Equity Markets, Valuation, and Analysis

CHAPTER 8Company Analysis

David Craig Nichols

Associate Professor of Accounting, Syracuse University

INTRODUCTION

This chapter introduces company analysis in the context of a three-step framework linking business activities to share prices. The origin of this framework is Nichols, Wahlen, and Wieland (2017) and Nichols and Wahlen (2020). The financial reporting process captures information on a company's underlying business activities, aggregates the information into financial reports, and communicates that information to investors (step 1). The financial statements provide crucial input for fundamental analysis, from which analysts and investors develop cash flow expectations and estimates of share value (step 2). In the final step, traders act on their information and value estimates, and these trading activities incorporate investor information about a company's business activities into the price (step 3).

This chapter focuses on company analysis, encompassing step 1 and the fundamental analysis part of step 2. The next section of this chapter describes each of these steps in more detail. The chapter then discusses accounting analysis, followed by fundamental analysis, before concluding.

THREE STEPS LINKING BUSINESS ACTIVITIES TO EQUITY PRICES

The relation between current accounting information and current stock prices depends on three steps, as depicted in Figure 8.1. Step 1 is the financial reporting process. In this process, the accounting system captures information ...