Chapter 17

Chapter 17Chapter 17

Company AnalysisCompany Analysis

Define fundamental analysis at the Define fundamental analysis at the company level.company level.

Explain the accounting aspects of a Explain the accounting aspects of a company’s earnings.company’s earnings.

Describe the importance of EPS Describe the importance of EPS forecasts.forecasts.

Estimate the P/E ratio of a company.Estimate the P/E ratio of a company. Use the beta coefficient to estimate the Use the beta coefficient to estimate the

risk of a stock.risk of a stock.

Learning ObjectivesLearning Objectives

Last step in EIC is individual Last step in EIC is individual company analysiscompany analysis

Goal: estimate share’s intrinsic valueGoal: estimate share’s intrinsic value– Constant growth version of dividend Constant growth version of dividend

discount modeldiscount model

g-k

DP̂ valueIntrinsic 1

0 g-k

DP̂ valueIntrinsic 1

0

Value justified by fundamentals

Fundamental AnalysisFundamental Analysis

Earnings multiple could also be usedEarnings multiple could also be usedPP0 0 = estimated EPS = estimated EPS justified P/E ratio justified P/E ratio

Stock is under- (over-) valued if intrinsic Stock is under- (over-) valued if intrinsic value is larger (smaller) than current value is larger (smaller) than current market pricemarket price

Focus on earnings and P/E ratioFocus on earnings and P/E ratio– Dividends paid from earningsDividends paid from earnings– Close correlation between earnings and Close correlation between earnings and

stock price changesstock price changes

Fundamental AnalysisFundamental Analysis

How is EPS derived and what does EPS How is EPS derived and what does EPS represent?represent?

Financial statements provide majority Financial statements provide majority of financial information about firmsof financial information about firms

Analysis implies comparison over time Analysis implies comparison over time or with other firms in the same industryor with other firms in the same industry

Focus on how statements used, not Focus on how statements used, not mademade

Accounting Aspects of Accounting Aspects of EarningsEarnings

Balance SheetBalance Sheet– Items listed in order of liquidity (assets) Items listed in order of liquidity (assets)

or in order of payment (liabilities)or in order of payment (liabilities)– AssetsAssets

Cash vs. non-cash assetsCash vs. non-cash assets– Non-cash assets may be worth more or less than Non-cash assets may be worth more or less than

the amount carried on the booksthe amount carried on the books Depreciation methods for fixed assetsDepreciation methods for fixed assets Inventory evaluation choices Inventory evaluation choices

Basic Financial StatementsBasic Financial Statements

Balance SheetBalance Sheet– LiabilitiesLiabilities

Fixed claims against the firmFixed claims against the firm

– EquityEquity Residual claimsResidual claims Adjusts when the value of assets changeAdjusts when the value of assets change Linked to Income StatementLinked to Income Statement

– ““Snapshot” at one point in timeSnapshot” at one point in time


Income StatementIncome StatementSales or revenuesSales or revenues

- Product costs- Product costs

Gross profitGross profit

- Period Costs- Period Costs

EBITEBIT

- Interest- Interest

EBTEBT

EBTEBT

- Taxes- Taxes

Net Income Net Income available to ownersavailable to owners

- Dividends- Dividends

Addition to Retained Addition to Retained EarningsEarnings

EPS and DPSEPS and DPS


Earnings per shareEarnings per share

EPS = Net Income/average number of EPS = Net Income/average number of shares outstandingshares outstanding– Net Income before adjustments in Net Income before adjustments in

accounting treatment or one-time eventsaccounting treatment or one-time events Certifying statementsCertifying statements

– Auditors do not guarantee the accuracy of Auditors do not guarantee the accuracy of earnings, but only that statements are a earnings, but only that statements are a fair financial representationfair financial representation


EPS for a company is not a precise EPS for a company is not a precise figure that is readily comparable over figure that is readily comparable over time or between companiestime or between companies– Alternative accounting treatments used Alternative accounting treatments used

to prepare statementsto prepare statements– Difficult to gauge the ‘true’ performance Difficult to gauge the ‘true’ performance

of a company with any one methodof a company with any one method– Investors must be aware of these Investors must be aware of these

problemsproblems

Problems with Reported Problems with Reported EarningsEarnings

Important to determine whether a Important to determine whether a company’s profitability is company’s profitability is increasing or decreasing and whyincreasing or decreasing and why

Return on equity (ROE)Return on equity (ROE) emphasized because it is a key emphasized because it is a key component in finding earnings and component in finding earnings and dividend growthdividend growth

EPS = ROE EPS = ROE Book value per share Book value per share

Analyzing a Company’s Analyzing a Company’s ProfitabilityProfitability

Share prices depend partly on ROEShare prices depend partly on ROE Management can influence ROEManagement can influence ROE Decomposing ROE into its Decomposing ROE into its

components allows analysts to components allows analysts to identify adverse impacts on ROE identify adverse impacts on ROE and to predict future trendsand to predict future trends

Highlights expense control, asset Highlights expense control, asset utilization, and debt utilizationutilization, and debt utilization

DuPont AnalysisDuPont Analysis

Three components of return on equity: Three components of return on equity: Net Margin = Net Income / SalesNet Margin = Net Income / Sales. The . The

higher a company’s profit margin the higher a company’s profit margin the better. better.

Asset Turnover = Sales / Total AssetsAsset Turnover = Sales / Total Assets. . The higher the number the better. The higher the number the better.

Leverage Factor = Total Assets / Leverage Factor = Total Assets / SEquitySEquity. The higher the number, the . The higher the number, the more debt the company has.more debt the company has.



Eqty

TA

TA

Sales

Sales

EBIT

EBIT

EBT

EBT

NI

Tax Burden

Interest Burden

EBIT Efficiency

TA Turnover

NI / Sales = Net Income Margin

NI / TA = ROA

Equity

TA ROA Leverage Ratio = TA / Equity

LeverageRatio

EQUITY

TA

TA

Sales

SALES

NI

Equity

NI

Net Profit Margin

Asset Turnover

Leverage Ratio

EQUITY

TAROAROE

Expected EPS is of the most valueExpected EPS is of the most value Stock price is a function of future Stock price is a function of future

earnings and the P/E ratioearnings and the P/E ratio– Investors estimate expected growth in Investors estimate expected growth in

dividends or earnings by using dividends or earnings by using quarterly and annual EPS forecastsquarterly and annual EPS forecasts

Estimating internal growth rateEstimating internal growth rate– EPSEPS1 1 = EPS= EPS00(1+g)(1+g)

Estimates of EarningsEstimates of Earnings

Future expected growth rate matters Future expected growth rate matters in estimating earnings, dividendsin estimating earnings, dividends

g = ROE g = ROE (1 – Payout ratio) (1 – Payout ratio)– Only reliable if company’s current ROE Only reliable if company’s current ROE

remains stableremains stable– Estimate is dependent on the data Estimate is dependent on the data

periodperiod What matters is the future growth What matters is the future growth

rate, not the historical growth raterate, not the historical growth rate

Internal Growth RateInternal Growth Rate

Security analysts’ forecasts of earningsSecurity analysts’ forecasts of earnings– Consensus forecast superior to individualConsensus forecast superior to individual

Time series forecastTime series forecast– Use historical data to make earnings Use historical data to make earnings

forecastsforecasts Evidence favours analysts over Evidence favours analysts over

statistical models in predicting what statistical models in predicting what actual reported earnings will beactual reported earnings will be– Analysts are still frequently wrongAnalysts are still frequently wrong

Forecasts of EPSForecasts of EPS

What is the role of expectations in What is the role of expectations in selecting stocks?selecting stocks?– Old information is already incorporated Old information is already incorporated

into stock prices (market is efficient)into stock prices (market is efficient)– Unexpected information implies revisionUnexpected information implies revision

Stock prices affected byStock prices affected by– Level and growth in earningsLevel and growth in earnings– Market’s expectation of earningsMarket’s expectation of earnings

Earnings SurprisesEarnings Surprises

Measures how much investors currently Measures how much investors currently are willing to pay per dollar of earningsare willing to pay per dollar of earnings– Summary evaluation of firm’s prospectsSummary evaluation of firm’s prospects– A relative price measure of a stockA relative price measure of a stock

A function of expected dividend payout A function of expected dividend payout ratio, required rate of return, expected ratio, required rate of return, expected growth rate in dividendsgrowth rate in dividends

g)k/()/E(DP/E 11 g)k/()/E(DP/E 11

The P/E RatioThe P/E Ratio

Dividend levels usually maintainedDividend levels usually maintained– Decreased only if no other alternativeDecreased only if no other alternative– Not increased unless it can be supportedNot increased unless it can be supported– Adjust with a lag to earningsAdjust with a lag to earnings

In theory, the higher the expected In theory, the higher the expected payout ratio, the higher the P/E ratiopayout ratio, the higher the P/E ratio– However, growth rate will probably However, growth rate will probably

decline, adversely affecting the P/E ratio decline, adversely affecting the P/E ratio

Dividend Payout RatioDividend Payout Ratio

A function of the riskless rate of A function of the riskless rate of return and a risk premiumreturn and a risk premium

k = RF + RPk = RF + RP Constant growth version of dividend Constant growth version of dividend

discount model can be rearranged so discount model can be rearranged so thatthat

k = (Dk = (D11/P/P00) + g) + g

– Growth forecasts are readily availableGrowth forecasts are readily available

Required Rate of ReturnRequired Rate of Return

Risk premium for a stock regarded as a Risk premium for a stock regarded as a composite of business, financial, and composite of business, financial, and other risksother risks

If the risk premium rises (falls), then k If the risk premium rises (falls), then k will rise (fall) and Pwill rise (fall) and P00 will fall (rise) will fall (rise)

If RF rises (falls), then k will rise (fall) If RF rises (falls), then k will rise (fall) and Pand P00 will fall (rise) will fall (rise)

Discount rates and P/E ratios move Discount rates and P/E ratios move inversely to each otherinversely to each other

Required Rate of ReturnRequired Rate of Return

Function of return on equity and the Function of return on equity and the retention rateretention rate

g = ROE (1 – Payout ratio)g = ROE (1 – Payout ratio)– The higher the g, the higher the P/E The higher the g, the higher the P/E

ratioratio P/E ratio depends onP/E ratio depends on

– Confidence that investors have in Confidence that investors have in expected growthexpected growth

– Reasons for earnings growthReasons for earnings growth

Expected Growth RateExpected Growth Rate

Regardless of detail and complexity, Regardless of detail and complexity, analysts and investors seek an estimate analysts and investors seek an estimate of earnings and a justified P/E ratio to of earnings and a justified P/E ratio to determine intrinsic valuedetermine intrinsic value

Security analysis always involves Security analysis always involves predicting an uncertain future; mistakes predicting an uncertain future; mistakes will be made and outlooks will differwill be made and outlooks will differ

www.netadvantage.standardpoor.com www.netadvantage.standardpoor.com

Fundamental Security Fundamental Security Analysis in PracticeAnalysis in Practice

Appendix 17-A Financial Ratio Appendix 17-A Financial Ratio AnalysisAnalysis

Used to examine a firm’s financial Used to examine a firm’s financial performanceperformance

A ratio on its own has limited value – A ratio on its own has limited value – to be useful, one must examine:to be useful, one must examine:– TrendsTrends– Ratios of comparable firms or industry Ratios of comparable firms or industry

benchmarksbenchmarks

Five types of ratios used to analyze a Five types of ratios used to analyze a firm:firm:1.1. LiquidityLiquidity: ability to generate cash and : ability to generate cash and

meet short-term debtmeet short-term debt

2.2. Asset ManagementAsset Management: : ability to effectively ability to effectively manage its assets to generate sales and manage its assets to generate sales and profitsprofits

3.3. Debt ManagementDebt Management: ability to effectively : ability to effectively handle its debthandle its debt

4.4. ProfitabilityProfitability: ability to generate profits: ability to generate profits

5.5. ValueValue: market value versus accounting: market value versus accounting values values

Appendix 17-A Financial Ratio Appendix 17-A Financial Ratio AnalysisAnalysis

STATEMENT OF INCOME:STATEMENT OF INCOME: 20002000 20012001 20022002 20032003 20042004

Total Total Revenue...............Revenue............... 14260001426000 21433002143300 28923002892300 30586003058600 44480004448000

Cost of Cost of Sales...............Sales............... 12387001238700 19314001931400 25594002559400 26992002699200 40058004005800

Depreciation/Depreciation/Amortization...Amortization... 4010040100 4360043600 7680076800 7530075300 101300101300

Interest Interest Expense............Expense............ 53005300 75007500 5320053200 5260052600 7900079000

Research / Research / Exploration......Exploration...... 00 00 3630036300 5370053700 7310073100

Other Other Expense...............Expense............... 3310033100 4360043600 4610046100 5640056400 3790037900

Unusual Unusual Items...............Items............... 00 00 00 00 00

Pre-Tax Pre-Tax Income..............Income.............. 108800108800 117200117200 120500120500 121400121400 150900150900

Income Income Tax..................Tax.................. -19900-19900 -25700-25700 -20400-20400 -13700-13700 -18100-18100

Earnings BEFORE Extra. Earnings BEFORE Extra. ItemsItems 8890088900 9150091500 100100100100 107700107700 132800132800

Extraordinary Extraordinary Items.........Items......... 00 00 00 00 00

Income AFTER Extra. ItemsIncome AFTER Extra. Items 8890088900 9150091500 100100100100 107700107700 132800132800

Dividends - Preferred Dividends - Preferred SharesShares 35003500 38003800 40004000 29002900 26002600

Income Available to Common Income Available to Common SharesShares 8540085400 8770087700 9610096100 104800104800 130200130200

Earnings Earnings /Share............./Share............. 0.680.68 0.680.68 0.7060.706 0.7270.727 0.850.85

Common Shares - Year End Common Shares - Year End (1000s)(1000s) 125658125658 131398131398 141443141443 152337152337 154280154280

Common Shares - Average Common Shares - Average (1000s)(1000s) 125536125536 128932128932 136073136073 144121144121 153237153237

Dividends - Common Dividends - Common Shares...Shares... 1470014700 2200022000 2870028700 2740027400 3220032200

Market Price per Share Market Price per Share (Close)(Close) 6.696.69 7.637.63 7.887.88 17.1317.13 11.6311.63

ExampleExample

ASSETS:ASSETS: 20002000 20012001 20022002 20032003 20042004

Cash & Cash & Equivalent...........Equivalent........... 150000150000 8400084000 8750087500 179200179200 235100235100

Accounts Accounts Receivable.........Receivable......... 174000174000 428800428800 413700413700 360100360100 380400380400

Inventory..................Inventory.................... 220200220200 583500583500 992700992700 12157001215700 18031001803100

Marketable Marketable Securities.......Securities....... 00 00 00 00 00

Other......................Other........................ 00 00 00 00 00

<TOTAL> Current <TOTAL> Current Assets......Assets...... 544200544200 10963001096300 14939001493900 17550001755000 24186002418600

Fixed Assets - GrossFixed Assets - Gross 13727001372700 16505001650500 19562001956200 22776002277600 29146002914600

less: Accumulated less: Accumulated DepreciationDepreciation -766200-766200 -809800-809800 -886600-886600 -961900-961900 -1063200-1063200

Fixed Assets - Fixed Assets - Net..........Net.......... 606500606500 840700840700 10696001069600 13157001315700 18514001851400

<TOTAL> <TOTAL> Assets..............Assets.............. 11507001150700 19370001937000 25635002563500 30707003070700 42700004270000

LIABILITIES AND EQUITY:LIABILITIES AND EQUITY: 19971997 19981998 19991999 20002000 20012001

Bank Loans & Bank Loans & Equivalent.....Equivalent..... 147800147800 346800346800 537400537400 620800620800 828500828500

Accounts Accounts Payable............Payable............ 347200347200 684400684400 831800831800 901400901400 13809001380900

Current Portion of L-T Current Portion of L-T Debt.Debt. 54005400 3000030000 2080020800 1930019300 5640056400

<TOTAL> Current <TOTAL> Current Liabilities........Liabilities........ 500400500400 10612001061200 13900001390000 15415001541500 22658002265800

Long-Term Debt & Long-Term Debt & Debentures.Debentures. 8350083500 211000211000 425500425500 586600586600 963700963700

Deferred Taxes & Deferred Taxes & Credits....Credits.... 4160041600 4200042000 5380053800 4330043300 5640056400

Equity: Preferred Equity: Preferred Stock.....Stock..... 158300158300 157700157700 3740037400 3570035700 3410034100

Common Common Stock........Stock........ 190600190600 223100223100 347400347400 476800476800 465200465200

Retained Retained Earnings...Earnings... 176300176300 242000242000 309400309400 386800386800 484800484800

Total Total Equity........Equity........ 525200525200 622800622800 694200694200 899300899300 984100984100

<TOTAL> Liabilities + <TOTAL> Liabilities + EquityEquity 11507001150700 19370001937000 25635002563500 30707003070700 42700004270000

XYZ COMPANYXYZ COMPANY

FINANCIAL RATIOS:FINANCIAL RATIOS: 20002000 20012001 20022002 20032003 20042004

Current RatioCurrent Ratio 1.091.09 1.031.03 1.071.07 1.141.14 1.071.07

Acid Test (Quick) RatioAcid Test (Quick) Ratio 0.650.65 0.480.48 0.360.36 0.350.35 0.270.27

ACP (days)ACP (days) 44.5444.54 73.0273.02 52.2152.21 42.9742.97 31.2231.22

Inventory TurnoverInventory Turnover 5.625.62 3.313.31 2.582.58 2.222.22 2.222.22

Total Asset TurnoverTotal Asset Turnover 1.241.24 1.111.11 1.131.13 1.001.00 1.041.04

Debt RatioDebt Ratio 0.510.51 0.660.66 0.710.71 0.690.69 0.760.76

Debt-to-Equity RatioDebt-to-Equity Ratio 1.111.11 2.042.04 2.622.62 2.372.37 3.283.28

Equity MultiplierEquity Multiplier 2.192.19 3.113.11 3.693.69 3.413.41 4.344.34

TIE (or Interest Coverage)TIE (or Interest Coverage) 21.5321.53 16.6316.63 3.273.27 3.313.31 2.912.91

Net Income MarginNet Income Margin 6.23%6.23% 4.27%4.27% 3.46%3.46% 3.52%3.52% 2.99%2.99%

Return on Assets (ROA)Return on Assets (ROA) 7.73%7.73% 4.72%4.72% 3.90%3.90% 3.51%3.51% 3.11%3.11%

Return on Equity (ROE)Return on Equity (ROE) 16.93%16.93% 14.69%14.69% 14.42%14.42% 11.98%11.98% 13.49%13.49%

P/E RatioP/E Ratio 9.849.84 11.2111.21 11.1511.15 23.5623.56 13.6813.68

M/B RatioM/B Ratio 2.292.29 2.152.15 1.701.70 3.023.02 1.891.89

Dividend Yield Dividend Yield 1.75%1.75% 2.24%2.24% 2.68%2.68% 1.11%1.11% 1.81%1.81%

Dividend Payout RatioDividend Payout Ratio 0.170.17 0.250.25 0.300.30 0.260.26 0.250.25

INDUSTRY AVERAGESINDUSTRY AVERAGES

FINANCIAL RATIOS:FINANCIAL RATIOS: 20002000 20012001 20022002 20032003 20042004

Current RatioCurrent Ratio 2.122.12 2.852.85 2.252.25 2.012.01 1.691.69

Acid Test (Quick) RatioAcid Test (Quick) Ratio 1.211.21 1.971.97 1.361.36 1.241.24 1.091.09

ACP (days)ACP (days) 35.2035.20 34.0934.09 44.5044.50 45.9045.90 46.9046.90

Inventory TurnoverInventory Turnover 7.787.78 8.208.20 7.687.68 8.528.52 8.168.16

Total Asset TurnoverTotal Asset Turnover 1.781.78 1.431.43 1.371.37 1.261.26 1.231.23

Debt RatioDebt Ratio 0.230.23 0.330.33 0.320.32 0.290.29 0.320.32

Debt-to-Equity RatioDebt-to-Equity Ratio 0.360.36 0.610.61 0.560.56 0.490.49 0.550.55

Equity MultiplierEquity Multiplier 1.571.57 1.821.82 1.781.78 1.701.70 1.741.74

TIE (or Interest Coverage)TIE (or Interest Coverage) 34.4134.41 42.1942.19 5.955.95 5.535.53 8.618.61

Net Income MarginNet Income Margin 8.47%8.47% 6.03%6.03% 4.34%4.34% 4.19%4.19% 5.68%5.68%

Return on Assets (ROA)Return on Assets (ROA) 15.08%15.08% 8.64%8.64% 5.95%5.95% 5.27%5.27% 7.01%7.01%

Return on Equity (ROE)Return on Equity (ROE) 23.68%23.68% 15.72%15.72% 10.59%10.59% 8.96%8.96% 12.20%12.20%

P/E RatioP/E Ratio 6.426.42 9.089.08 12.1312.13 22.3822.38 15.5315.53

M/B RatioM/B Ratio 1.511.51 1.421.42 1.281.28 2.002.00 1.881.88

Dividend Yield Dividend Yield 1.71%1.71% 1.73%1.73% 2.86%2.86% 2.67%2.67% 2.08%2.08%

Dividend Payout RatioDividend Payout Ratio 0.130.13 0.240.24 0.350.35 0.390.39 0.260.26

A. LiquidityA. Liquidity

1. 1. Current Ratio Current Ratio = Current assets / Current liabilities= Current assets / Current liabilities

For XYZ (2004):For XYZ (2004):= 2,418,600 / 2,265,800 = 1.07= 2,418,600 / 2,265,800 = 1.07

2. 2. Quick Ratio Quick Ratio = [CA – Inventory] / Current liabilities= [CA – Inventory] / Current liabilities

For XYZ (2004)For XYZ (2004)= (2,418,600 – 1,803,100) / = (2,418,600 – 1,803,100) /

2,265,8002,265,800= 0.27= 0.27

B. Asset ManagementB. Asset Management

3. 3. Average Collection Period (ACP) Average Collection Period (ACP) = Account Receivable / (Sales/365days)= Account Receivable / (Sales/365days)

For XYZ (2004):For XYZ (2004):

= 380,400 / (4,448,000/365) = 31.22 days= 380,400 / (4,448,000/365) = 31.22 days

NoteNote::

A/R Turnover = Sales / Acct ReceivableA/R Turnover = Sales / Acct Receivable

= 365 / ACP= 365 / ACP

For XYZ (2004) = 365/31.22 days = 11.69 timesFor XYZ (2004) = 365/31.22 days = 11.69 times

B. Asset Management B. Asset Management (Cont’d)(Cont’d)

4. 4. Inventory Turnover Inventory Turnover = Cost of goods / Inventory= Cost of goods / Inventory

oror = Net Sales / Inventory= Net Sales / Inventory

For XYZ (2004) (using COGS):For XYZ (2004) (using COGS):

= (4,005,800) /1,803,100 = (4,005,800) /1,803,100

= 2.22 times= 2.22 times

Days Inventory Days Inventory = Inventory / Daily COGS (or Sales)= Inventory / Daily COGS (or Sales)

= 365 / Inventory Turnover = 365 / Inventory Turnover

For XYZ (2004) For XYZ (2004) = 365/2.22 = 164.4 days= 365/2.22 = 164.4 days

5. 5. Total Asset Turnover Total Asset Turnover = Sales / TA= Sales / TA = 4,488,000 / = 4,488,000 /

4,270,000 4,270,000 = 1.042= 1.042

C. Debt RatiosC. Debt Ratios

6. 6. Debt Ratio = Total Debt / TADebt Ratio = Total Debt / TA

= (2,265,800 + 963,700) / 4,270,000 = (2,265,800 + 963,700) / 4,270,000

= 0.756 = 0.756

7. 7. Debt-to-Equity = Total Debt / Total Debt-to-Equity = Total Debt / Total EquityEquity

= (2,265,800 + 963,700) / 984,100 = (2,265,800 + 963,700) / 984,100

= 3.282= 3.282

TA = Debt + Equity

C. Debt Ratios (Cont’d)C. Debt Ratios (Cont’d)

8. 8. Leverage Ratio (or Equity Multiplier)Leverage Ratio (or Equity Multiplier) = = TA / EquityTA / Equity = 4,270,000 / (984,100) = 4,270,000 / (984,100) = 4.339= 4.339

Higher values More debtHigher values More debt

9. 9. TIE (or Interest Coverage)TIE (or Interest Coverage) = = EBIT / InterestEBIT / Interest= (150,900 + 79,000) / 79,000 = 2.91 times= (150,900 + 79,000) / 79,000 = 2.91 times

D. ProfitabilityD. Profitability

10. 10. ROE = NI / EquityROE = NI / Equity

= 132,800 / 984,100 = 13.49%= 132,800 / 984,100 = 13.49%

11. 11. ROA = NI / TAROA = NI / TA

= 132,800 / 4,270,000 = 3.11%= 132,800 / 4,270,000 = 3.11%

12. 12. Net Income Margin = NI / SalesNet Income Margin = NI / Sales

= 132,800 / 4,448,000 = 2.99%= 132,800 / 4,448,000 = 2.99%

E. Value RatiosE. Value Ratios

13. 13. Dividends Payout = DPS / EPSDividends Payout = DPS / EPS oror

= = Common Dividends / Earnings Common Dividends / Earnings Available to Available to Common Shareholders Common Shareholders

= 32,200 / 130,200 = .2473 = 24.73%= 32,200 / 130,200 = .2473 = 24.73%

14. 14. P/E = Market Price per Share / P/E = Market Price per Share / EPSEPS

= 11.63 / 0.85 = 13.68= 11.63 / 0.85 = 13.68

E. Value Ratios (Cont’d)E. Value Ratios (Cont’d)

15. 15. Market-to-book (M/B) = Market price per Market-to-book (M/B) = Market price per share / share / Book value per Book value per shareshare

= 11.63 / [(984,100 – 34,100) / 154,280]= 11.63 / [(984,100 – 34,100) / 154,280]

= 11.63 / 6.16 = 1.89= 11.63 / 6.16 = 1.89

16. 16. Dividend Yield = DPS / Market price per Dividend Yield = DPS / Market price per shareshare

= (32,200 / 153,237) / 11.63 = .21 / 11.63 = = (32,200 / 153,237) / 11.63 = .21 / 11.63 = 1.81%1.81%

XYZ (2004)XYZ (2004) NI / EBT = 132,800 / 150,900 = .880NI / EBT = 132,800 / 150,900 = .880 EBT / EBIT = 150,900 / (150,900 + 79,000) = EBT / EBIT = 150,900 / (150,900 + 79,000) =

150,900 / 229,900 = .656150,900 / 229,900 = .656 EBIT / Sales = 229,900 / 4,448,000 = .0517EBIT / Sales = 229,900 / 4,448,000 = .0517 Sales / TA = 1.042 (previously calculated)Sales / TA = 1.042 (previously calculated) TA / Equity = 4.339 (previously calculated)TA / Equity = 4.339 (previously calculated) ROE = (.8800)(.6564)(.0517)(1.042)(4.339) ROE = (.8800)(.6564)(.0517)(1.042)(4.339)

= .1350 = 13.50%= .1350 = 13.50% This differs from the 13.49% we calculated This differs from the 13.49% we calculated

previously due to rounding errorspreviously due to rounding errors

XYZ (2004)XYZ (2004)

NI / Sales = 0.0299 (previously calculated)NI / Sales = 0.0299 (previously calculated) Sales /TA = 1.042 (previously calculated)Sales /TA = 1.042 (previously calculated) Calculate ROA = (.0299)(1.042) = .0311 = Calculate ROA = (.0299)(1.042) = .0311 =

3.11% (equals the 3.11% previously 3.11% (equals the 3.11% previously calculated) calculated)

TA / Equity = 4.339 (previously calculated)TA / Equity = 4.339 (previously calculated) So, ROE = (.0299)(1.042)(4.339) = 13.52% So, ROE = (.0299)(1.042)(4.339) = 13.52%

(differs from 13.49% previously calculated (differs from 13.49% previously calculated due to rounding errors)due to rounding errors)

LiquidityLiquidity

Below averageBelow average – Current and quick ratios of 1.07 and Current and quick ratios of 1.07 and

0.27 are both well below industry 0.27 are both well below industry averages of 1.69 and 1.09averages of 1.69 and 1.09

Bad trendBad trend– Current ratio has been steady, but quick Current ratio has been steady, but quick

ratio has deteriorated significantlyratio has deteriorated significantly Low and deteriorating quick ratio is Low and deteriorating quick ratio is

due to high levels of inventorydue to high levels of inventory

Asset ManagementAsset Management

Collections as measured by ACP is above Collections as measured by ACP is above average (31 days versus 47 days) and is average (31 days versus 47 days) and is improvingimproving

Inventory turnover is very low (2.3 versus Inventory turnover is very low (2.3 versus industry average of 8.2), and has been industry average of 8.2), and has been continually deteriorating, and they continually deteriorating, and they maintain high inventory levelsmaintain high inventory levels

TA turnover is below average, has been TA turnover is below average, has been over the period, and continues to over the period, and continues to deterioratedeteriorate

Debt ManagementDebt Management Debt levels have increased steadily and Debt levels have increased steadily and

coverage has deterioratedcoverage has deteriorated– Debt ratio is 0.76 (from 0.51 in 2000)Debt ratio is 0.76 (from 0.51 in 2000)– Debt-to-equity is 3.28 (from 1.11 in 2000)Debt-to-equity is 3.28 (from 1.11 in 2000)– Coverage is 2.91 (from 21.53 in 2000)Coverage is 2.91 (from 21.53 in 2000)

Debt capacity and coverage are both below Debt capacity and coverage are both below average average – Debt ratio is 0.76 versus 0.32 industry averageDebt ratio is 0.76 versus 0.32 industry average– Debt-to-equity is 3.28 versus 0.55 industry Debt-to-equity is 3.28 versus 0.55 industry

averageaverage– Coverage is 2.91 versus 8.61 industry averageCoverage is 2.91 versus 8.61 industry average

ProfitabilityProfitability

Steady decline in net income margin, Steady decline in net income margin, ROA, and ROE over periodROA, and ROE over period

Below industry averages, except for Below industry averages, except for ROEROE– ROE is above average due to use of ROE is above average due to use of

greater leverage (as noted above)greater leverage (as noted above)


XYZ (2004)XYZ (2004)– ROE = (NI/Sales) (Sales/TA) ((TA/Equity)ROE = (NI/Sales) (Sales/TA) ((TA/Equity)

= (.0299)(1.042)(4.339) = 13.51%= (.0299)(1.042)(4.339) = 13.51%

Industry averages (2004) Industry averages (2004) – ROE = (NI/Sales) (Sales/TA) ((TA/Equity)ROE = (NI/Sales) (Sales/TA) ((TA/Equity)

= (.0568)(1.23)(1.74) = 12.16% = (.0568)(1.23)(1.74) = 12.16% This analysis suggests that XYZ displays an This analysis suggests that XYZ displays an

above average ROE due to its higher leverage above average ROE due to its higher leverage factor, and despite the fact it has below factor, and despite the fact it has below average profitability and asset turnoveraverage profitability and asset turnover

Value RatiosValue Ratios

P/E and M/B ratios are close to P/E and M/B ratios are close to average, which is also the case for average, which is also the case for their dividend yields (Note: a lower their dividend yields (Note: a lower dividend yield implies a higher price)dividend yield implies a higher price)

They have been close to, or slightly They have been close to, or slightly above average over the entire period above average over the entire period

This suggests the market views XYZ as This suggests the market views XYZ as an “average” company despite some an “average” company despite some of the problems we have observedof the problems we have observed

SummarySummary

Below average and deteriorating in terms of Below average and deteriorating in terms of liquidity, inventory turnover, and debt liquidity, inventory turnover, and debt managementmanagement

However, they are profitable, even if they are However, they are profitable, even if they are not up to industry standards, and their not up to industry standards, and their profitability is dwindlingprofitability is dwindling

The market views XYZ as an “average” The market views XYZ as an “average” company despite its problems company despite its problems

XYZ will probably have to deal with its debt, XYZ will probably have to deal with its debt, inventory and liquidity problems in order to inventory and liquidity problems in order to maintain an average valuation in the marketmaintain an average valuation in the market

Documents

Chapter 17