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)2 (1+𝑘)3
• 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
Chapter 4 Security Analysis
Equivalent form:
𝐷(0)(1 + 𝑔)
𝑃(0) =
𝑘−𝑔
• 𝐷(0): Dividend in the current period (time 0)
• 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
𝐴𝑀𝐴𝑛,𝑡 = ∑ 𝑃𝑡−𝑖
𝑛
𝑖=0
• 𝐴𝑀𝐴𝑛,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
Chapter 4 Security Analysis
5. Exponential Moving Average (EMA)
𝐸𝑀𝐴𝑡 = 𝛼𝑃𝑡 + (1 − 𝛼)𝐸𝑀𝐴𝑡−1
• 𝐸𝑀𝐴𝑡 : Exponential moving average at time 𝑡
• 𝑃𝑡 : Price at time 𝑡
• 𝐸𝑀𝐴𝑡−1 : EMA at time 𝑡 − 1 (previous period)
• 𝛼: Smoothing constant (exponent), 0 < 𝛼 ≤ 1
Calculation of the smoothing constant:
2
𝛼=
𝑛+1
• 𝑛: Number of periods for moving average
Alternate formula for calculation:
𝐸𝑀𝐴𝑡 = (𝑃𝑡 − 𝐸𝑀𝐴𝑡−1 ) × 𝛼 + 𝐸𝑀𝐴𝑡−1
• 𝑃𝑡 : Current price
• 𝐸𝑀𝐴𝑡−1 : Previous EMA
• 𝛼: Smoothing factor
6. Run Test for Randomness
Mean number of runs (𝜇𝑟 ):
2𝑛1 𝑛2
𝜇𝑟 = +1
𝑛1 + 𝑛2
• 𝑛1 : Number of positive changes
• 𝑛2 : Number of negative changes
• 𝜇𝑟 : Expected number of runs in a random sequence
Chapter 4 Security Analysis
Standard deviation of runs (𝜎𝑟 ):
2𝑛1 𝑛2 (2𝑛1 𝑛2 − 𝑛1 − 𝑛2 )
𝜎𝑟 = √
(𝑛1 + 𝑛2 )2 (𝑛1 + 𝑛2 − 1)
• Variables as defined above
Test statistic 𝑍:
∣ 𝑟 − 𝜇𝑟 ∣
𝑍=
𝜎𝑟
• 𝑟: Observed number of runs
• 𝜇𝑟 : Expected runs (mean)
• 𝜎𝑟 : Standard deviation of runs
7. T-test for Run Test at significance level
Lower limit:
𝐿𝐿 = 𝜇𝑟 − 𝑡 × 𝜎𝑟
Upper limit:
𝑈𝐿 = 𝜇𝑟 + 𝑡 × 𝜎𝑟
• 𝑡: Critical value from t-distribution for given degrees of freedom and significance level
• 𝜇𝑟 : Mean runs
• 𝜎𝑟 : 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
Chapter 4 Security Analysis
9. Calculation of Price Changes Sign (used in Run Test)
Sign of price change at time 𝑡:
+ if 𝑃𝑡 > 𝑃𝑡−1
𝑆𝑡 = {
− if 𝑃𝑡 < 𝑃𝑡−1
• 𝑃𝑡 : Price at time 𝑡
• 𝑃𝑡−1 : Price at previous time
10. Breadth Index
𝑁𝑒𝑡 𝐴𝑑𝑣𝑎𝑛𝑐𝑒𝑠 𝑜𝑟 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
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 𝑃𝑡 ≥ 𝑃𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑏𝑢𝑦 × (1 + 𝑁%)
Sell Signal:
If 𝑃𝑡 ≤ 𝑃𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 ℎ𝑖𝑔ℎ × (1 − 𝑁%)
• 𝑃𝑡 : Price at time 𝑡
• 𝑁%: Percentage threshold for triggering buy/sell
• 𝑃𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑏𝑢𝑦 : Price at last buy
Chapter 4 Security Analysis
• 𝑃𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 ℎ𝑖𝑔ℎ : Highest price after last buy
13. Calculation of Percentage Growth Rate
𝑉𝑎𝑙𝑢𝑒𝑡 − 𝑉𝑎𝑙𝑢𝑒𝑡−1
𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒 = ( ) × 100
𝑉𝑎𝑙𝑢𝑒𝑡−1
• 𝑉𝑎𝑙𝑢𝑒𝑡 : Value at current period
• 𝑉𝑎𝑙𝑢𝑒𝑡−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:
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)
𝑀𝐴𝑡 + 𝑀𝐴𝑡−1
Centered MA at 𝑡 =
2
• 𝑀𝐴𝑡 : Moving average at time 𝑡
• Centered MA smoothes moving averages by averaging two consecutive MAs