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Measuring Profitability. James Dow For GBUS 600 Spring 2004. Outline. (1) Using financial statements to evaluate past profitability. (2) Using financial statements to think about future performance. (3) Using stock prices to think about future

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Measuring profitability

Measuring Profitability

James Dow

For GBUS 600

Spring 2004


Outline
Outline

(1) Using financial statements to evaluate

past profitability.

(2) Using financial statements to think about

future performance.

(3) Using stock prices to think about future

performance.


1 using financial statements to evaluate past profitability
(1) Using financial statements to evaluate past profitability.

  • Useful when assessing management.

  • Perhaps useful for forecasting future.

  • Historical information is what you want.


Quick overview of financial statements
Quick Overview of Financial Statements profitability.

  • Annual Report

  • Income Statement

  • Balance Sheet


Income statement
Income Statement profitability.

  • Revenue

    - Costs

    = Earnings

  • Net Earnings or Income = Profits


Is 300 million a lot
Is $300 Million a Lot? profitability.

  • Profit margin (earnings/sales)?

  • What about earnings per share?

  • Return on equity (earnings/equity)


Balance sheet
Balance Sheet profitability.

  • Assets = Liabilities + Equity

  • Equity is like “net worth”

  • “Book” (historical) value of equity


Is 15 a lot
Is 15% a Lot? profitability.

  • Opportunity cost of generating earnings.

  • Cost of capital

  • ROE – cost of equity


Problems with roe
Problems with ROE profitability.

  • Only one period of earnings.

    • Need longer history for evaluating past.

    • Need future earnings for future.

  • Book value of equity vs. market value.

  • Can we get information from market value?


2 using financial statements to think about future performance
(2) Using financial statements to think about future performance.

  • This is a business question.

  • Historical financial information provides clues.

  • Market prices also provide information.


Income statements in more detail
Income Statements in More Detail performance.

  • Revenues

  • - Costs of goods sold

  • - Other costs (such as)

    Administrative Costs

    Research Costs

    Interest and Taxes

    Extraordinary Items

    = Net Earnings


Why report different costs
Why report different costs? performance.

  • Why split out administrative costs?

  • Why split out extraordinary items?


Thinking about the future
Thinking about the Future performance.

  • What will change?

  • How will that affect the financial position?

  • A quick comment on financial ratios.


3 using stock prices to think about future performance
(3) Using stock prices to think about future performance. performance.

  • Stock price represents the value of a company.

  • The value of a company depends on future prospects.

  • Stock price depends on future prospects.

  • But how? We need a theory!


An oversimplified theory of stock prices
An oversimplified theory of performance. stock prices

  • ROE = (total earnings)/(book equity)

  • Earnings yield

  • = (total earnings)/(market capitalization)

  • = e/p (inverse of p/e ratio)


More oversimplified theory
More Oversimplified Theory performance.

  • e/p should equal opportunity cost of investing in stocks.

  • Changes in e produce changes in p.

  • Of course, it’s future e’s that really matter.


Things that affect stock prices
Things That Affect Stock Prices performance.

  • Current and future earnings.

  • Risk of the particular stock.

  • Attitudes towards stock in general.

  • Attitudes towards saving in general.


Using stock prices
Using Stock Prices performance.

  • Use price information to judge earnings prospects.

  • How to separate firm specific factors from other forces?

  • Compare with the “average” behavior of stocks.


Figure 3 relative stock performance international paper and s p 500
Figure 3. Relative Stock Performance: International Paper and S&P 500.

S&P500

International Paper


Conclusion
Conclusion and S&P 500.

  • Know your question!

  • Use financial data to guide your investigations.

  • Use financial data to support your analysis.


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