Ratio Analysis - Bellevue College, Washington

Transcript Ratio Analysis - Bellevue College, Washington

Module 8 Ratio Analysis

Module 8 - Learning Objectives

• Define key valuation ratios: price to earnings, PEG, price to sales,

price to book, and price to cash flow.

• Evaluate stocks using valuation ratios. • Define profitability ratios and use these ratios to evaluate stocks. • Define management effectiveness ratios and use these ratios to

evaluate stocks.

• Define financial health ratios and use these ratios to evaluate

stocks.

• Define operating efficiency ratios and use these ratios to evaluate

stocks.

• Locate and download financial ratios from a financial website. 2

True or False

• A company with a 10% profit margin is better

than a company with a 7% profit margin.

• You should always choose a company growing

at 15% over a company growing at 10%.

• A company with $100 million debt is more

shaky than a company with $50 million debt.

• A company with a great CEO is always a good

investment.

Financial Ratios

• Valuation ratios

tell you whether or not you’re getting a good deal.

• Financial strength ratios

let you know the state of the company’s financial health.

• Profitability ratios

let you know how the company does on the bottom line.

• Management effectiveness and efficiency ratios

tell you how well management is doing.

Valuation Ratios

• What you pay for every $1 of earnings,

sales, book value, or cash flow.

• All other factors being equal,

lower valuation ratios tend to perform better.

Valuation - Price to Earnings Ratio

Using PE Ratios

PEs differ by sector and industry.

Price to Earnings Ratio by Sector (First Quarter 2001) Utilities Transportation Technology Services Healthcare Financial Energy Consumer NonCyclical Consumer Cyclical Conglomerates Capital Goods Basic Materials 0 Source: www.multex.com, early 2001 5 10 15 20 25 30 35 Stock Price Divided by Earnings Per Share 40

Information Technology Utilities Financials Energy Health Care Industrials Materials Consumer Staples Telecommunications Consumer Discretionary S&P 500 More recent information Sector PE Dec 2004 0 10 20 30 40 50 60 70

Check out the PE’s of the following companies from Fortune’s 2001 Fastest-Growing list. Does high growth mean high PEs?

Company Immunex (IMNX) Zomax (ZOMX) Sonic Automotive (SAH) 4Kids Entertainment (KDE) Siebel Systems (SEBL) Industry Biotech and drugs. CD manufacturer Automobile retailer Pokemon licensing, toys and games. Customer management software. 3-year Annual Growth in EPS 973% 93% 79% 242% 155% PE 54 11 11 14 58 10

PEG

• High PEs don’t necessarily mean high growth. • PEG used as a measure that combines PE and

growth in one number.

• Compare value (PE) for every percent of growth • The

lower the better.

Calculate PEGs. Which company represents the best value?

• Gateway (GTW), a computer manufacturer, has

earnings of -$1.13, a stock price of $6.22 and a projected 12% growth rate for the next five years.

• Dell (DELL), a computer manufacturer is selling for

$42 and has earnings of $1.21. Its projected growth rate is 20%.

• Hewlett Packard (HPQ) is selling for $20.58 and earns

$1.15 per share. Its projected growth rate is 10%.

Valutation - Price to Sales Ratio

• Works the same as PE but gives you what

you’re paying for every $1 of sales.

• Some analysts claim this is the best ratio to use • All other things being equal, the

lower better.

the

Price to Sales varies by sector or industry Price to Sales by Sector Utilities Transportation Technology Services Healthcare Financial Energy Consumer NonCyclical Consumer Cyclical Conglomerates Capital Goods Basic Materials 0 1 Source: www.multex.com, early 2001 2 3 4 5 6 Stock Price Divided by Sales Per Share 7 8

Latest data Price to Sales as of Dec 2004 Information Technology Utilities Financials Energy Health Care Industrials Materials Consumer Staples Telecommunications Consumer Discretionary S&P 500 0 2 4 6 8 10 12 14 16 18

These companies were all hot in the communications equipment arena during the technology bull market. Evaluate them in terms of price to sales. The current market price to sales ratio is 4 and the industry price to sales is 7. Which would be the best buy based on this ratio?

Company JDS Uniphase (JDSU) Ciena (CIEN) Nortel (NT) Sonus (SONS) Juniper (JNPR) Sycamore (SCMR) Price to Earnings No earnings 99.88

No earnings No earnings 89.5

222 Price to Sales 6.03

11.85

1.37

36.74

19.67

6.07

Valuation - Price to Book Value Ratio

• Book value is the net worth (assets minus

liabilities) of the company on the books.

• Academic studies show that companies with

low price to book value perform better than companies with high price to book value.

Price to Book Value varies by sector or industry.

Price to Book Value by Sector Utilities Transportation Technology Services Healthcare Financial Energy Consumer NonCyclical Consumer Cyclical Conglomerates Capital Goods Basic Materials 0 Source: www.multex.com, early 2001 2 4 6 8 Stock Price Divided by Book Value Per Share 10 12

Low price to book (or high book to market) perform better over the long run

Find the book value and the market value

• General Motors (GM) • Boeing (BA) • Oracle (ORCL) • Ebay (EBAY) • Citigroup (C) • MCI Worldcom (WCOM) 20

Low price to book value and high growth?

Stock screeners can identify stocks by their financial ratios. You decide what kinds of financial ratios you want and they sort through all stocks and give you a list of the ones that meet your criteria. Let’s say, you are looking for stocks with low book value. Are there any companies selling below book value? Low book value might be warranted because of slow growth. Let’s add another criteria: growth of 25%.

http://www.morningstar.com

Valuation - Price to Cash Flow

• Similar to PE ratio, what you’re paying for every

$1 cash flow.

• Used for established companies. • New companies are not expected to throw off

cash right away.

• The

lower , the better the value.

Investors look at supermarkets to throw off cash. Look at the following supermarket companies. Which presents the best value based on price to cash flow?

Company Krogers (KR) SuperValu (SVU) Safeway (SWY) Albertson (ABS) Price to Cash Flow 10.1

3.1

13.9

6.8

Profitability

• Profitability ratios

many levels.

come in

• Return on sales

bottom line profitability picture.

is the

• Operating margins

out taxes.

leave

• Gross margins

only the cost of the product.

consider

Profitability varies by sector or industry.

Net Profit and Operating Margins by Sector (First Quarter 2001) Utilities Transportation Technology Services Healthcare Financial Energy Consumer NonCyclical Consumer Cyclical Conglomerates Capital Goods Basic Materials 0% Source: Marketguide early 2001 5% Operating Margin Net Profit Margin 10% 15% Percent of Revenues 20% 25% 30%

These are all computer manufacturers. Compare their net profit margins. Which is the most profitable company?

Company Gateway (GTW) Dell (DELL) IBM (IBM) Hewlett Packard (HWP) Compaq (CPQ) Net Profit Margin (%) 2.6

7.0

9.2

6.3

1.4

Here are 5 well-known retailers and their 2000 profit margins.

Find the most recent net profit margin information.

Use www.thomsoninvest.net or www.multexinvestor.com.

How do they compare to 2000 profit margins?

Company Gap (GPS) Limited (LTD) Nordstrom (JWN) Abercrombie & Fitch (ANF) Talbots (TLB) Net Profit Margin 6.4

4.3

1.9

12.7

7.2

Management Effectiveness - Return on Assets and Return on Equity

• Return on Assets

assets it has.

lets you know how much the company earns on all the

• Return on Equity

let you know how much the company earns on its net worth or book value.

• The

higher better.

the ratio the

Return on Assets and Return on Equity vary by sector or industry.

Return on Equity and Return on Assets by Sector Utilities Transportation Technology Services Healthcare Financial Energy Consumer NonCyclical Consumer Cyclical Conglomerates Capital Goods Basic Materials 0% 5% Source: www.multex.com, early 2001 Return on Assets Return on Equity 10% 15% 20% 25% 30% 35% 40%

Looking at the return on equity and return on assets for the following semiconductor manufacturers. Which is the best managed?

Company Intel (INTC) Advanced Micron Dev (AMD) Micron (MU) Texas Instruments (TXN) Applied Materials (AMAT) Taiwan Semiconductor (TSM) Return on Assets 22 20 15 17 28 25 Return on Equity 29 40 21 26 36 37 30

You are a bank loan officer. Evaluate two people for a $15,000 loan.

• Individual A – Assets = $80,000 – Debt = $60,000 – Equity = $20,000 • Individual B – Assets = $80,000 – Debt = $20,000 – Equity = $60,000 31

Financial Health - Debt to Equity Ratio

• Variety of ratios show whether the company is

able to handle yearly obligations

• Debt to Equity

health ratio gives overall financial

• The

lower the debt to equity, the better

Drug companies usually have to finance the development of new drugs. Which drug companies are financially strong? Which are weaker? Use debt to equity ratios to evaluate these companies.

Company Merck (MRK) Johnson and Johnson (JNJ) Pfizer (PFE) Eli Lilly (LLY) Astra Zeneca (AZN) Schering Plough SGP Total Debt to Equity 0.25 0.17 0.36 0.53 0.08 .35 33

Efficiency Ratios

• Revenue per employee

or net income per employee Revenues divided by number of employees or earnings divided by number of employees

• Accounts receivable turnover

accounts receivable - Net sales divided by

• Inventory turnover

- Cost of goods sold divided by inventory

Dividend Yield Sector Dividend Yield Dec 2004 Information Technology Utilities Financials Energy Health Care Industrials Materials Consumer Staples Telecommunications Consumer Discretionary S&P 500 0% 1% 1% 2% 2% 3% 3% 4% 4%

High dividend companies perform better over the long run.

Analyst Ratings

• Security analysts do indepth fundamental

analysis on stocks

• They create financial models and

projections of what the stock price will be in the future

• They make recommendations. 37

Analyst Ratings

• Buy

(also referred to as Strong Buy enthusiastic about the stock and thinks the price will go up a lot in the next year or two.

). The analyst is very

• Buy/Hold

(also referred to as Buy or Outperform ). The analyst likes the stock and recommends that you buy.

• Hold

(also referred to Neutral recommending a sell as yet.

). Prospects for the company may be uncertain and the analyst is not

• Hold/Sell

(also referred to as Underperform ). This stock will not do as well as its counterparts.

• Sell.

Get rid of the stock now.