CMA Final · Strategic Financial Management

Fundamental Analysis and Technical Analysis: formula sheet

Full chapter guide

Key formulas

Undervalued / overvalued test: Intrinsic value > Market price → undervalued (buy); Intrinsic value < Market price → overvalued (sell); This is the decision rule of fundamental analysis. If the two are equal, the security is fairly priced.
Top-down fundamental order: Economy analysis → Industry analysis → Company analysis; A bottom-up approach reverses this and starts from the company.
Investment process order: Objectives and policy → Security analysis → Portfolio construction → Portfolio revision → Performance evaluation; Use this sequence when asked for steps. Revision and evaluation feed back into the earlier stages.
Holding period return: Return = (Dividend + Closing price − Opening price) ÷ Opening price; Used for simple return comparisons when judging a security.
Top-down approach: Economy → Industry → Company; Economic analysis is the first stage; the conclusion sets the backdrop for the later two.
Intrinsic value (general): V₀ = Σ [CFₜ ÷ (1 + k)ᵗ]; Macro factors change CFₜ (earnings) and k (required return). Use this to explain effects.
Real interest rate (exact): (1 + real rate) = (1 + nominal rate) ÷ (1 + inflation); Approximation: real ≈ nominal − inflation. Use the exact form when asked for precision.
Gordon growth value: P₀ = D₁ ÷ (k − g); A rise in k lowers P₀; a rise in sustainable g raises it. Needs k > g.
Business cycle phases: Expansion → Peak → Contraction → Trough; Stock prices usually lead the cycle; corporate profits tend to lag.
Top-down sequence: Economy analysis → Industry analysis → Company analysis; Industry analysis sits in the middle. Bottom-up reverses this order.
Industry life cycle stages: Pioneering → Expansion (growth) → Maturity (stabilisation) → Decline; Some books add a fifth stage. Use the stage names given in the question.
Porter's five forces: New entrants + Suppliers' power + Buyers' power + Substitutes + Rivalry among existing firms; The stronger the forces, the lower the industry's profit potential.
Industry growth comparison: Industry growth rate vs GDP growth rate; industry share of sales or profit over time; Use to judge whether an industry is growing faster than the economy, in line with it or below it.
Intrinsic value, general DDM: P₀ = Σ Dₜ ÷ (1 + ke)ᵗ + Pₙ ÷ (1 + ke)ⁿ; Use when dividends vary year by year and a sale price at year n is given.
Gordon (constant growth) model: P₀ = D₁ ÷ (ke − g) = D₀ × (1 + g) ÷ (ke − g); Valid only when ke > g and growth is constant forever. Check whether the given dividend is D₀ or D₁.
Zero growth model: P₀ = D ÷ ke; Dividend stays flat forever, as with a perpetuity.
Sustainable growth rate: g = b × r, where b = retention ratio = 1 − payout ratio and r = ROE (or return on retained earnings); Use when growth is not given but retention and ROE are.
Cost of equity by CAPM: ke = Rf + β × (Rm − Rf); Use when ke is not given directly.
P/E valuation: Value per share = EPS × P/E ratio; EPS = earnings available to equity ÷ number of equity shares.
P/E ratio: P/E = Market price ÷ EPS; Its inverse, EPS ÷ price, is the earnings yield.
Terminal value in multi-stage DDM: Pₙ = Dₙ₊₁ ÷ (ke − g₂); Discount Pₙ back n years at ke, then add it to the PV of the high-growth dividends.
Justified P/E under constant growth: P/E = Payout ratio × (1 + g) ÷ (ke − g), using EPS₀; or Payout ratio ÷ (ke − g), using EPS₁; Match the formula to whether EPS is current or next year's.
Dow Theory trends: Primary (months to years) > Secondary (weeks to months) > Minor (days to weeks); Secondary moves are corrections against the primary trend. Durations are approximate.
Head and shoulders: Left shoulder → Head (highest peak) → Right shoulder; neckline break = sell signal; Bearish reversal pattern. Inverse form with a neckline break upward is bullish.
Price target from head and shoulders: Target ≈ Neckline − (Head peak − Neckline); A common rule of thumb for the minimum fall, not a guarantee. Measure the head height from the neckline.
Support and resistance: Break above resistance = bullish; break below support = bearish; A level broken decisively often reverses its role. Volume confirmation makes the signal stronger.
Candlestick body: Body = difference between open and close; shadows = high and low beyond the body; Bar chart carries the same four data points but shows them as a vertical line with ticks.
Simple moving average (n periods): SMA = (P1 + P2 + … + Pn) ÷ n; Equal weights. Drop the oldest price and add the newest for each new period.
EMA smoothing factor: k = 2 ÷ (n + 1); For a 9-period EMA, k = 2 ÷ 10 = 0.2.
Exponential moving average: EMA today = (Price today × k) + (EMA yesterday × (1 − k)); The first EMA is usually taken as the SMA of the first n periods.
Relative Strength (RS): RS = Average gain ÷ Average loss; Averages are over the period, usually 14. Losses are taken as positive numbers.
Relative Strength Index: RSI = 100 − [100 ÷ (1 + RS)]; Above 70 overbought, below 30 oversold, as a common convention.
MACD line: MACD = 12-period EMA − 26-period EMA; Positive means short-term average is above long-term average.
MACD signal line: Signal = 9-period EMA of MACD; MACD crossing above signal is bullish. Crossing below is bearish.
Bollinger bands: Middle = 20-day SMA; Upper = Middle + 2σ; Lower = Middle − 2σ; σ is the standard deviation of the same 20 closing prices.
Advance-decline ratio: A/D ratio = Number of advancing shares ÷ Number of declining shares; Above 1 means more shares rose than fell. Unchanged shares are left out.
Net advances and A/D line: Net advances = Advances − Declines; A/D line = Σ net advances; Cumulative total. Compare its direction with the index.
Weak form efficiency: Prices reflect all past price and volume data; Technical analysis fails to earn abnormal returns. Fundamental analysis and insider information may still work.
Semi-strong form efficiency: Prices reflect all publicly available information (includes weak form); Both technical and fundamental analysis fail to earn abnormal returns. Only insider information may work.
Strong form efficiency: Prices reflect all information, public and private (includes semi-strong form); No one earns abnormal returns, not even insiders.
Random walk: Pt = Pt-1 + expected return + random error; The error is unpredictable and independent over time, so past changes cannot predict future changes.

Quick revision

Fundamental analysis finds intrinsic value; technical analysis studies price and volume history.
Fundamental analysis is top-down: economy, then industry, then company.
Buy when intrinsic value is above market price; sell when it is below.
Industry analysis looks at life cycle stage and competitive forces.
Company analysis combines qualitative review with financial ratios and valuation.
Dow Theory: markets move in primary, secondary and minor trends.
Technical analysis assumes price discounts everything and trends tend to continue.
A moving average smooths prices; price crossing it is read as a signal.
Market breadth compares advancing and declining shares to judge market strength.
Weak form: past prices are already reflected, so technical analysis cannot beat the market.
Semi-strong form: all public information is reflected, so fundamental analysis cannot beat the market.
Strong form: all information, including private, is reflected.
Random walk: price changes are independent, so past moves do not predict future ones.

Common mistakes

Saying technical analysis finds intrinsic value. Fix: Remember that technical analysis studies price and volume to time trades. Only fundamental analysis estimates intrinsic value.
Listing investment process steps in the wrong order. Fix: Start with investor objectives and constraints, then analysis, construction, revision and evaluation.
Saying higher inflation always lowers share prices. Fix: Say high or unexpected inflation hurts through costs and rates, while firms with pricing power can pass it on. Qualify the statement.
Naming the effect but not the channel. Fix: Always say whether earnings, the discount rate or both change. This is where marks are given.
Listing Porter's five forces without applying them to the industry in the question. Fix: Add a one-line judgement for each force, such as strong because many buyers can switch easily.
Treating the life cycle as a rigid timetable that every industry follows. Fix: Say that stages vary in length and that some industries renew themselves through new products or technology.
Using D₀ directly in the Gordon formula. Fix: The numerator is the next dividend, D₁. If D₀ is given, compute D₀ × (1 + g) first.
Applying the constant growth model when ke is not greater than g. Fix: Always compare ke and g first. If g ≥ ke, the model gives a meaningless value.
Treating a secondary trend as a reversal of the primary trend. Fix: Under Dow Theory a reversal needs confirmation, such as lower highs and lower lows and confirmation by the second index. Until then it is a correction.
Calling a head and shoulders a sell signal as soon as the right shoulder forms. Fix: The signal comes only when price breaks below the neckline, preferably with higher volume.

Exam tips

For 'differentiate' questions, write in point form with equal coverage of both approaches. Four to six points with clear heads score well.
Keep the investment process in order. Examiners check the sequence, so number the steps.
In a case, quote the data that points to your choice, such as earnings and growth for fundamental and price charts for technical.
Link the efficient market view to the weak and semi-strong forms in one line. This shows you understand why the approaches are debated.
In MCQs, watch for statements that give intrinsic value to technical analysis. They are usually the wrong option.
Write both channels (earnings and discount rate) in every theory answer; examiners reward the linkage.
For 'discuss' questions, give each factor a short heading with its effect and one example sector.
Show the before-and-after values in numerical questions and state the percentage change.