Financial Statements Economics 98 / 198 Fall 2007 Copyright 2007 Jason Lee
Announcements <ul><li>Oct 31 versus Nov 31 lecture? </li></ul><ul><li>Simulation Exercise - Money </li></ul>
CURRENT EVENT / NEWS
LECTURE CONTENT
Today’s Lecture <ul><li>Trading Psychology </li></ul><ul><li>Financial Statements introduction </li></ul><ul><ul><li>Incom...
TRADING  PSYCHOLOGY
Trading Psychology <ul><li>Emotions severely impair your judgment in deciding whether to buy or sells tocks </li></ul><ul>...
 
Psychology & The Stock Market <ul><li>Emotions can wreak havoc on your results and decisions </li></ul><ul><li>Need to tak...
Trading Psychology <ul><li>“ Your biggest enemy, when trading, is within yourself. Success will only come when you learn t...
Accounting 101: Financial Statements
Reporting Financial Statements <ul><li>Public co. required to publish 10K and 10Q </li></ul><ul><ul><li>10K = Annual finan...
The Income Statement <ul><li>Shows how much a company earned or lost during that specific period  </li></ul><ul><li>Consid...
Income Statements <ul><li>Generally, 3 Major Parts </li></ul><ul><ul><li>Revenues </li></ul></ul><ul><ul><li>Expenses </li...
Balance Sheet <ul><li>Summarizes company’s assets, liabilities, and shareholders’ equities at specific time </li></ul><ul>...
Balance Sheet <ul><li>Assets </li></ul><ul><ul><li>Current Assets: life span of 1 year or less </li></ul></ul><ul><ul><li>...
Statement of Cash Flows <ul><li>Shows how much money coming in (inflows) and going out (outflows) </li></ul><ul><ul><li>Ca...
Earnings Season <ul><li>Companies release quarterly reports and annual reports </li></ul><ul><ul><li>“ Financial Report Ca...
 
Understanding Earnings <ul><li>Actual earnings value is important, but so is the growth of these earnings  </li></ul><ul><...
EPS % Growth: Google  Q2 2007 Source: MSN Money Stock Quotes EPS growth calculated comparing Q2 2007 to Q2 2006 Q2 2007EPS...
Why do Investors Care About Earnings? <ul><li>Strong earnings or expectations of strong earnings drive stock prices. Why? ...
Ratio Analysis
Ratio Analysis <ul><li>Used to gain idea of valuation and financial performance </li></ul><ul><li>Compared to competitors ...
Profit Margins <ul><li>Profit Margins </li></ul><ul><li>= net income / net sales (revenue) </li></ul><ul><ul><li>Measures ...
Profit Margins: Example <ul><li>Company has a net income of $10 million from sales of $100 million, giving it a profit mar...
Price to Earnings Ratio (P/E) <ul><li>P/E Ratio </li></ul><ul><li>= Price per share / Earnings per share </li></ul><ul><ul...
Price to Earnings Ratio (P/E) <ul><li>Use as a guide, not a guarantee in your analysis </li></ul><ul><li>Sometimes, there ...
Return on Equity (ROE) <ul><li>Return on Equity (ROE) </li></ul><ul><li>= Net Income / Shareholder’s Equity </li></ul><ul>...
Return on Equity (ROE) PC Industry Example (Dell vs. Gateway vs. HP) Dell HP Gateway
Debt-to-Equity Ratios <ul><li>Debt / Equity Ratio </li></ul><ul><li>=  Total Liabilities / Shareholder’s Equity </li></ul>...
Google Example
Other Relevant Ratios <ul><li>Current Ratio </li></ul><ul><li>Return on Assets </li></ul><ul><li>Inventory Turnover </li><...
Reading <ul><li>Motley Fool. “Analyzing Stocks” </li></ul><ul><li>Recommended: </li></ul><ul><li>Investopedia. “Valuation”...
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Lecture 05 - Financial Statements

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  • Example. PC industry between 1998 – 2003. Dell leading the way as its direct sales strategy had paid off in terms of share price and strong earnings Dell 5-year ROE (46%) vs. HP (12%) vs. Gateway (-2.5%)
  • Lecture 05 - Financial Statements

    1. 1. Financial Statements Economics 98 / 198 Fall 2007 Copyright 2007 Jason Lee
    2. 2. Announcements <ul><li>Oct 31 versus Nov 31 lecture? </li></ul><ul><li>Simulation Exercise - Money </li></ul>
    3. 3. CURRENT EVENT / NEWS
    4. 4. LECTURE CONTENT
    5. 5. Today’s Lecture <ul><li>Trading Psychology </li></ul><ul><li>Financial Statements introduction </li></ul><ul><ul><li>Income Statement </li></ul></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Cash Flow Statement </li></ul></ul><ul><ul><li>Earning Season </li></ul></ul><ul><li>Ratio Analysis </li></ul>
    6. 6. TRADING PSYCHOLOGY
    7. 7. Trading Psychology <ul><li>Emotions severely impair your judgment in deciding whether to buy or sells tocks </li></ul><ul><ul><ul><ul><li>HOPE </li></ul></ul></ul></ul><ul><ul><ul><ul><li>FEAR </li></ul></ul></ul></ul><ul><ul><ul><ul><li>GREED </li></ul></ul></ul></ul><ul><ul><ul><ul><li>PRIDE </li></ul></ul></ul></ul>
    8. 9. Psychology & The Stock Market <ul><li>Emotions can wreak havoc on your results and decisions </li></ul><ul><li>Need to take emotion out of investing </li></ul><ul><li>Do this by developing a system with rules to follow with discipline </li></ul>
    9. 10. Trading Psychology <ul><li>“ Your biggest enemy, when trading, is within yourself. Success will only come when you learn to control your emotions” </li></ul><ul><li>- Edwin Lefevre </li></ul>
    10. 11. Accounting 101: Financial Statements
    11. 12. Reporting Financial Statements <ul><li>Public co. required to publish 10K and 10Q </li></ul><ul><ul><li>10K = Annual financial reports </li></ul></ul><ul><ul><li>10Q = Quarterly financial reports </li></ul></ul><ul><li>Income Statement </li></ul><ul><li>Balance Sheet </li></ul><ul><li>Statement of Cash Flows </li></ul><ul><li>Why do we care about these reports? </li></ul>
    12. 13. The Income Statement <ul><li>Shows how much a company earned or lost during that specific period </li></ul><ul><li>Considered the most analyzed statement for investors </li></ul><ul><li>Divulges into a company’s profitability </li></ul><ul><li> IS THE COMPANY MAKING PROFIT? </li></ul>
    13. 14. Income Statements <ul><li>Generally, 3 Major Parts </li></ul><ul><ul><li>Revenues </li></ul></ul><ul><ul><li>Expenses </li></ul></ul><ul><ul><li>Net Income </li></ul></ul><ul><li>Earnings Per Share (EPS) </li></ul><ul><ul><li>= Profits / Shares Outstanding </li></ul></ul><ul><li>Investors pay very close attention to profits (earnings) and revenue (sales) </li></ul>Income = Revenues - Expenses
    14. 15. Balance Sheet <ul><li>Summarizes company’s assets, liabilities, and shareholders’ equities at specific time </li></ul><ul><li>Assets = Liabilities + Shareholder’s Equity </li></ul><ul><li>How do we analyze this statement? </li></ul><ul><ul><li>We use ratios and changes in trends to analyze the information </li></ul></ul>
    15. 16. Balance Sheet <ul><li>Assets </li></ul><ul><ul><li>Current Assets: life span of 1 year or less </li></ul></ul><ul><ul><li>Non-Current assets </li></ul></ul><ul><li>Liabilities </li></ul><ul><ul><li>Current Liabilities </li></ul></ul><ul><ul><li>Non-current liabilities </li></ul></ul><ul><li>Shareholder’s Equity </li></ul><ul><ul><li>Common / Preferred Stock </li></ul></ul><ul><ul><li>Retained Earnings </li></ul></ul>
    16. 17. Statement of Cash Flows <ul><li>Shows how much money coming in (inflows) and going out (outflows) </li></ul><ul><ul><li>Cash flow from operations </li></ul></ul><ul><ul><li>Cash flow from investing </li></ul></ul><ul><ul><li>Cash flow from financing </li></ul></ul><ul><li>Shows if company having trouble with cash </li></ul><ul><ul><ul><li>Profitable companies can struggle cash flows. Why? </li></ul></ul></ul><ul><li>Cash is king! Pays for bills and funds operations! </li></ul>
    17. 18. Earnings Season <ul><li>Companies release quarterly reports and annual reports </li></ul><ul><ul><li>“ Financial Report Cards” </li></ul></ul><ul><li>Stock analysts issue earnings estimate </li></ul><ul><ul><li>Consensus earnings estimates </li></ul></ul><ul><li>Earnings surprise is a good thing </li></ul><ul><ul><li>Meeting / beating / missing expectations </li></ul></ul><ul><ul><li>If below estimates, then stock usually head downwards fast! </li></ul></ul>
    18. 20. Understanding Earnings <ul><li>Actual earnings value is important, but so is the growth of these earnings </li></ul><ul><li>Compare EPS / Revenue? </li></ul><ul><ul><li>Do we compare them to last quarter? </li></ul></ul><ul><ul><li>Do we compare them to the same quarter last year? </li></ul></ul>
    19. 21. EPS % Growth: Google Q2 2007 Source: MSN Money Stock Quotes EPS growth calculated comparing Q2 2007 to Q2 2006 Q2 2007EPS Growth 2007 Q2 EPS 2006 Q2 EPS $2.98 / sh $2.39 / sh =25%
    20. 22. Why do Investors Care About Earnings? <ul><li>Strong earnings or expectations of strong earnings drive stock prices. Why? </li></ul><ul><ul><li>Potential for greater reinvestment, and greater earnings </li></ul></ul><ul><ul><li>Passing the money to shareholders in various forms (dividends, buybacks, etc.) </li></ul></ul><ul><li>Ultimately, earnings provide a return on the investment for shareholders </li></ul>
    21. 23. Ratio Analysis
    22. 24. Ratio Analysis <ul><li>Used to gain idea of valuation and financial performance </li></ul><ul><li>Compared to competitors and historical values to gain understanding about company’s value </li></ul><ul><ul><li>Is it undervalued? Overvalued? </li></ul></ul><ul><ul><li>How is it performing? </li></ul></ul>
    23. 25. Profit Margins <ul><li>Profit Margins </li></ul><ul><li>= net income / net sales (revenue) </li></ul><ul><ul><li>Measures how much out of every dollar of sales a company actually keeps in earnings </li></ul></ul><ul><li>High profit margins indicates that management efficient at controlling costs </li></ul><ul><ul><li>Increased earnings are good, but if costs are increasing faster than sales, leads to lower profit per sale </li></ul></ul><ul><li>Good sign if company has growing profit margins </li></ul>
    24. 26. Profit Margins: Example <ul><li>Company has a net income of $10 million from sales of $100 million, giving it a profit margin of 10% ($10 million/$100 million) </li></ul><ul><li>If in the next year net income rose to $15 million on sales of $200 million. </li></ul><ul><li>Would its profit margins be growing or diminishing? What does this mean? </li></ul>
    25. 27. Price to Earnings Ratio (P/E) <ul><li>P/E Ratio </li></ul><ul><li>= Price per share / Earnings per share </li></ul><ul><ul><li>Look at company’s earnings relative to its price </li></ul></ul><ul><li>Most basic valuation method of company </li></ul><ul><ul><li>How do you we use it? </li></ul></ul><ul><li>Ex. If BIG OIL co. has P/E ratio of 15 and has solid fundamentals, and the industry average is 40, then the BIG OIL would be considered undervalued </li></ul>
    26. 28. Price to Earnings Ratio (P/E) <ul><li>Use as a guide, not a guarantee in your analysis </li></ul><ul><li>Sometimes, there is a reason for high or low P/E ratios (understanding business and industry is important) </li></ul><ul><ul><li>High P/E ratios : investors may be willing to pay more for less earnings because its expect higher growth rates in the future </li></ul></ul><ul><ul><li>Low P/E ratios : may seem like a bargain, but low ratio may signal questionable future prospects </li></ul></ul>
    27. 29. Return on Equity (ROE) <ul><li>Return on Equity (ROE) </li></ul><ul><li>= Net Income / Shareholder’s Equity </li></ul><ul><ul><li>how much profit a company can generate with the money shareholders have invested </li></ul></ul><ul><ul><li>Is it a profit-making machine or an inefficient clunker? </li></ul></ul><ul><li>Useful for comparing profitability and efficiency of a company to other firms in same industry </li></ul><ul><ul><li>can indicate whether a company is growing without pouring new capital into business </li></ul></ul><ul><li>Growing ROE also shows management making better use of money invested by shareholders </li></ul>
    28. 30. Return on Equity (ROE) PC Industry Example (Dell vs. Gateway vs. HP) Dell HP Gateway
    29. 31. Debt-to-Equity Ratios <ul><li>Debt / Equity Ratio </li></ul><ul><li>= Total Liabilities / Shareholder’s Equity </li></ul><ul><ul><li>Proportion of equity and debt to finance assets </li></ul></ul><ul><li>High ratio: aggressive debt, potential for higher earnings per share but at more risk </li></ul><ul><ul><li>More volatile earnings and larger interest expenses </li></ul></ul><ul><li>Compare this similar companies </li></ul><ul><li>Warren Buffet preferred to see lower ratio so that earnings growth is generated by investors rather than borrowed money </li></ul>
    30. 32. Google Example
    31. 33. Other Relevant Ratios <ul><li>Current Ratio </li></ul><ul><li>Return on Assets </li></ul><ul><li>Inventory Turnover </li></ul><ul><li>Interest Coverage </li></ul><ul><li>More on Ratio Analysis / Financial Statement Analysis: </li></ul><ul><li>http://www.investopedia.com/university/ratios/ratios1.asp </li></ul><ul><li>http://www.investopedia.com/university/financialstatements/ </li></ul><ul><li>UGBA 102A: Introduction to Financial Accounting </li></ul>
    32. 34. Reading <ul><li>Motley Fool. “Analyzing Stocks” </li></ul><ul><li>Recommended: </li></ul><ul><li>Investopedia. “Valuation” </li></ul>

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