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Ratio Analysis

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Ratio Analysis

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    1. Ratio Analysis

    3. Overview of Ratio Analysis Techniques Caveats Decision Context Dupont Framework Factors Influencing Margin Versus Turnover Trade-Off Interactive Case Using eVal

    4. Techniques of Ratio Analysis Time-Series Analysis: Comparing a firm’s ratios across time Facilitates the identification of changes in performance and the detection of the underlying causes Cross-Sectional Analysis (comps): Comparing a firm’s ratios with the ratios of comparable firms Facilitates the identification of differences in performance and the detection of the underlying causes

    5. Three Caveats of Ratio Analysis There is no generally accepted set of rules for computing ratios Ratios do not provide answers, they just help direct you in your search for answers Managers know that investors fixate on certain ratios, and many window-dress accordingly

    6. Decision Context: The Key Drivers of Value ROE Create value by generating long-run ROE that exceeds r Business strategy and competitive environment Accounting distortions affect short-run ROE Growth in Equity Magnifies value created by ROE If ROE>r, then growth creates value If ROE<r, then growth destroys value

    9. The Margin versus Turnover Trade-Off

    10. Factors Influencing the Margin vs. Turnover Trade-Off Lower turnover (and higher margins) result from: industry-wide production technology that requires significant capital investment following a product differentiation versus a cost leadership strategy following a vertical integration versus an outsourcing strategy

    11. Ratio Analysis in eVal Start eVal Click ‘View Ratio Analysis’ button time-series analysis Go to ‘Data Center’ Sheet, sort by Industry, and load competitors or industry composites cross-sectional analysis

    12. Interactive Case: Task 1 Identify an example of an industry that operates with low turnover ratios and high margins and another example of an industry that operates with high turnover ratios and low margins. In each case, explain the features of the industry’s production technology that lead to these ratios.

    13. Interactive Case: Task 2 Identify an example of a product differentiator and an example of a cost leader within a particular industry. In each case, try to select an example where the strategy is appropriately reflected in the turnover ratios.

    14. Interactive Case: Task 3 Identify an example of a vertical integrator and an example of an outsourcer within a particular industry. In each case, try to select an example where the strategy is appropriately reflected in the turnover ratios

    15. Recap Ratio analysis should take place within a clear decision context. Ratio analysis does not provide answers, it just helps guide your search for answers. Ratios should be interpreted in the context of the firm’s business environment Use of canned ratio analysis software simplifies ratio analysis BUT must know how ratios have been computed

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