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Chapter 1. What is Financial Analysis?. Defining Financial Analysis. Financial analysis is the process of evaluating financial and other information for decision-making. A six-step approach is suggested for systematic financial analysis. Six-step Process.

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Chapter 1 l.jpg

Chapter 1

What is Financial Analysis?


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Defining Financial Analysis

  • Financial analysis is the process of evaluating financial and other information for decision-making.

  • A six-step approach is suggested for systematic financial analysis.


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Six-step Process

  • Identify purpose of financial analysis

  • Corporate overview

  • Financial analysis techniques

  • Detailed accounting analysis

  • Comprehensive analysis

  • Decision or recommendation


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Corporate Overview

  • Industry analysis--key economic characteristics, historical context, profit drivers, business risks

  • Firm’s business strategy--competitive strategy given the industry characteristics


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Industry Analysis

  • Competition--growth rates, concentration ratios, degree of product differentiation, economies of scale (& relative fixed & variable costs), substitute products

  • Legal barriers--patent & copyrights, licensing, regulation

  • bargaining power of buyers (& suppliers) & price sensitivity


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Industry Analysis Criteria

  • What is the industry?

  • Relative size & significance

  • Largest companies

  • Geographic presence

  • Business cycle effects, current situation

  • Future potential


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Business Strategy

  • Cost leadership: low cost producer, economies of scale, efficient production, low input prices

  • Product differentiation: specific attributes that customers value (e.g., quality, variety, service, delivery time), brand name

  • Importance of core competencies


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Business Strategy Criteria

  • Historical perspective

  • Primary focus of operations

  • Most important strategy

  • Major operating segments

  • Corporate outlook/ forecast


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Qualitative Analysis--Dell Computer

  • Industry—primarily PCs: high tech, competitive (e.g., Gateway, IBM, Apple, others), changing products, high growth rates, low barriers of entry

  • Business strategy--(1) cost leadership strategy: direct selling, made-to-order manufacturing, early on the internet, low receivables; (2) product differentiation?? [IBM clones, Intel & Microsoft components]

  • Current situation—market share; what is the impact of the business cycle (e.g., PCs are durable goods)?


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Quantitative Financial Analysis

  • Systematic analysis of key elements based on analysis context

  • Ratios, cash flows, common-size, time series, comparative (e.g., specific firms, industry, all firms), models (e.g., DuPont, Altman’s)

  • In-depth analysis for “red flag” items


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Quantitative Financial Analysis

  • Financial Statements

  • Common-size Analysis

  • Financial Ratios

  • Growth/trend Analysis

  • Quarterly analysis

  • DuPont Model

  • Market Analysis


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Detailed Accounting Analysis

  • Does accounting information capture the underlying business reality?

  • Identify areas of “accounting flexibility” & evaluate accounting policies (choices) & disclosures; especially notes & MD&A

  • Evaluate earnings management potential

  • Recast accounting numbers when necessary


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Comprehensive Analysis

  • Summarize key points: what is particularly important for decision making?

  • “Red flags” are particularly important

  • Consider a written executive summary

  • Consider a rating scale, such as 1-10


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Decision

  • What is the recommendation or decision?

  • What is the key rationale for this decision? [This is based on the specific decision: for a credit decision the key factors relate to credit risk, with particular focus on leverage and liquidity.]

  • Be prepared to defend this decision.


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Chapter 2

The Financial Environment



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Credit Decisions

  • Commercial banks provide short-term commercial loans

  • The major concern: will the company pay interest & principal when due?

  • Loan terms: interest rate, collateral, debt covenants


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Equity Investment Decisions

  • Public securities trade on formal market exchanges (these are secondary markets)

  • Buying & selling are now relatively cheap transactions

  • Mutual funds are a useful alternatives to individual securities

  • Stock investing has high short-term risks


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SEC Regulation

  • Mission: Protect investors & maintain integrity of the securities markets

  • Established following the Great Market Crash (SEC Act of 1934)

  • SEC requires public registration, proxy statements & annual (10-K) and quarterly (10-Q) reports, 8-K for specific events

  • Update: Sarbanes-Oxley Act of 2002 & Public Company Accounting Oversight Board; Dodd-Frank, 2010


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Goals of Financial Accounting in a Market Economy?

  • Capture business economics of the firm (e.g., relationship to industry, competitive strategy, business model). How does firm create value?

  • Reduce management discretion on financial reporting (what is reality? Vs. misleading information--analysts sort this out). Note management incentives for earnings management


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Accounting Regulators

  • Securities & Exchange Commission (SEC)--regulates securities markets and financial reporting (10-K, 10-Q, 8-K)

  • Financial Accounting Standards Board (FASB)--promulgates GAAP

  • International Accounting Standards Board (IASB)—issuing International Financial Reporting Standards (IFRS)


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U.S. Standard Setters: 1938-Present

  • Committee on Accounting Procedures (CAP) issued 51 Accounting Research Bulletins (ARBs)--1938-59

  • Accounting Principles Board (APB) issued 31 Opinions--1959-73

  • Financial Accounting Standards Board (FASB) has issued 168 Statements through 2009 (SFASs) plus other standards—now Standards Codification in 4 volumes, by topic



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The FASB

  • Seven member board, full time, appointed by FAF, presumed independent

  • Extensive due process: agenda items, discussion memoranda (DM), exposure drafts (ED), pronouncements, public exposure with written & oral comments

  • Super-majority (5-2 vote) [simple majority used 1977-90]

  • Standard setting a political process


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Annual Report Information

  • Corporate Overview

  • MD&A

  • Financial Statements: Balance Sheet, Income Statement, Statement of Cash Flows, Statement of Equity

  • Notes to financial statements

  • Auditor’s Opinion


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Management Incentives

  • Managers have incentives to present information in the most favorable light (e.g., bonuses, stock options, promotions)

  • Accounting choice: accounting polities, estimates, additional disclosures

  • Standardize vs. estimates: what is reality?

  • Management have best information, but communications to investors may not be completely credible


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Financial Statement Considerations

  • Managers’ information on economic reality

  • Estimation errors

  • Distortion from managers’ accounting choices & disclosure

  • Question: Can investor perceptions be manipulated?


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Finance Theory Perspectives

  • Efficient Markets

  • Random Walk

  • Portfolio Theory

  • Beta Analysis

  • Economic Behavior & Agency Theory

  • Earnings Management & Accounting Choice


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Efficient Markets

  • Markets are efficient if information is impounded immediately in capital prices in an unbiased fashion

  • Research supports market efficiency in the semi-strong form, for short windows

  • Why?—Analyst following

  • Note long-term anomalies & other challenges (e.g., behavioral economics)


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Random Walk

  • The concept that a professional portfolio cannot outperform a randomly selected stock portfolio

  • Research generally confirms this result

  • Consistent with efficient markets; that is, all information has been impounded in stock price


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Portfolio Theory

  • Harry Markowitz introduced the concept of portfolio diversification with his 1952 dissertation

  • Portfolio theory insists that investment portfolios should be diversified to reduce the risk relative to return

  • Capital asset pricing model: E(Ri) = Rf + [E(Rm) – Rf)


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Beta Analysis

  • Beta () comes directly from the slope of the market model: Rit = i + iRmt + eit

  • Beta measures the relationship between price movements of the individual stock to market averages

  • Beta is a measure of systematic risk, where a =1 stock should move with the market; a >1 stock has greater market risk


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Economic Behavior

  • Rationality: assume bounded rationality—people are intendedly rationale but limited

  • Self-interest behavior: Obedience Simple self interest Opportunism (self interest with guile-- that is, willing to violate normal ethical boundaries for personal benefit)


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Agency Theory

  • Contracts have a principal (e.g., owners) and agent (e.g., managers). The principal will attempt to maximize wealth, contract to avoid conflict, and minimize transaction and agency costs.

  • Agency costs: information asymmetries (limited information by one side), adverse selection, moral hazard (e.g., shirking).


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How to Reduce Agency Costs

  • Better acquisition decisions

  • Monitoring--including audits and financial reporting

  • Align preferences of agents with principals (e.g., debt covenants, management compensation)--a reason for stock options

  • Control devises such as budgets


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Earnings Management

  • Operations and discretionary accounting methods to adjust earnings to a desired outcome, often income smoothing

  • Underlying theory: agency theory, transaction cost economics

  • Importance of efficient contracting: corporations are a network of contracts and exist because they write contracts efficiently


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Accounting Choice

  • Discretionary choices to optimize behavior, using techniques such as: 1. Select alternative accounting methods (e.g., inventory) & level of disclosure (e.g., contingencies) 2. Lobbying (e.g., on proposed standards) 3. Financial, production & investment activities


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Discretion Under GAAP

  • Taking a bath

  • Creating hidden reserves

  • Off-balance-sheet financing

  • Overstating performance (e.g., aggressive revenue recognition)

  • Not reporting obligations (contingencies, commitments, other liabilities)


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Earnings Manipulation

  • Because alternatives are allowed, financial accounting has many discretionary aspects.

  • Managers can manipulate income by timing (e.g., recognition this year v next year) and classification (e.g., ordinary v extraordinary)

  • Accruals can be mandatory (e.g., other post employment benefits) or voluntary (e.g., depreciation)


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Earnings Quality

  • Importance of full disclosure

  • Look for “conservative” reporting

  • Review indicators of high quality

  • Relationship of risk to earnings quality

  • Be aware of earnings management incentives and evidence of earnings manipulation


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Normalizing Income

  • Attempt to determine earning power--related to normal operating earnings

  • Remove the “noise”--usually associated with nonrecurring items

  • Separate analysis of nonrecurring items--reorganization, “big bath” write-offs, changing GAAP

  • Evidence of earnings manipulation may require substantial adjustments to arrive at “normal earnings”


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Financial Analysis Decision

  • Based on Elliott’s “value chain of information”: this is the $1,000 per hour stage

  • The purpose of financial analysis is to arrive at an informed recommendation or decision


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Chapter 3

The Financial Statements


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Financial Statements

  • Balance Sheet

  • Income Statement

  • Statement of Cash Flows

  • Statement of Stockholders’ Equity


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Balance Sheet

  • Assets: probable future economic benefits

  • Liabilities: probable future economic sacrifices

  • Stockholders’ Equity: residual interest, representing ownership interest (also called net assets)


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Assets

  • Current Assets (cash & cash equivalents, short-term marketable securities), accounts receivable, inventory, other)

  • Property, plant & equipment

  • Long-term investments

  • Other assets


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Liabilities

  • Current Liabilities (accounts payable, accrued & other current liabilities)

  • Long-term debt

  • Commitments & contingencies

  • Other liabilities

  • Potential off-balance sheet debt


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Stockholders’ Equity

  • Preferred stock

  • Common stock

  • Other paid-in capital

  • Retained earnings

  • Treasury stock

  • Other comprehensive income

  • Other equity items


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Income Statement

  • Revenues: inflows from major operations

  • Expenses: outflows from major operations

  • Gains & Losses: changes in equity from peripheral activities

  • Net income: bottom line all operating activities recorded on the income statement

  • Comprehensive income: Changes in equity from all non-owner sources


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Revenue

  • Sales

  • Services

  • Other revenue items

  • Importance of revenue recognition criteria


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Operating Expenses

  • Cost of goods sold (manufacturing)

  • Cost of sales (services or services included)

  • Operating expenses (selling, general & administrative, research & development, other)

  • Interest income & expenses & related

  • Provision for tax


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Non-recurring Items

  • Extraordinary items

  • Discontinued operations

  • Accounting changes

  • Other non-recurring items

  • Other gains & losses


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Earnings Measures

  • Gross profit

  • Operating income

  • Income before tax

  • Income from continuing operations

  • Net income

  • Comprehensive income


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Cash Flow Statement

  • Cash Flows from Operations

  • Cash Flows from Investing Activities

  • Cash Flows from Financial Activities

  • Statement of Stockholders’ Equity


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Cash From Operations

  • Net income

  • Depreciation & amortization

  • Other operating adjustments

  • Changes in non-cash working capital items


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Cash From Investing & Financing

  • Cash from investing Investment purchases Investment maturities & sales

    Capital expenditures

  • Cash from financing Issuance of equity Purchase/acquisition of equity New debt Debt maturities or retirement

    Dividends

    Treasury Stock


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Statement of Stockholders’ Equity

  • Reconciliation of stockholders’ equity, alternative formats used

  • Key categories (changes) Common stock, other paid-in capital Retained earnings Treasury stock Other comprehensive income


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Chapter 4

Quantitative Financial Analysis Using Financial Statement Information


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Quantitative Financial Analysis

  • Systematic analysis of key elements based on analysis context

  • Quantitative techniques to standardize financial information for relevant comparisons

  • In-depth analysis for key factors, including “red flags”


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Quantitative Financial Analysis

  • Financial Statements

  • Common-size Analysis

  • Financial Ratios

  • Growth Analysis

  • Du Pont Model

  • Earnings Quality/Normalizing Earnings


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Useful Financial Comparisons

  • Benchmarks: rules of thumb or averages

  • Common Sense

  • Trend Analysis (analysis over time)

  • Near Competitors

  • Industry Averages

  • Market Averages


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Common-size Analysis

  • Overview vs. detail

  • Balance sheet: total assets = 100%

  • Income Statement: sales (or total revenues) = 100%

  • Comparisons over time & across firms (or industry averages)

  • Useful starting point for financial overview


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Ratio Analysis

  • A ratio converts financial information to a percentage, one approach to standardization

  • Each ratios provides a somewhat different analysis

  • Ratios overlap—a problem in one area should show up as problems in other areas

  • The importance of specific ratios differs, based on the purpose of the financial analysis

  • Ratios for the most recent period are usually the most important


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Ratio Categories

  • Liquidity—cash, working capital & cash flow related

  • Activity—turnover ratios as possible efficiency measures

  • Leverage—debt & solvency analysis

  • Performance (or profitability)—bottom line or earnings related


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Liquidity Ratios

  • Current ratio: current assets/current liabilities

  • Quick (acid test) ratio: (cash+marketable securities+net receivables)/current liabilities

  • Cash ratio: (cash+marketable securities)/current liabilities

  • Operating ratio: cash flows from operations/current liabilities


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Leverage Ratios

  • Debt to equity ratio: total liabilities/total stockholders’ equity

  • Debt ratio: total liabilities/total assets

  • Interest coverage: (income before tax +interest expense)/interest expense [note that the numerator is earnings before interest and taxes or EBIT]*

  • Long-term debt to equity: long-term liabilities/total stockholders’ equity

  • Debt to market equity: total liabilities at book value/total equity at market value

    *alternatively: (income from continuing operations + interest expense + tax expense)/interest expense


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Activity Ratios

  • Inventory turnover: cost of sales [or COGS]/average inventory

  • Receivables turnover: sales/average accounts receivable

  • Payables turnover: sales/average accounts payable

  • Working capital turnover: sales/average working capital

  • Fixed asset turnover: sales/average property, plant & equipment

  • Total asset turnover: sales/average total assets


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Activity Ratios in Days

  • Average days inventory in stock: 365/inventory turnover

  • Average days receivables outstanding: 365/receivables turnover

  • Average days payable outstanding: 365/payables turnover

  • Length of operating cycle: average days inventory + average days receivables


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Profitability

  • Gross margin: (Sales-cost of sales)/sales

  • Return on sales: net income/sales

  • Return on assets: net income/average total assets

  • Pretax return on assets: earnings before interest & taxes/average total assets

  • Return on total equity: net income/average stockholders’ equity

  • Dividend payout: common dividends/net income [per share basis: dividends per share / EPS]


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Du Pont Model

  • ROE = Profitability x Activity x Solvency

  • Net Income / Average Common Equity = (Net Income / Sales) x (Sales / Average Total Assets) x (Average Total Assets / Average Common Equity)

  • ROA = Profitability x Activity


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Decomposition using Du Pont

  • Start with Return on Sales

  • Activity is avg. total asset ratio—this is a measure of asset turnover or efficiency

  • ROS x ATAR is Return on Assets (calculate as net income / average total assets)

  • Solvency is ATA / Avgas. Common Equity—this is a standard leverage ratio

  • ROA x Solvency is Return on Equity (calculate as net income / average common equity)

  • In summary, the differences between ROS, ROA & ROE depend on activity & solvency


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Ratio

Profit (Return on Sales)

Activity (Asset Turnover)

Return on Assets

Solvency (Common Equity Leverage)

Return on Equity

Calculation

Net Income/Sales

Sales/Avg. Total Assets (ATA)

Net Income/ATA

ATA/Average Common Equity (ACE)

Net Income/ ACE

Du Pont Model


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Ratio Analysis Limitations

  • Ratios are presented on a percentage basis

  • Relative size is ignored (e.g., both large & small firms can be compared)

  • It is assumed that all numbers used are correct (consider both possible errors and earnings management)

  • If the numbers are not reliable, ratios are not particularly useful



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Chapter 5

Multiperiod Quantitative Financial Analysis


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Growth Analysis (period-by-period change)

  • Long-term trends over time can be significant. Are current year performance measures consistent with earlier years (e.g., maintaining consistent ratios while sales are rising smoothly)?

  • As a first step, present growth rates (including % increases) for the last 5-10 years

  • Declining or negative growth rates might be obvious red flags; Red flags and other indicators of poor growth performance require further analysis


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Base-Year Analysis(also called Trend Analysis)

  • Set the earliest year, evaluated as the base year, at 100. [Note: this assumes that earliest year is “normal.”] Calculate growth by dividing the more current year numbers by the base year number.

  • This is an alternative presentation to growth rate percentages over 5-10 years (or more)


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Quarterly Analysis

  • The most recent financial data is presented quarterly (e.g., 10-Q). [The one exception is at year end, with annual information is presented]

  • Financial analysts focus on quarterly data and the quarterly earnings announcement is the most important (& earliest) information

  • Common-size and ratios analysis is conducted, and compared over earlier quarters: particularly important are current quarter data to (1) the previous quarter and (2) the same quarter one year ago


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Chapter 6

Quantitative Financial Analysis Techniques: Incorporating Market Information


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Quantitative Market Analysis

  • Stock prices & stock charts

  • Earnings per share—actual & forecast

  • Price earnings ratios (PE)

  • Dividend yield

  • Market value & market-to-book

  • Price earnings to growth ratios (PEG)

  • Valuation models


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Stock Prices

  • Prices change continuously

  • Using daily closing price

  • Stock charts, various periods

  • Industry & market comparisons

  • Internet sites


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Earnings Per Share (EPS)

  • Performance measure on per share basis

  • Basic vs. diluted

  • Forecasted EPS (Analysts’ Estimates on Yahoo)

  • Annual vs. quarterly EPS

  • Annual—last 4 quarters

  • 5 year forecasts (relevance vs. reliability)


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PE Ratios

  • Stock price as a market premium for earnings

  • Which price? (most current, historic…)

  • Which EPS? (current year actual--usually last 4 quarters, future forecast, basic vs. diluted)

  • Closing prices

  • Alternatives & how to evaluate them


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Market-based Ratios

  • Price earnings ratio (PE): Stock price / EPS

  • Dividend Yield: Dividend per share / Stock price

  • Market value: stock price x shares outstanding

  • Market-to-book: market value / stockholders’ equity


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Dividends

  • Dividends given on a per share basis; focus on dividends per share, last 4 quarters. [Note—equivalent to dividends/shares outstanding.]

  • Dividend yield: dividends per share/stock price—income focus; average yield is about 2% for the S&P 500.

  • Dividend payout: dividends per share/earnings per share.


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Market-related Ratios

  • Market-to-book: market value / stockholders’ equity [or measure on a per share basis—stock price / book value per share]—why is a “market premium to book” common?

  • Sales to market value: annual sales to outstanding shares x (1) year-end closing market price or (2) most recent closing market price.


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Price Earnings to Growth (PEG)

  • High PE is usually associated with the expectation of high earnings growth, which can be evaluated with PEG

  • “Historic PEG” = PE based on actual EPS / 5-year historic earnings growth

  • “Forecast PEG” = PE based on forecast EPS / 5-year earnings forecast

  • PEG is useful to evaluate growth stocks, less useful for income stocks


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Earnings-based Growth Model

  • P = kE / (r – g) where P is “expected” stock price, k is dividend payout rate (actual or predicted), E is EPS, r is the discount rate, and g the projected earnings growth rate

  • This model requires dividends, the discount rate is arbitrary (it could be the actual cost of capital—or based something else), and the growth rate is a forecast; results can change substantially using different assumptions


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Stock Screening

  • The purpose of stock screening is the determine which firms meet specific criteria (such as minimum ROE or dividend yield)

  • Several internet sites have stock screeners, such as Yahoo

  • The technique is useful to limit the number of companies on which to conduct a complete financial analysis


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Chapter 11

Capital Structure & Credit Risk


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Corporate Liabilities

  • Accounts Payable

  • Commercial Paper & other short-term market liabilities

  • Other current liabilities

  • Corporate Bonds

  • Other long-term market debt

  • Other liabilities (including off-balance-sheet)


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Credit Risk

  • Credit risk: probability that a corporation will either default on debt or declare bankruptcy. Default risk: probability that a corporation will not pay interest & principal when they come due Bankruptcy risk: probability that a corporation will file for bankruptcy


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Default Risk

  • What is the chance (probability) that the corporation will fail to make interest or principal payments when due?

  • Because of high collection costs, creditors evaluate credit risk carefully

  • Failure events: restructurings, especially troubled debt restructuring; default; bond rating down-grading; going-concern qualifications; bankruptcy


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Bankruptcy Risk

  • Probability that a firm will file for Chapter 11 bankruptcy.

  • Importance of failure events: losses, defaults, troubled debt restructuring, going concern qualified audit opinion

  • Altman’s Z-score can be used as a prediction model for credit risk


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Financial Leverage

  • Financial leverage is the relative mix of debt (especially long-term debt) & equity

  • Long-term debt increases credit risk & has interest charges

  • The financial leverage index (FLI) is ROE/ROA

  • A high FLI indicates the increasing use of leverage to raise ROE relative to ROA

  • The financial structure leverage ratio (FSLR) is average total assets/average common equity. This is the same ratio used in the DuPont Model for solvency. A higher ratio means higher leverage, but also a higher ROE. The ratio is identical to FL1 if there is no preferred stock. When preferred stock is present, the FSLR is higher than FLI.


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Altman’s Z-score, 1983 Model

  • 6.56 x (working capital / total assets)

  • + 3.26 x (retained earnings / total assets)

  • + 6.72 x (EBIT / total assets)

  • + 1.05 x (book value of equity / book value of debt)

  • = Altman’s Z-score


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Altman’s Z-score

  • Indicator of overall financial health

  • Cutoffs: les than 1.1 bankrupt 1.1 – 2.6 gray area greater than 2.6 healthy

  • A Z-score of 1.1 or less does not mean the company is bankrupt, but does suggest that financial problems may exist


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Bond Ratings

  • Bond rating agencies include Standard & Poor’s & Moody’s

  • Corporations are expected to have investment grade ratings, Baa and above (for Moody’s)

  • Bond ratings below investment grade are junk bonds, which is usually recognized as a red flag



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Chapter 12

Credit Analysis


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Credit Analysis Process

  • Loan Purpose

  • Corporate Overview

  • Financial Analysis

  • Accounting Analysis

  • Comprehensive Analysis

  • Loan Decision


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Loan Purpose

  • Commercial Bank Loan: term loan revolving line of credit other

  • Commercial Paper

  • Corporate Bonds


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Corporate Overview

  • Wide variety of firms need bank loans

  • Size characteristics—local or regional to national & global

  • Industry specializations, including impact on bank credit risk

  • Large companies have more credit options


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Quantitative Financial Analysis

  • Primary focus is on financial report analysis, with less emphasis on market information

  • Particular interest in liquidity & leverage

  • Evidence of financial health (as measured by credit risk) rather than earnings performance & forecasts


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Accounting Analysis

  • Emphasis on liquidity & cash flow information

  • Analysis of unrecorded obligations & potential overstated assets

  • Forecasts of sales & operations plus future cash flows


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Comprehensive Analysis

  • Summary of key information (executive summary recommended)

  • Importance of credit risk

  • Adequate information to make informed recommendations/decisions


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Loan Decisions

  • Yes/ No on loan

  • What interest rate (prime rate +)?

  • What collateral?

  • What Debt covenants?

  • Other considerations (e.g., compensating balances)


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Chapter 13

Equity Investment Analysis


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Investment Portfolio

  • Importance of Portfolio Diversification

  • Based on Investor Goals

  • Short-term, liquidity focus

  • Mid-term, return but limited risk focus

  • Long-term, return focus


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Mutual Funds

  • Investment portfolios managed by professionals & regulated by the SEC

  • Advantages: diversification, professional management, liquidity, small investment

  • Disadvantages: Fees, average returns less than expected, lack of control over investments, taxes


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Mutual Fund Categories

  • Money Market Funds

  • Bond

  • Stock: growth, income, value, asset allocation, international, sector, regional

  • Balanced

  • Real estate, usually REITs


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Gotrocks Funds

  • Growth Fund: maximize long-term market appreciation using large-cap stocks (focus on earnings & earnings growth potential)

  • Income Fund: maximize intermediate- & long-term income using bonds and large-cap stock that pay high dividends (+ total return as a secondary goal)

  • Value Fund: invest in large-cap stocks that out of favor—requires evidence of substantial stock price drop & ongoing restructuring (usually low market-to-book)


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Investment Strategies

  • Buy & hold

  • Index funds

  • Dollar-cost averaging

  • Risk measures, such as Beta analysis

  • Asset allocation decisions; e.g., % of cash, bonds & stocks


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Six-step Analysis

  • Investment purpose

  • Corporate overview

  • Quantitative financial & market analysis

  • Detailed accounting analysis

  • Comprehensive analysis

  • Recommendation or decision


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Investment Purpose

  • Short-term (stressing liquidity & low risk)

  • Long-term (e.g., retirement—stressing long-term return, willing to accept more risk)

  • Using market averages such as the Dow Jones Industrial Average

  • Utilities may fit income funds because of high dividend yields

  • High tech firms may fit growth funds


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Decisions

  • Decisions: buy, sell, hold (& how much?)

  • Different important characteristics based on investment goals: Income Investment: importance of dividend yield Growth fund: importance of profit & earnings growth forecast Values funds: importance of “bargain price”


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