Master Element 4 of the RSE exam covering securities analysis. Learn fundamental analysis, key financial ratios (P/E, ROE, Current Ratio), economic indicators, and the basics of technical analysis.
RSE Exam Element 4: Securities Analysis (~12%, 14 Questions)
This element requires a mix of conceptual understanding (Economics) and calculation/interpretation (Financial Statements & Ratios). Don't just memorize formulas - understand what they mean.
Fundamental Analysis - Top-Down Approach
The standard method: Analyze the Economy first (Is it a good time to invest?), then the Industry (Which sector will outperform?), and finally the specific Company (Which stock is the best in that sector?).
Fiscal vs. Monetary Policy
| Policy | Controlled By | Tools | Expansionary | Contractionary |
|---|---|---|---|---|
| Fiscal | Government | Taxation, Spending | Cut taxes / Increase spending | Raise taxes / Cut spending |
| Monetary | Bank of Canada | Interest rates, Open Market Operations | Lower rates (cheap borrowing) | Raise rates (cool inflation) |
Economic Indicators
Leading Indicators (Predict the Future)
- Stock market indexes (S&P/TSX)
- Housing starts
- Manufacturers' new orders
Coincident Indicators (Current State)
- GDP
- Retail Sales
- Personal Income
Lagging Indicators (Confirm History)
- Unemployment rate
- Inflation (CPI)
- Prime Rate
Interest Rates & Valuation
Interest rates act as gravity on asset prices:
Higher rates = Higher discount rate = Lower present value of future cash flows = Lower Stock Prices
Business Cycle Stages
- Expansion: Growth, rising employment
- Peak: Maximum output, inflationary pressure
- Contraction: Slowing growth, rising unemployment
- Trough: The bottom, just before recovery
Recession Definition: Two consecutive quarters of negative GDP
Financial Statements
Balance Sheet (The Snapshot)
Equation: Assets = Liabilities + Shareholders' Equity
Shows financial position at a specific point in time.
Income Statement (The Movie)
Equation: Revenue - Expenses = Net Income
Shows performance over a period of time.
Cash Flow Statement
Tracks actual cash moving in and out. Crucial because a company can show "Net Income" but still go bankrupt if it has no cash.
Key Financial Ratios
Liquidity Ratios (Can they pay short-term bills?)
- Current Ratio: Current Assets ÷ Current Liabilities
- Quick Ratio (Acid Test): (Current Assets - Inventory) ÷ Current Liabilities (stricter test)
Solvency Ratios (Can they handle long-term debt?)
- Debt-to-Equity: Total Debt ÷ Total Equity (lower is safer)
- Interest Coverage: EBIT ÷ Interest Expense (higher is better)
Profitability Ratios
- Net Margin: Net Income ÷ Revenue
- ROE (Return on Equity): Net Income ÷ Shareholder Equity (measures efficiency)
Valuation Ratios
- P/E Ratio: Price ÷ EPS. High P/E = Growth expectations. Low P/E = Value stock.
- P/B Ratio: Price ÷ Book Value per share. Used for banks/finance companies.
- Dividend Yield: Annual Dividend ÷ Price
Technical Analysis Basics
Three Basic Tenets
- The market discounts everything (all news is already in the price)
- Prices move in trends
- History repeats itself (psychology doesn't change)
Support and Resistance
- Support: The "Floor" - price level where buyers step in
- Resistance: The "Ceiling" - price level where sellers step in
- Breakout: When price pushes through resistance (Bullish)
Moving Average Signals
- Golden Cross: Short-term average crosses ABOVE long-term (Bullish)
- Death Cross: Short-term average crosses BELOW long-term (Bearish)
Market Theories
Efficient Market Hypothesis (EMH)
- Weak Form: Past price data is useless (Technical analysis doesn't work)
- Semi-Strong: All public information is useless (Fundamental analysis doesn't work)
- Strong Form: All information is useless (Impossible to beat the market)
RSE Exam Tips for Securities Analysis
- Leading indicators PREDICT; Lagging indicators CONFIRM
- High P/E = Growth stock expectations
- Current Ratio vs Quick Ratio: Quick excludes inventory
- Rising interest rates = falling stock prices (generally)
- ROE is the key measure of management efficiency