the-envelope kinda model but the fine-tuning and the wizardry as well call it is for the IBs. 
Feel free to clarifiy if some of it din’t make much sense. :~)
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*Originally posted by Khanzada: *
Negative. We look for such one-timers and base valuations for such multiples exclusive of these distorters.
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Well, but ultimately you don't value them using P/E multiples where the earnings are based on noise that has no relation to the firm's typical ongoing operations.
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*Originally posted by Khanzada: *
There are a lot of variants of the generic DCF approach such as the Free Cash Flows to Equity (FCFE) and the Free Cash Flows to Firm (FCFF) which take into account the impact of various growth phases of a company
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Agreed. Different variations of the same fundamental approach. I like to unleverage the balance sheet fully, get the free cash flows the firm generates, and account for appropriate leverage in the discount rate. This works best for acquisition valuations. For purely stock picking purposes, it is better to model the balance sheet with leverage.
ok so different models are used for evaluating firms to different levels/accuracy. Is this done by IBs or are they only focused on venture capital for new firms?
Second question, if the models are reasonably well developed, why are they off when compared to predictions? Are there any specific assumptions that make them particularly sensitive to random/unpredicatable changes? Are the predictions for all the listed stocks updated everyday?
So far this is what I understand:
P/E ratio is a relatively simple and fast way of getting some ball park idea of stock prices/changes.
Market cap/annualized revenue and other revenue related models: can be twisted through accountants?
Free Cash flow models and methods: Mostly for newer firms that may not be able secure short/long term finances.
hmcq,
It is good to understand the fundamentls of a company, however, people like you and me will never understand it to its fullest extent. And then again, dont you think somebody who invest billions into the stock market will have the fundamental information long before it is issued out to us. I only get the very basic information out of income statements, balance sheets and cash flow statements, probably only 10% of the total info. I am, however, good with numbers and graphs, so I rely more (but not solely) on Technical Analysis.
In a perfectly logical world where humans could separate their emotions from investment decisions, then, fundamental analysis the determination of price based on future earnings, would work magnificently. And since we would all have the same completely logical expectations, prices would only change when quarterly reports or relevant news was released.
The price of a stock represents a consensus. It is the price at which one person agrees to buy and another agrees to sell. The price at which an investor is willing to buy or sell depends primarily on his expectations. If he expects the security's price to rise, he will buy it; if the investor expects the price to fall, he will sell it. These simple statements are the cause of a major challenge in forecasting stockprices, because they refer to human expectations. As we all know firsthand, humans are not easily quantifiable nor predictable. This fact alone will keep any mechanical trading system from working consistently.
Because humans are involved, much of the world's investment decisions are based on irrelevant criteria. Our relationships with our family, our neighbors, our employer, the traffic, our income, and our previous success and failures, all influence our confidence, expectations, and decisions.
If prices are based on investor expectations, then knowing what a stock should sell for (fundamental analysis) becomes less important than knowing what other investors expect it to sell for. That's not to say that knowing what a security should sell for isn't important--it is. But there is usually a fairly strong consensus of a stock's future earnings that the average investor cannot disprove.
Technical analysis is the process of analyzing a stock's historical prices in an effort to determine probable future prices. This is done by comparing current price action (current expectations) with comparable historical price action to predict a reasonable outcome.
Investment is exposure to risk and my risk is a lot greater than the billioaire with insider info.
If the fundaments are the indicators of long run equilibrium price for a stock then should not holding onto a stock with the right fundamentals for the long run be ok, since the short term ups and downs are not really only mechanistic but also include the human factor, but in the long term the stock will tend towards the fundamentals pricing?
Perhaps the question for the IB bankers should be how many stocks tend towards their fundamentals pricing?