04 company analysis
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noorulhadi Lecturer at Govt College of Management Sciences, noorulhadi99@yahoo.com i have prepared these slides and still using in mylectures, Reference: Portfolio management by S kevin and onlin
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04 company analysis
- 1. Portfolio Management LECTURE FOUR Fundamental Analysis Company Analysis Prepared By: Noorulhadi Qureshi Lecturer Govt College of Management Sciences Prepared By: Noorulhadi Lecturer GCMS Peshawar Peshawar
- 2. Final Stage of fundamental Analysis Broad outline of the prospect of-- Growth in the economy. Internal information consists External resources of of data and events made information are those public by companies generated independently concerning their operations. Company Analysis outside the company. Its include annual report to These are prepared by Share holder, public and investment services and private stakeholders. the financial press. Company Analysis deal with Return and risk of individual Share and security. Analyst tries to forecast the Future earning which has Direct effect on share price. Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 3. Financial Statements • Two Basic financial statement are: – Balance Sheet (picture of Company asset and liabilities.) – Profit and Loss Account. (It postulates the earning of company). • It helps to asses the profitability and financial health. • Balance Sheet gives the list of assets and liabilities. – Fixed Assets are intended to be used up over a period of several years. – Current assets are intended to be converted into cash with in one year. – The outside liabilities are short and long term liabilities. – Liability toward share holder show the share capital value. Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 4. Financial Statements • Income statement reveals the revenue earned and the cost incurred for a period in the company. • Profit is • Profit is • Profit is z Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 5. Financial Analysis • Assessment of the firm’s past, present and future financial conditions • Done to find firm’s financial strengths and weaknesses • Primary Tools: – Financial Statements – Comparison of financial ratios to past, industry, sector and all firms Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 6. Financial Statements • Balance Sheet • Income Statement • Cashflow Statement • Statement of Retained Earnings Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 7. Sources of Data • Annual reports – Via mail, SEC or company websites • Published collections of data – e.g., Dun and Bradstreet or Robert Morris • Investment sites on the web – Examples • http://moneycentral.msn.com/investor • http://www.marketguide.com Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 8. Review: Major Balance Sheet Items Assets Liabilities and Equity • Current assets: • Current liabilities: – Cash & securities – Payables – Receivables – Short-term debt – Inventories • Long-term liabilities • Fixed assets: • Shareholders' equity – Tangible assets – Intangible assets Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 9. Abbreviated Balance Sheet • Assets: – Current Assets: + – Non-Current Assets: + – Total Assets: + • Liabilities: – Current Liabilities: + – LT Debt & Other LT Liab.: + – Equity: + – Total Liab. and Equity: + Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 10. Review: Major Income Statement Items • Gross Profit = Sales - Costs of Goods Sold • EBITDA = Gross Profit - Cash Operating Expenses • EBIT = EBDIT - Depreciation - Amortization • EBT = EBIT - Interest • NI or EAT = EBT- Taxes • Net Income is a primary determinant of the firm’s cashflows and, thus, the value of the firm’s shares Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 11. Abbreviated Income Statement Sales + Costs of Goods Sold + Gross Profit + Cash operating expense - EBITDA + Depreciation & Amortization - Other Income (Net) - EBIT + Interest - EBT + Income Taxes - Special Income/Charges - Prepared By: Noorulhadi Lecturer GCMS Peshawar Net Income (EAT) +
- 12. Objectives of Ratio Analysis • Standardize financial information for comparisons • Evaluate current operations • Compare performance with past performance • Compare performance against other firms or industry standards • Study the efficiency of operations • Study the risk of operations Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 13. Rationale Behind Ratio Analysis • A firm has resources • It converts resources into profits through – production of goods and services – sales of goods and services • Ratios – Measure relationships between resources and financial flows – Show ways in which firm’s situation deviates from • Its own past • Other firms • The industry • All firms- Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 14. Types of Ratios • Financial Ratios: – Liquidity Ratios • Assess ability to cover current obligations – Leverage Ratios • Assess ability to cover long term debt obligations • Operational Ratios: – Activity (Turnover) Ratios • Assess amount of activity relative to amount of resources used – Profitability Ratios • Assess profits relative to amount of resources used • Valuation Ratios: Prepared By: Noorulhadi Lecturer GCMS Peshawar • Assess market price relative to assets or earnings
- 15. Liquidity Ratio • Current Ratio: • Quick (Acid Test) Ratio: Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 16. Leverage Ratio • Debt Ratio: Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 17. Profitability Ratio • Return on Assets (ROA): • Return on Equity (ROE): Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 18. Profitability Ratio • Net Profit Margin: • Retention Ratio Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 19. Activity (Turnover) Ratio • Total Asset Turnover Ratio: • Inventory Turnover Ratio: Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 20. The DuPont System • Method to breakdown ROE into: – ROA and Equity Multiplier • ROA is further broken down as: – Profit Margin and Asset Turnover • Helps to identify sources of strength and weakness in current performance • Helps to focus attention on value drivers Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 21. The DuPont System ROE ROA E q u ity M u ltip lie r P ro fit M a rg in T o ta l A s s e t T u rn o v e r Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 22. The DuPont System ROE ROA E q u ity M u ltip lie r P ro fit M a rg in T o ta l A s s e t T u rn o v e r ROE = ROA × Equity Multiplier Net Income Total Assets = × Total Assets Common Equity Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 23. The DuPont System ROE ROA E q u ity M u ltip lie r P ro fit M a rg in T o ta l A s s e t T u rn o v e r ROA = Profit Margin × Total Asset Turnover Net Income Sales = × Sales Total Assets Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 24. The DuPont System ROE ROA E q u ity M u ltip lie r P ro fit M a rg in T o ta l A s s e t T u rn o v e r ROE = Profit Margin × Total Asset Turnover × Equity Multiplier Net Income Sales Total Assets = × × Sales Total Assets Common Equity Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 25. The DuPont System Net Income Sales Total Assets ROE = × × Sales Total Assets Common Equity = Profit Margin × Total Asset Turnover × Equity Multiplier = ROA × Equity Multiplier Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 26. Summary of Financial Ratios • Ratios help to: – Evaluate performance – Structure analysis – Show the connection between activities and performance • Benchmark with – Past for the company – Industry • Ratios adjust for size differences Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 27. Limitations of Ratio Analysis • A firm’s industry category is often difficult to identify • Published industry averages are only guidelines • Accounting practices differ across firms • Sometimes difficult to interpret deviations in ratios • Industry ratios may not be desirable targets • Seasonality affects ratios Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 28. Ratios and Forecasting • Common stock valuation based on – Expected cashflows to stockholders – ROE and ρ are major determinants of cashflows to stockholders • Ratios influence expectations by: – Showing where firm is now – Providing context for current performance • Current information influences expectations by: – Showing developments that will alter future performance Prepared By: Noorulhadi Lecturer GCMS Peshawar
- 29. How Might Ratios Help Me on the IEM? • Analysis of AAPL, IBM and MSFT, and comparisons to the S&P500 companies can help to: – Assess the (absolute and relative) financial state of each company – Show each company’s strengths and weaknesses – Predict sustainable growth rate • Combined with current information, this can help to: – Assess likely future performance – Predict future valuation and earnings growth – Predict returns Prepared By: Noorulhadi Lecturer GCMS Peshawar
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Notes de l'éditeur
- Ratios are compared to industry averages. There are 14 to 16 common ratios grouped into 4 types. Dun and Bradstreet and Robert Morris Associates give industry average ratios for hundreds of industries. We will describe the types of ratios and focus on several important financial ratios. Financial Statements 1. Financial statements report a firm’s position at a point in time and on operations over some past period 2. Investors use financial statements to predict future earnings/dividends 3. Management uses financial statements to help anticipate future conditions and as starting point for planning actions that will affect future event Financial ratios 1. Help evaluate a financial statement 2. Facilitate comparison of firms
- Balance Sheet Statement of financial position at specific point in time Income Statement Summarizes revenues and expenses over an accounting period Statement of Cash Flows Amount of cash generated during period is not what is shown on balance sheet Tells you what happened to cash generated during specified period Categories in Statement of Cash Flows (a) Operating activities (b) Investing activities (c) Financing activities Statement of Retained Earnings Reports how much of earnings retained in business rather than paid out in dividends over the life of the firm Retained earnings is claim against assets (a) Earnings retained to expand business (b) Do not represent cash
- Annual Report Used by investors to help form expectations about future earnings and dividends Verbal Section Explain why things turned out the way they did Describes firms operating results during past year Discusses new developments that will affect future earnings Financial Statements Report what actually happened to assets, earnings, dividends Balance sheet Income statement Statement of retained earnings Statement of cash flows Advantages and Disadvantages of Data Sources The advantage of Annual reports is that give a great deal of information. They are available through the web now. The disadvantage is that they are not in a standard format and they are frequently affected by subtle differences in accounting rules. The advantage of published data on ratios is that they standardize the financial statements and compute ratios based on this information. The disadvantage is that this may hide important factors and the information my be far from current. The advantage of investment sites on the web is that they have the most current data. Some of them even standardize statements (e.g., Microsoft’s MoneyCentral). Of course, this has advantages and disadvantages.
- Balance Sheet Statement of financial position at specific point in time Shows assets owned by the firm and sources of the money used to purchase those assets. Liquidity Order Assets: length of time typically to convert to cash Liabilities: how soon must be paid Characteristics Cash versus other assets Only cash represents actual money Noncash assets should produce cash in time Liabilities versus stockholders’ equity Both claims against assets Breakdown of common equity accounts Common stock Retained earnings Impacted by Inventory accounting Depreciation methods Position at one point in time
- Dell’s Balance Sheet: Assets the firm owns total more that $11 billion** , more short-term assets than long-term assets like plant and equipment. Those assets were purchased with money that came mainly from equity and short-term borrowing. Relatively little long-term debt.
- Income Statement 1. Summarizes revenues and expenses over an accounting period 2. Information includes (a) Net income available to common stockholders (b) Earnings per Share – “bottom line” (c) Usually compared to budget 3. The income statement serves as the basis for determining cashflows.
- Dell had more than $25 billion sales during the period. A large part of revenues went to pay for the raw materials that went into production. Depreciation reflects expenditure on a long-term asset which firm must expense over several years for tax purposes. It does not reflect an actual expenditure during this particular accounting period.
- Uses 1. Managers – to help analyze, control, improve a firm’s operations 2. Credit analysts – to help ascertain a company’s ability to pay its debts 3. Stock analysts – to determine a company’s efficiency, risk and growth potential
- Liquidity Ratios: Current Ratio Quick (Acid Test) Ratio Cash Ratio Net Working Capital to Total Assets Leverage Ratios: Total Debt Ratio Debt to Equity Ratio Equity Multiplier Long-term Debt Ratio Times Interest Earned Ratio Cash Coverage Ratio Activity (Turnover) Ratios: Inventory Turnover Days’ Sales in Inventory Receivables Turnover Days’ Sales in Receivables NWC Turnover Fixed Asset Turnover Total Asset Turnover Profitability Ratios: Profit Margin Return on Assets Return on Equity Valuation Ratios: Price to Earnings Market to Book
- Used to study ability to cover current obligations Can firm raise cash to pay its current and upcoming bills on time? Basic Formulation: Liquid asset measures include: Current Assets Current Assets minus Inventories If industry average is 3.5, then Dell has fewer current assets per dollar of current liabilities than the norm If acid test ratio > 1, then Dell can meet all current liabilities even if sales cease
- Measure ability to cover long term debt How much debt has the firm issued? Can the firm afford to pay its long term interest and principal obligations? Basic formulation: Debt and debt service measures include: Total liabilities Long term debt Annual interest expenses Asset, profit or cash flow measures include: Total assets Total capitalization EAT, Profit... 1-Debt Ratio is fraction of firm owned by equity holders If industry average is 2.5 then revenues for Dell relative to interest expenses exceed industry norm
- Used to study operating profitability. How do profits compare to sales or assets? Basic Formulation: Profit measures include: Sales less costs Net Income Income Available to Common Stock Holders Sales/Asset measures include: Sales Total Assets Common Equity NOTE: Some books use: If yours does, use these equations AND adjust the DuPont Method accordingly by adding the the debt burden.
- Used to study operating profitability. How do profits compare to sales or assets? Basic Formulation : Profit measures include: Sales less costs Net Income Income Available to Common Stock Holders Sales/Asset measures include: Sales Total Assets Common Equity
- Profitability is also affected by the firm’s ability to use its assets efficiently. Used to study operating efficiency. How do sales compare to the assets used in production? Basic Formulation: Assets include: All Assets Inventories Accounts Receivable If industry average is 1.25, then Dell gets more sales per dollar invested in assets than typical in the industry If industry average is 2, then Dell turns its inventory over more times on average than industry (Few assets are tied up in inventories)
- DuPont Chart and Equation - Tie the Ratios Together Shows how profit margin, asset turnover ratio, and equity multiplier determine ROE Shows how expense control (profit margin), efficient use of assets in production (asset turnover) and capital structure (equity multiplier) affect return on equity. Ties together all aspects of firm - production and financing.
- Notice that using more debt (and less equity) to finance assets raises the Equity Multiplier. This has two effects for stockholders. The Equity Multiplier acts as a lever to magnify the effects of ROA on returns for stockholders. If ROA is positive, ROE is a larger positive value, but if ROA is negative ROE is a larger negative. Raising the s magnifying effect also raises the risk for stockholders.
- Return on Assets is affected by two areas of operations. The Profit Margin measures the degree to which the firm controls expenses. Since expenses comprise the difference between Sales and Net Income, lowering the expenses taken out of each dollar of sales raises the Profit Margin. At the same time, Return on Assets can be raised by producing sales by using fewer assets. Asset Turnover measures the dollar of sales produced with each dollar invested in assets. This is often thought of as sales volume. Different industries achieve ROA in different ways. Some have low profit margins but high volume, e.g. grocery stores. Others have lower volume but are able to maintain higher profit margins, e.g. car dealerships.
- Dells ROE 31.39% is higher than the industry standard (24.1% average over the past 4 years). Where is Dell making these high profits? Dell’s ROE comes from: Dell’s profit margin is 6.59% The industry average over the preceding 4 years is only 3.69%. So, Dell is nearly twice as efficient as the industry average in generating profits from its sales. Dell’s sales-to-assets ratio is 2.20. The industry average over the preceding 4 years is 2.05. So, Dell is about average is generating sales from its assets. Dell’s equity multiplier is 2.16. The industry average over the preceding 4 years is 2.50. So, Dell is a little below average in its equity multiplier (using a little more equity and a little less debt than an average company in the industry.) Thus, we can conclude that Dell’s profitability comes from it’s operating efficiency!
- Knowing the absolute level of a single entry on the income statement or balance sheet doesn’t provide sufficient information to evaluate performance. Ratios help by focusing on relationships among entries on the financial statements. The ratios in the DuPont system show the connection between the firm’s operations, its capital structure and the returns for investors. Because a firm’s size affects financial statement values, it’s hard to evaluate performance using absolute levels. By controlling for differences in size to make comparisons ratios facilitate the evaluation of a firm’s performance.
- Limitations 1. Large firms operate different divisions in different industries a. Difficult to develop meaningful industry averages b. More useful for small, narrowly focused firms 2. Firms want to be better than average a. Attaining average performance not necessarily good b. Best to focus on industry leaders’ ratios 3. Inflation may have distorted balance sheets a. Must consider effects when comparing over time 4. Seasonal factors distort ratio analysis a. Use monthly averages for season items such as inventory 5. Window dressing can make financial statements look better 6. Different accounting practices can distort comparisons a. Inventory valuation, depreciation methods 7. Difficult to generalize whether a ratio is “good” or “bad” a. High current ratio – strong liquidity or too much cash (nonearning) 8. Ratios can give “mixed” view of company a. Analyze net effects of a set of ratios
- Stock prices can be thought of as discounted present value of expected future dividends. Dividends are paid out of earnings. Therefore expectations of future dividends would be based on current earnings (ROE) and sustainable growth rate on earnings. Ratio analysis can help evaluate current performance as well as firm’s likelihood to be able to sustain performance. High current ROE that is the result of high Equity Multiplier implies higher risk for stockholders. High ROE that derives from high ROA is less risky and possibly more sustainable.