3. Industry and Company Analysis Flashcards
Compare bottom-up, top-down and hybrid approaches for developing inputs to equity valuation models.
Bottom-up analysis starts with analysis of an individual company or its reportable segments. Revenue projections based on historical revenue growth or a company’s new product introductions over the forecast horizon are considered bottom-up approaches.
Top-down analysis begins with expectations about a macroeconomic variable, often the expected growth rate of nominal GDP. Revenue projections that are derived from an estimate of GDP growth and an expected relationship between GDP growth and company sales are an example of a top-down approach.
Hybrid analysis incorporates elements of both top-down and bottom-up analysis. By using elemnets of both methods, a hybrid analysis can highlight any inconsistencies in assumptions betwwen the top-down and bottom-up approaches. A hybrid analysis is the most common type.
Explain statutory tax rate, effective tax rate and cash tax rate.
Statutory Tax Rate is the percentage tax charged in the country where the firm is domicilied
Effective Tax Rate is income tax expense (recall that income tax expense is cash tax due plus changes in deffered tax liabilities minus changes in deferred tax assets) as a percentage of pretax income on the income statement
Cash Tax Rate is cash paid as a percentage of pretax income
Describe Return on Invested Capital (ROIC).
The Return on Invested Capital (ROIC) can be calculated as net operating profit adjusted for taxes (NOPLAT) divided by invested capital (operating assets minus operating liabilities). ROIC is a return on both equity and debt and is preferable to return on equity in some contexts because it allows comparisons accross firms with different capital structures. Firms with higher ROIC (relative to peers) are likely exploiting some competitive advantage in the production and/or sale of their products.
Explain Return On Capital Employed.
Return on capital employed is similar to ROIC, with the same denominator (=operating assets minus operating liabilities) but uses pretax operating earinings in the numerator to facilitate comparison between companies that face different tax rates.
