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Financial Ratios

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  1. Financial Ratios Ratios

  2. Ratio Analysis • Measure firm performance • Compare over time • Compare with other firms or industries • Analyze ROE • Project financial statements into future Ratios

  3. Ratios • Profitability • Activity or Utilization • Liquidity • Leverage • Growth • Valuation Ratios

  4. Profitability Ratios 1. Profit Margin (PM) = 2. Operating Profit Margin (not in the book) = 3. Return on Assets (ROA) = 4. Return on Equity (ROE) = Ratios

  5. Liquidity Ratios Current Ratio = Quick Ratio = Cash Ratio = Ratios

  6. Activity or Utilization Ratios Receivables Turnover = Average Collection Period = Inventory Turnover* = Fixed Asset Turnover = Total Asset Turnover = * Sometimes = Ratios

  7. Leverage Ratios Debt Ratio (DR) = Long-term Debt Ratio* = Time Interest Earned (XIE) = Cash Coverage = Fixed Charge Coverage (not in the book) = Debt to Equity = Equity Multiplier (EM) = *Also called Debt to Capital Ratio Ratios

  8. Growth Rates 1. Percentage growth of Sales, Net Income, etc. Example: 2. Sustainable Growth = ROBE(1-PO) where PO is the payout ratio = Div/NI Ratios

  9. Sustainable Growth Growth financed through: • Internal equity funds • Supportable debt Such that: • Firm’s debt ratio is held constant SG (Grant’s approx.) (Book’s formula) Where b is the “plowback” or retention ratio Ratios

  10. Valuation Ratios Price Earnings (PE) = Market to Book = Ratios

  11. P/E Ratio Ratios

  12. Price-earnings Ratios for Selected U.S. Companies Jan. Jan. Jan. Jan. Jan. June July Corporation Industry 1983 1986 1990 1993 1996 1998 2004 Coca-Cola . . . . . Beverages 13 17 20 25 34 53 27 Disney . . . . . . Entertainment 25 20 19 26 23 38 23 Liz Claiborne . . . Clothing 13 19 11 19 17 29 13 McDonald’s . . . . Restaurants 10 16 18 20 24 28 22 NationsBank . . . Banking 7 10 9 10 10 21 Phelps Dodge . . . Copper 6 8 4 17 7 23 35 Southwest Air . . . Airlines 20 14 15 38 21 21 27 Texas Utilities . . . Public Utilities 6 7 8 15 14 14 Wal-Mart . . . . . Retail 26 28 24 39 18 38 25 Standard & Poor’s . . . (500 Stock Index) 11 14 15 22 17 25 20 Ratios

  13. Comparison of Market Value to Book Value per Share Ratios

  14. Du Pont Analysis • ROE = • ROE = • = • 3. ROE = Profit Margin * Total Asset Turnover * Equity Multiplier (PM) (TAT) (EQ) Ratios

  15. Sustainable Growth and Du Pont Sales Asset Asset Equity PAT Sales 1 - PO Ratios

  16. Microsoft Income Statements(in millions) Ratios

  17. Microsoft Balance Sheet(in millions) Ratios

  18. Wal-Mart Stores Income Statement(in thousands) Ratios

  19. Wal-Mart Stores Balance Sheet (in thousands) Ratios

  20. Wal-Mart Stores Balance Sheet (cont.)(in thousands) Ratios

  21. Du Pont Examples Microsoft ROE = 24.6% * 0.867 * 1.21 = 25.7% Wal-Mart ROE = 3.5% * 2.547 * 2.46 = 21.8% Ratios

  22. How Are They Doing Now? MicrosoftWal-Mart Ratios

  23. Things to Consider Concerning Financial Ratios • What aspect of the firm or its operations are • we attempting to analyze? • Generally, the aspects are “fuzzy”, e.g., utilization • What goes into a particular ratio? • Historical cost? Market values? What accounting conventions? • What is the unit of measurement? • Dollars? Days? Turns? • What would a desirable ratio value be? • Always? Ratios

  24. Income Statement for the Year 2004 Discrepancies 1. Revenue recognition (i.e., installment sales and leases) 2. Cost of goods sold (i.e., may use LIFO during inflation) 3. Extraordinary losses Ratios

  25. Trends in Annual Reports • Interactive On-line Reports http://www.intel.com/intel/finance • Plain Speaking http://www.berkshirehathaway.com/2003ar/2003ar.pdf • Filings, i.e. 10k annual reports http://www.edgar-online.com/bin/esearch/fullsearch.asp Ratios