Chapter 4 Security Analysis
1. Dividend Valuation Model (Uniform Dividends)
D(1)=D(2)=D (3)=…=D
D(t ): Dividend per share at time t
D : Constant dividend amount per share every year
D D D
P(0)= + + +…
1+k ( 1+k ¿ ( 1+ k ¿ 3
2
P(0): Present value (price) of the share at time 0
D : Dividend per share per period (constant)
k : Required rate of return or discount rate
Terms represent the discounted value of dividends over infinite time
D
P(0)=
k
Simplified formula for price with constant dividends
P(0): Price of share today
D : Dividend per share
k : Required rate of return
2. Dividend Growth Model (Gordon Growth Model)
D(1)
P(0)=
k−g
P(0): Present value (price) of the share
D(1): Dividend expected at end of first period
k : Required rate of return
g: Constant growth rate of dividends, g< k
Equivalent form:
D(0)(1+ g)
P(0)=
k −g
D(0) : Dividend in the current period (time 0)
Chapter 4 Security Analysis
g: Dividend growth rate
k : Required rate of return
3. Dividend Growth Model with Dividend Payout Ratio and Earnings
b × E(1)
P(0)=
k −g
P(0): Present value (price) of the share
b : Dividend payout ratio (fraction of earnings paid as dividends)
E(1): Earnings per share at end of first period
k : Required rate of return
g: Growth rate of dividends/earnings
Equivalent form:
b × E(0)(1+ g)
P(0)=
k−g
E(0): Earnings per share at current period
Other variables as above
4. Arithmetic Moving Average (AMA)
n−1
1
AM An , t= ∑ Pt−i
n i=0
AM An , t : n-period arithmetic moving average at time t
Pt −i : Price at time t−i
n: Number of periods over which average is calculated
5. Exponential Moving Average (EMA)
EM A t=α Pt +(1−α )EM A t−1
EM A t: Exponential moving average at time t
Pt : Price at time t
EM A t−1: EMA at time t−1 (previous period)
α : Smoothing constant (exponent), 0< α ≤1
Chapter 4 Security Analysis
Calculation of the smoothing constant:
2
α=
n+1
n: Number of periods for moving average
Alternate formula for calculation:
EM A t=(Pt −EM At −1)×α + EM At −1
Pt : Current price
EM A t−1: Previous EMA
α : Smoothing factor
6. Run Test for Randomness
Mean number of runs ( μr ):
2 n1 n2
μr = +1
n1 +n2
n1: Number of positive changes
n2: Number of negative changes
μr : Expected number of runs in a random sequence
Standard deviation of runs (σ r):
σ r=
√ 2n 1 n2 (2 n1 n2−n1−n2 )
¿¿
¿
Variables as defined above
Test statistic Z :
∣ r−μr ∣
Z=
σr
r : Observed number of runs
μr : Expected runs (mean)
σ r: Standard deviation of runs
Chapter 4 Security Analysis
7. T-test for Run Test at significance level
Lower limit:
¿=μr−t ×σ r
Upper limit:
UL=μr +t ×σ r
t : Critical value from t-distribution for given degrees of freedom and significance
level
μr : Mean runs
σ r: Standard deviation of runs
8. Price-Earnings Ratio (P/E)
Market Price per Share
P/ E=
Earnings per Share
Market Price per Share: Current trading price of share
Earnings per Share (EPS): Net earnings divided by number of shares outstanding
9. Calculation of Price Changes Sign (used in Run Test)
Sign of price change at time t :
St =
{
+¿ if P t > Pt −1
−¿ if P t < Pt −1
Pt : Price at time t
Pt −1 : Price at previous time
10. Breadth Index
Net Advances ∨ Declines
Breadth Index=
Total Number of Issues Traded
Net Advances or Declines: Number of advancing stocks minus declining stocks
Total Number of Issues Traded: Total stocks traded in the market
11. Confidence Index
Chapter 4 Security Analysis
Yield on High−grade Bonds
Confidence Index=
Yield on Low−grade Bonds
Yield on High-grade Bonds: Return on government or high-quality bonds
Yield on Low-grade Bonds: Return on lower-quality or riskier bonds
12. Filter Rule (Trading Strategy)
Buy Signal:
If P t ≥ P previous buy ×(1+ N %)
Sell Signal:
If P t ≤ P previous high ×( 1−N %)
Pt : Price at time t
N %: Percentage threshold for triggering buy/sell
P previous buy : Price at last buy
P previous high : Highest price after last buy
13. Calculation of Percentage Growth Rate
Growth Rate=
( Value t−Value t−1
Valu et −1 )
×100
Valu et : Value at current period
Valu et −1: Value at previous period
14. Relationship for Exponential Moving Average Exponent (from text)
Given exponent a is expressed as:
2
a=
n+1
n: Number of days for which average is calculated
a : Exponential smoothing constant
15. Calculation of Moving Average Sum (from Practical Illustration)
Sum of last n closing prices:
Chapter 4 Security Analysis
n−1
St =∑ Pt −i
i=0
St : Sum of closing prices over last n periods up to time t
Pt −i : Closing price at period t−i
16. Calculation of Two-item Centered Moving Average (Practical Example)
M At + M At −1
Centered MA at t=
2
M A t : Moving average at time t
Centered MA smoothes moving averages by averaging two consecutive MAs