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Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
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Chapter 17
Chapter 17
Chapter 17
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Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
Chapter 17
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Chapter 17

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  • 1. Company Analysis Chapter 17
  • 2.  
  • 3. Financial Statement Analysis
    • Financial information presented in the form of financial statements
        • Income statement
        • Balance sheet
    • Analyst must be able to interpret the information provided on the statements
    • Look at example: XYZ Company…
  • 4. 11.63 17.13 7.88 7.63 6.69 Market Price per Share (Close) 32200 27400 28700 22000 14700 Dividends - Common Shares... 153237 144121 136073 128932 125536 Common Shares - Average (1000s) 154280 152337 141443 131398 125658 Common Shares - Year End (1000s) 0.85 0.727 0.706 0.68 0.68 Earnings /Share............. 130200 104800 96100 87700 85400 Income Available to Common Shares 2600 2900 4000 3800 3500 Dividends - Preferred Shares 132800 107700 100100 91500 88900 Income AFTER Extra. Items 0 0 0 0 0 Extraordinary Items......... 132800 107700 100100 91500 88900 Earnings BEFORE Extra. Items -18100 -13700 -20400 -25700 -19900 Income Tax.................. 150900 121400 120500 117200 108800 Pre-Tax Income.............. 0 0 0 0 0 Unusual Items............... 37900 56400 46100 43600 33100 Other Expense............... 73100 53700 36300 0 0 Research / Exploration...... 79000 52600 53200 7500 5300 Interest Expense............ 101300 75300 76800 43600 40100 Depreciation/Amortization... 4005800 2699200 2559400 1931400 1238700 Cost of Sales............... 4448000 3058600 2892300 2143300 1426000 Total Revenue............... 2001 2000 1999 1998 1997 STATEMENT OF INCOME:
  • 5. 4270000 3070700 2563500 1937000 1150700 <TOTAL> Liabilities + Equity 984100 899300 694200 622800 525200 Total Equity........ 484800 386800 309400 242000 176300 Retained Earnings... 465200 476800 347400 223100 190600 Common Stock........ 34100 35700 37400 157700 158300 Equity: Preferred Stock..... 56400 43300 53800 42000 41600 Deferred Taxes & Credits.... 963700 586600 425500 211000 83500 Long-Term Debt & Debentures. 2265800 1541500 1390000 1061200 500400 <TOTAL> Current Liabilities........ 56400 19300 20800 30000 5400 Current Portion of L-T Debt. 1380900 901400 831800 684400 347200 Accounts Payable............ 828500 620800 537400 346800 147800 Bank Loans & Equivalent..... 2001 2000 1999 1998 1997 LIABILITIES AND EQUITY: 4270000 3070700 2563500 1937000 1150700 <TOTAL> Assets.............. 1851400 1315700 1069600 840700 606500 Fixed Assets - Net.......... -1063200 -961900 -886600 -809800 -766200 less: Accumulated Depreciation 2914600 2277600 1956200 1650500 1372700 Fixed Assets - Gross 2418600 1755000 1493900 1096300 544200 <TOTAL> Current Assets...... 0 0 0 0 0 Other....................... 0 0 0 0 0 Marketable Securities....... 1803100 1215700 992700 583500 220200 Inventory................... 380400 360100 413700 428800 174000 Accounts Receivable......... 235100 179200 87500 84000 150000 Cash & Equivalent........... 2001 2000 1999 1998 1997 ASSETS:
  • 6. 0.25 0.26 0.30 0.25 0.17 Dividend Payout Ratio 1.81% 1.11% 2.68% 2.24% 1.75% Dividend Yield 1.89 3.02 1.70 2.15 2.29 M/B Ratio 13.68 23.56 11.15 11.21 9.84 P/E Ratio 13.49% 11.98% 14.42% 14.69% 16.93% Return on Equity (ROE) 3.11% 3.51% 3.90% 4.72% 7.73% Return on Assets (ROA) 2.99% 3.52% 3.46% 4.27% 6.23% Net Income Margin 2.91 3.31 3.27 16.63 21.53 TIE (or Interest Coverage) 4.34 3.41 3.69 3.11 2.19 Equity Multiplier 3.28 2.37 2.62 2.04 1.11 Debt-to-Equity Ratio 0.76 0.69 0.71 0.66 0.51 Debt Ratio 1.04 1.00 1.13 1.11 1.24 Total Asset Turnover 2.22 2.22 2.58 3.31 5.62 Inventory Turnover 31.22 42.97 52.21 73.02 44.54 ACP (days) 0.27 0.35 0.36 0.48 0.65 Acid Test (Quick) Ratio 1.07 1.14 1.07 1.03 1.09 Current Ratio 2001 2000 1999 1998 1997 FINANCIAL RATIOS: XYZ Company
  • 7. 0.26 0.39 0.35 0.24 0.13 Dividend Payout Ratio 2.08% 2.67% 2.86% 1.73% 1.71% Dividend Yield 1.88 2.00 1.28 1.42 1.51 M/B Ratio 15.53 22.38 12.13 9.08 6.42 P/E Ratio 12.20% 8.96% 10.59% 15.72% 23.68% Return on Equity (ROE) 7.01% 5.27% 5.95% 8.64% 15.08% Return on Assets (ROA) 5.68% 4.19% 4.34% 6.03% 8.47% Net Income Margin 8.61 5.53 5.95 42.19 34.41 TIE (or Interest Coverage) 1.74 1.70 1.78 1.82 1.57 Equity Multiplier 0.55 0.49 0.56 0.61 0.36 Debt-to-Equity Ratio 0.32 0.29 0.32 0.33 0.23 Debt Ratio 1.23 1.26 1.37 1.43 1.78 Total Asset Turnover 8.16 8.52 7.68 8.20 7.78 Inventory Turnover 46.90 45.90 44.50 34.09 35.20 ACP (days) 1.09 1.24 1.36 1.97 1.21 Acid Test (Quick) Ratio 1.69 2.01 2.25 2.85 2.12 Current Ratio 2001 2000 1999 1998 1997 FINANCIAL RATIOS: INDUSTRY AVERAGES
  • 8. Ratio Analysis
    • Used to examine a firm’s financial performance
    • A ratio on its own has limited value – to be useful, one must examine:
      • Trends
      • Ratios of comparable firms or industry benchmarks
  • 9. Ratio Analysis (cont’d)
    • Five types of ratios used to analyze a firm:
      • Liquidity : ability to generate cash and meet s/t debt
      • Asset Management : ability to effectively manage its assets to generate sales and profits
      • Debt Management : ability to effectively handle its debt
      • Profitability : ability to generate profits
      • Value : market value versus accounting values
  • 10. A. Liquidity
    • 1. Current ratio
      • = current assets / current liabilities
      • For XYZ (2001):
      • = 2,418,600 / 2,265,800 = 1.07
    • 2. Quick ratio
      • = [CA - Inventory] / current liabilities
      • For XYZ (2001)
      • = (2,418,600 – 1,803,100) / 2,265,800
      • = 0.27
  • 11. B. Asset Management
    • 3. Average Collection Period (ACP)
      • = Account Receivable / (Sales/365days)
      • For XYZ (2001):
      • = 380,400 / (4,448,000/365) = 31.22 days
      • Note:
      • A/R Turnover = Sales / Acct Receivable
      • = 365 / ACP
      • For XYZ (2001) = 365/31.22 days = 11.69 times
  • 12. B. Asset Management (cont.)
    • 4. Inventory Turnover
      • = Cost of goods / Inventory
      • or = Net Sales / Inventory
      • For XYZ (2001) (using CoGS):
      • = (4,005,800) /1,803,100
      • = 2.22 times
      • Days Inventory = Inventory / Daily COGS (or Sales)
      • = 365 / Inventory Turnover
      • For XYZ (2001) = 365/2.22 = 164.4 days
    • 5. Total Asset Turnover = Sales / TA = 4,488,000 / 4,270,000 = 1.042
  • 13. C. Debt Ratios
    • 6. Debt Ratio = Total Debt / TA
    • = (2,265,800 + 963,700) / 4,270,000
    • = 0.756
    • 7. Debt-to-Equity = Total Debt / Total Equity
    • = (2,265,800 + 963,700) / 984,100 =
    • 3.282
    TA = Debt + Equity
  • 14. C. Debt Ratios (cont.)
    • 8. Leverage Ratio (or Equity Multiplier)
    • = TA / Equity
    • = 4,270,000 / (984,100)
    • = 4.339
    •  higher values  more debt
    • 9. TIE (or Interest Coverage)
    • = EBIT / Interest
    • = (150,900 + 79,000) / 79,000 = 2.91 times
  • 15. D. Profitability
    • 10. ROE = NI / Equity
    • = 132,800 / 984,100 = 13.49%
    • 11. ROA = NI / TA
    • = 132,800 / 4,270,000 = 3.11%
    • 12. Net Income Margin = NI / Sales
    • = 132,800 / 4,448,000 = 2.99%
  • 16. E. Value Ratios
    • 13. Div. Payout = DPS / EPS
    • = Common Dividends / Earnings Available to Common Shareholders
    • = 32,200 / 130,200 = .2473 = 24.73%
    • 14. P/E =Market Price per Share / EPS
    • = 11.63 / 0.85 = 13.68
  • 17. E. Value Ratios (cont’d)
    • 15. M/B = Market price per share / Book value per share
    • = 11.63 / [(984,100 – 34,100) / 154,280]
    • = 11.63 / 6.16 = 1.89
    • 16. Dividend Yield
    • = DPS / Market price per share
    • = (32,200 / 153,237) / 11.63 = .21 / 11.63 = 1.81%
  • 18. DuPont Analysis
    • ROE = NI / Equity
    Tax Burden Interest Burden EBIT Efficiency TA Turnover NI / Sales = Net Income Margin NI / TA = ROA Leverage Ratio = TA / Equity LeverageRatio
  • 19. Net Profit margin Asset Turnover Leverage Ratio
  • 20. XYZ (2001)
    • NI / EBT = 132,800 / 150,900 = .880
    • EBT / EBIT = 150,900 / (150,900 + 79,000) = 150,900 / 229,900 = .656
    • EBIT / Sales = 229,900 / 4,448,000 = .0517
    • Sales / TA = 1.042 (previously calculated)
    • TA / Equity = 4.339 (previously calculated)
    • ROE = (.8800)(.6564)(.0517)(1.042)(4.339) = .1350 = 13.50%
    • This differs from the 13.49% we calculated previously due to rounding errors.
  • 21. XYZ (2001)
    • NI / Sales = 0.0299 (previously calculated)
    • Sales /TA = 1.042 (previously calculated)
    • Calculate ROA = (.0299)(1.042) = .0311 = 3.11% (equals the 3.11% previously calculated)
    • TA / Equity = 4.339 (previously calculated)
    • So, ROE = (.0299)(1.042)(4.339) = 13.52% (differs from 13.49% previously calculated due to rounding errors)
  • 22. Liquidity
    • Below average
      • Current and quick ratios of 1.07 and 0.27 are both well below industry averages of 1.69 and 1.09
    • Bad trend
      • Current ratio has been steady, but quick ratio has deteriorated significantly
    • Low and deteriorating quick ratio is due to high levels of inventory
  • 23. Asset Management
    • Collections as measured by ACP is above average (31 days versus 47 days) and is improving
    • Inventory turnover is very low (2.3 versus industry average of 8.2), and has been continually deteriorating, and they maintain high inventory levels
    • TA turnover is below average, has been over the period, and continues to deteriorate
  • 24. Debt Management
    • Debt levels have increased steadily and coverage has deteriorated
      • Debt ratio is 0.76 (from 0.51 in 1997)
      • Debt-to-equity is 3.28 (from 1.11 in 1997)
      • Coverage is 2.91 (from 21.53 in 1997)
    • Debt capacity and coverage are both below average
      • Debt ratio is 0.76 versus 0.32 industry average
      • Debt-to-equity is 3.28 versus 0.55 industry average
      • Coverage is 2.91 versus 8.61 industry average
  • 25. Profitability
    • Steady decline in net income margin, ROA and ROE over period
    • Below industry averages, except for ROE
      • ROE is above average due to use of greater leverage (as noted above)
  • 26. DuPont Analysis
    • XYZ (2001)
      • ROE = (NI/Sales)(Sales/TA)((TA/Eqty)
      • = (.0299)(1.042)(4.339) = 13.51%
    • Industry averages (2001)
      • ROE = (NI/Sales)(Sales/TA)((TA/Eqty)
      • = (.0568)(1.23)(1.74) = 12.16%
    • This analysis suggests that XYZ displays an above average ROE due to its higher leverage factor, and despite the fact it has below average profitability and asset turnover.
  • 27. Value Ratios
    • P/E and M/B ratios are close to average, which is also the case for their dividend yields (Note: a lower dividend yield implies a higher price)
    • They have been close to, or slightly above average over the entire period
    • This suggests the market views XYZ as an “average” company despite some of the problems we have observed
  • 28. Summary
    • Below average and deteriorating in terms of liquidity, inventory turnover, and debt management
    • However, they are profitable, even if they are not up to industry standards, and their profitability is dwindling
    • The market views XYZ as an “average” company despite its problems
    • XYZ will probably have to deal with its debt, inventory and liquidity problems in order to maintain an average valuation in the market
  • 29. Notes to Financial Statements
    • Provide important details about the company’s financial condition
    • Often included in the notes are:
      • Accounting policies
      • Description of fixed assets, share capital and LTD
      • Commitments and contingencies
    • Financial Statements should also disclose information by segments (i.e., by industry and by location)
  • 30. Management’s Discussion and Analysis
    • Important source of information
    • Provides overview of factors/issues affecting firm’s performance
    • May contain explanations of issues uncovered in an analysis of the financial ratios
    • It is the management’s point of view
  • 31. Estimating Earnings Per Share
  • 32. Estimating EPS
    • Security valuation often depends on having an estimate of EPS for the next year (or next several years)
        • To use the forward P/E multiple, you need an estimate of the multiple and an estimate of EPS 1
        • To use DCF methods, it is common to estimate the FCFE (or FCFF or Dividends) directly for the first few years and then assume a stable growth rate
  • 33. Estimating EPS
    • In order to estimate EPS, the easiest method is to simply remember that what you are analyzing is a business – it has revenues and costs. Estimates of future revenues and costs will translate into estimates of EPS (and with a little more work, estimates of free cash flow)
    • Appropriate methods for forecasting revenues and costs depend heavily on what type of company (i.e. what industry) you are looking at
  • 34. Estimating EPS
    • Consider a simple income statement:
    • An estimate of N.I. can be used to get EPS, or as a starting point for a free cash flow estimate
    Net Income -tax EBT
    • Interest
    EBIT -Depreciation & Amort. EBITDA
    • Costs
    Revenues
  • 35. Estimating EPS
    • To estimate NI for next year, simply estimate each piece of the income statement.
    • Revenues: a revenue estimate is extremely important!
    • The way to estimate depends on the type of firm
  • 36.
    • Examples of factors to consider in revenues:
      • For a firm with a few major products (e.g. pharmaceuticals) – estimate sales for each product –will they grow/decline from last year?
      • Retail firms – what will be the growth in “same store sales” over last year from existing stores? Are they opening new stores and what will their sales be?
      • Raw materials producers – need estimate of the output price (e.g. price of nickel, price of oil, etc.). Also need estimate of total output – will the mines start to produce more or less? Will new mines be opened?
      • Consumer or industrials – What is growth rate in overall product market? Will this company’s market share increase/decrease next year? Combine to estimate revenues.
  • 37.
      • Statistical techniques – Could use regression to estimate revenues. e.g. regress past sales on some variable thought to be related (maybe regress department store sales on GDP growth). The parameters from the regression, and an estimate of the economic variable for next year will give an estimate of next year’s sales.
      • Many other factors that you might consider. The point is to think of the company being analyzed as a business – what factors will affect its sales, what do you think will happen with those factors? Is the firm’s strategy going to result in increased or decreased sales? What about state of economy/industry etc.
      • Estimating revenues should use expertise you have gained in all your courses (marketing/strategy/stats etc.) and a lot of common sense.
  • 38. Estimating EPS
    • Based on estimate of sales, now estimate EBITDA
    • Often this is done by forecasting next year’s Gross Margin (a.k.a. the EBTIDA ratio (EBITDA/Revenues))
    • Could take average of last few years’ margins – Ave. Gross Margin X Rev = EBITDA
    • Note : this assumes that next year’s cost structure will be similar to the past
        • If you think that costs may increase or decrease for some reason, must adjust this
  • 39. Estimating EPS
    • Depreciation: usually, starting point is last year’s depreciation. Then adjust for declining balance of value of assets, and adjust for any new capital expenditures that will generate depreciation.
    • Interest: estimate based on debt outstanding, level of interest rates (if some debt must be renogiated), effect of any new borrowings
  • 40. Estimating EPS
    • Tax: estimate an effective tax rate paid by company.
    • Combine the above estimates to get an estimate of Net Income
    • An estimate of basic EPS is obtained by subtracting preferred dividends from NI and dividing by the number of common shares outstanding
  • 41. Using EPS estimate in DCF Valuation
    • An estimate of next year’s EPS could be translated into an estimate of div 1 if the firm uses a fixed payout ratio
    • Commonly, an estimate of FCFE could be obtained based on an estimate of EPS by looking at the extra pieces needed for FCFE
    • Note: it is normal to directly estimate FCFE (or FCFF) out for several years , and then assume a growth rate after that
  • 42. Estimating FCFE
    • Remember:
    • FCFE = Net Income
    • + Depreciation
    • – Capital Expenditures
    • – Change in non-cash Working Capital
    • + Net New Debt Issued
    • Given estimate of NI, an estimate of the last 4 factors are necessary
  • 43. Estimating FCFE
    • Sometimes, your knowledge of the firm will help a lot: are they expanding and planning on large capital expenditures? Are they planning on increasing/decreasing debt load? Are they increasing/decreasing inventory? etc.
    • Often, simplifying assumptions are used:
  • 44. Estimating FCFE
    • Examples of common assumptions:
        • For a firm that is not in a major growth phase, often assumed that capital expenditures = depreciation (e.g. they are simply replacing equipment as it wears out)
        • Often accounts receivable (part of working capital) is assumed to be a constant percentage of sales (unless a component of the firm’s strategy is to change this)
        • Often accounts payable (part of working capital) is assumed to be a constant percentage of costs
  • 45. Estimating FCFE
    • Common assumptions (cont.)
        • Inventory sometimes assumed to be a percentage of sales (but note that often firms are trying to build up inventory, or sell it down)
        • Investments in cap ex. or working capital must be financed – if the firm has a target debt/asset ratio then this is often used to determine how much of these investments will be finned with debt vs equity (which gives an estimate of debt issuance in the future)
    • There are other assumptions that you might make in your forecast, the appropriate ones depend on the situation and should be based on your knowledge of the firm and its industry
  • 46. Estimating Growth Rates
    • dividends are related to profitability
        • in particular, EPS are important
    • If the firm tries to maintain a constant payout ratio:
        • growth rate in dividends = growth rate in EPS
    • estimate future growth rate based on past growth rate in
    • dividends or EPS?
        • Appropriate?
  • 47.
    • estimate sometimes used is “sustainable” growth rate
      • growth rate in Div’s = growth rate in EPS
      • = (1 - payout ratio) ROE
      • need estimate of future ROE
    • the sustainable growth rate is the growth expected with no further investment of capital into the firm
    • Sustainable growth only appropriate as g if payout and ROE are both stable over time (mature industry)
  • 48. Estimating “g”
    • 1. Use historical information regarding growth in earnings + dividends:
    • a. Arithmetic averages over some past interval e.g. 3yrs/5yr/10yr/last year
    • b. Geometric averages
    • c. Regressions (e.g. div’s on some econ/industry/firm attribute)
    • 2. Use analyst forecasts
    • 3. Estimate “Sustainable Growth Rate” (see above)
    • 4. Combine #1-3 with judgement to reach final estimate (or range of estimates)
  • 49.
    • Other issues in estimating future growth rate:
      • growth in industry overall
      • is firm gaining/losing market share in its industry?
      • Growth rate of economy overall
      • the long term, stable growth rate for the firm cannot be larger than the long term growth rate of the overall economy
  • 50.
    • For long term growth, often an estimate of long term economic growth is used – or something lower if the industry is expected to grows slower than overall economy
    • In short term, growth rates often based on year by year forecasts of earnings for firm
        • Forecasts based on many factors, including growth of industry, growth of market share, revenue growth and costs changes etc.

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