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Chapter 19 Chapter 19 Presentation Transcript

  • Fin2802: Investments Spring, 2010 Dragon Tang
    • Lecture 15
    • Financial Statement Analysis
    • March 18, 2010
    • Readings: Chapter 19
    • Practice CFA Problem Sets: 6-9,13,14,16
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Everyone gets sick sometime!
    • Take your stocks to a doctor!
    • Regular checkups will prevent big problems
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Financial Statement Analysis FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
    • Objectives:
    • Use a firm’s income statement , balance sheet , and statement of cash flows to calculate standard financial ratios .
    • Calculate the impact of taxes and leverage on a firm’s return on equity using ratio decomposition analysis.
    • Measure a firm’s operating efficiency
    • Identify likely sources of biases in accounting data.
  • Fundamental Analysis
    • Economics
    • Finance
    • Accounting
      • How to interpret reported data?
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Financial Statements
    • The Balance Sheet: Snapshot of Financial Condition
      • Assets – Liabilities = Shareholders’ Equity
      • Current vs long-term
    • Income Statement: Summary of Profitability
      • Revenue – Expenses = Net Income
      • Expenses: raw material; salary; interest; tax
      • EBIT=Earnings – Raw Material – Salary
    • The Statement of Cash Flows: “Actual” Cash
      • More reliable
      • Activities: Operating; Investing; Financing
      • Depreciation is not smoothed
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Accounting vs Economic Earnings
    • Economic earnings: Sustainable cash flow that can be paid out without impairing the productive capacity
    • Accounting earnings: “Models” are used
    • Accounting earnings are still useful
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Return on Equity (ROE)
    • ROE=Net profit/Equity
    • Trend in ROE
    • Watch out financial leverage:
    • ROA: Return on Assets=EBIT/Assets
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Du Pont System: Decomposition of ROE FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis x ROA = Margin X Turnover ROE = Net Profit Pretax Profit x Pretax Profit EBIT x EBIT Sales Sales Assets x x Assets Equity (1) x (2) x (3) x (4) x (5) x Margin x Turnover x Leverage Tax Burden Interest Burden
  • Practice
    • An analyst applies the DuPont system of financial analysis to the following data for a company:
      • Leverage ration 2.2
      • Total asset turnover 2.0
      • Net profit margin 5.5%
      • Dividend payout ratio 31.8%
    • What is the company’s return on equity?
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Ratio Analysis
    • Asset utilization ratios: Efficiency
      • Fixed-asset turnover=Sales/Fixed Assets
      • Inventor turnover=cost of goods sold/average inventory
      • Average collection period=(Account receivables/Sales)*365
    • Liquidity and coverage ratios: Financial health
      • Current ratio=current assets/current liabilities
      • Quick ratio=(cash+receivables)/current liabilities
      • Interest coverage ratio=EBIT/interest expense
    • Market price ratios: Relative Value
      • Market/Book ratio(P/B): “Safeness”
      • Price-earnings ratio (P/E): No easy bargain
      • E/P=ROE/(P/B)
    • Choose a benchmark!
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Intel ’ s Financial Ratios Over Time FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Economic Value Added (EVA)
    • EVA=(ROA-Capitalization Rate)  Capital Invested
    • Growth is not the whole picture!
    • EVA can be positive or negative for firms that have positive earnings
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Key Financial Ratios of Growth Industries Inc. FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Growth Industries Statements of Cash Flow FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Comparability Problems
    • GAAP (Generally Accepted Accounting Principles) is not unique
      • Inventory valuation: LIFO vs FIFO
      • Depreciation: Straight line vs Accelerated
      • Real interest payments
    • Quality of earnings affected by:
      • Allowance of bad debt; nonrecurring items; stock option; revenue recognition; off-balance-sheet assets and liabilities
    • GAAP vs IAS (International Accounting Standards)
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Quality of Earnings: Areas of Accounting Choices
    • Allowance for bad debts
    • Non-recurring items
    • Reserves management
    • Stock options
    • Revenue recognition
    • Off-balance sheet assets and liabilities
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Figure 19.2 Comparative Accounting Rules FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Adjusted Versus Reported Price-Earnings Ratios FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Value Investing
    • Benjamin Graham
    • Pick value stocks (low P/B)
    • Rule: stock price < net current-asset value
    • Information sources: S&P’s Outlook and Value Line Investment Survey
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Browne: Value Investing Checklist
    • What is the outlook for pricing for products?
    • Can the company sell more?
    • Can the company increase profits on existing sales?
    • Can the company control expenses?
    • How much of the additional sales are net profits?
    • How competitive is the company?
    • Any one-time expenses?
    • Any unprofitable operations?
    • How well does the company meet expectations?
    • Growth over the next five year
    • Excess cash, competition strategies, acquisition value, stock repurchases, insider trading activities
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis
  • Summary
    • Fundamental Analysis
    • Economic earnings vs accounting earnings
    • Financial Statements
    • Du Pont System; ratio analysis
    • Economic Value Added
    • Comparability
    • Next: Macroeconomy and Stock Market
    FIN 2802, Spring 10 - Tang Chapter 19: Financial Statement Analysis