Transcript Document
Financial Statement Analysis 16.1 THE MAJOR FINANCIAL STATEMENTS Balance Sheet ◦ Common Sized ◦ Trend or Indexed Income Statement ◦ Common Sized ◦ Trend or Indexed Statement of Cash Flows Four broad classes: ◦ ◦ ◦ ◦ Cost of goods sold General and administrative expenses Interest expense Taxes on earnings HP for example: Operating revenue, Operating expense, Operating income EBIT: income earned if no debt or tax, measure of profitability of the firm’s operations Assets ◦ Current ◦ Long-term Liability and stockholders’ equity Income statement and balance sheets are based on accrual methods of accounting Statement of cash flows tracks the cash implications of transaction, recognizes only transactions in which cash changes hands ◦ Example: if goods are sold now, with payment due in 60 days. Income statement will treat the revenue as generated when the sale occurs, balance sheet will be immediately augmented by accounts receivable, but the statement of cash flows will not show an increase in available cash until the bill is paid 16.2 ACCOUNTING VERSUS ECONOMIC EARNINGS Economic earnings ◦ Sustainable cash flow that can be paid to stockholders without impairing productive capacity of the firm Accounting earnings ◦ Affected by conventions regarding the valuation of assets 16.3 PROFITABILITY MEASURES ROE: measures the profitability for contributors of equity capital ROE=Net income/equity ROA: measures the profitability for all contributors of capital ROA=EBIT/asset Leverage has a significant effect on profitability measures Data from recent past may provide information regarding future performance Analysts should always keep an eye on the future Expectations of future dividends and earnings determine intrinsic value of stock EXAMPLE Noddet: all equity financed , total assets of 100 million, tax rate 40% Somedett: 40 million debt, interest rate of 8%, 60 million equity. Same sales, EBIT, ROA, but somedett’s ROE exceeds that of nodett in normal and good years, and is lower in bad years. Debt ROE = (1 - Tax rate) ROA + (ROA - Interest rate) Equity ROE Net profit EBIT - Interest - Taxes (1 - Tax rate)(EBIT- Interest) Equity Equity Equity (ROA x Assets) - (Interest rate x Debt) (1 - Tax rate) Equity Equity + Debt Debt (1 - Tax rate) ROA x Interest rate x Equity Equity Debt (1 - Tax rate) ROA + (ROA - Interest rate) Equity Calculate the ROE of somedett in a normal year Debt ROE = (1 - Tax rate) ROA + (ROA - Interest rate) Equity 40 (1 40%) 0.1 (0.1 0.08) 6.8% 60 Increased debt will make a positive contribution to a firm’s ROE only if ROA>interest rate on the debt Higher ROE, not imply higher stock price. Financial leverage increases the risk of the firm’s equity, higher discount rate will offset the higher expected earnings 16.4 RATIO ANALYSIS ROE = Net Profit x Pretax Profit Burden x EBIT (1) Tax Pretax Profit x x (2) Interest Burden x EBIT Sales (3) x x Sales Assets (4) x x Assets Equity (5) x Margin x Turnover x Leverage ROE =tax burden interest burden margin turnover leverage tax burden= NI/pretax profit=NI/(EBIT-I) interest burden=pretax profit/EBIT=(EBIT-I)/EBIT operating profit margin (return on sales)=EBIT/sales total asset turnover=sales/asset leverage=A/E=1+D/E ROE =tax burden interest burden margin turnover leverage ROA=Margin Turnover Compound leverage factor=interest burden leverage ROE=tax burden ROA Compound leverage factor Profitability Ratios Turnover or Asset Utilization Ratios Liquidity Ratios Leverage Ratios Market Price Ratios One item from income statement, another from a balance sheet, take the average of the beginning and end-of-year balance sheet figures Fixed asset turnover=sales/ave fixed assets Inventory turnover=COGS/ave inventory Average collection period=365*ave Accounts receivable / sales Net Profit Margin % Net Income Sales Operating Return on Assets % Earnings Before Int. & Taxes Total Assets Return on Equity % Net Income Common Equity Inventory Turnover Sales or Cost of Goods Sold Inventory Total Asset Turnover Sales Total Assets Average Collection Period Accounts Receivable Sales Per Day Days to Sell Inventory Inventory Sales Per Day Current Ratio Current Assets Current Liabilities Quick Ratio Current Assets - Inventory Current Liabilities Times Interest Earned Earnings Before Int. & Taxes Interest Expense Fixed Charge Coverage Ratios Lease Payments Principal Repayments Preferred Dividends Debt to Assets % Long Term Debt Assets Debt to Equity % Long Term Debt Shareholders Equity Price to Earnings Market Price of Stock Earnings Market-to-Book-Value Market Price of Stock Book Value Per Share 16.5 ECONOMIC VALUE ADDED Difference between return on assets (ROA) and the opportunity cost of capital (k) ROA-K (Capital Invested in the firm) EVA is also called residual income EVA can be positive or negative for firms that have positive earnings 15.6 AN ILLUSTRATION OF FINANCIAL STATEMENT ANALYSIS 16.5 COMPARABILITY PROBLEMS Inventory valuation ◦ LIFO and FIFO Depreciation Inflation and interest expense Allowance for bad debts Non-recurring items Earnings smoothing Stock options Revenue recognition Off-balance sheet assets and liabilities Reserving practices Depreciation Intangibles 16.6 VALUE INVESTING: THE GRAHAM TECHNIQUE Graham believed careful analysis of a firm’s financial statements could turn up bargain stocks He developed many different rules for determining the most important financial ratios Accounting Differences ◦ Inventory Valuation ◦ Depreciation Inflation and Interest Expense Fair Value Accounting Quality of Earnings International Accounting Conventions Reserves – many other countries allow more flexibility in use of reserves Depreciation – US allows separate tax and reporting presentations Intangibles – treatment varies widely Careful analysis of a firm’s financial statements could turn up bargain stocks Purchase common stocks at less then their working-capital value Give no weight to plant or other fixed assets Deduct all liabilities in full from assets