Chapter 14: Problem solving Flashcards
There is no Core reading in this chapter of Subject SA7, so the flashcards consist of some useful revision from earlier subjects, other than Subject SP5.
Define gearing.
Gearing (or asset gearing)
= borrowings / equity
or
= borrowings / (borrowings + equity)
Borrowings usually includes all forms of long-term debt.
Equity means the value of the ordinary shares (including all equity reserves) shown on their statement of financial position.
Preference shares can be treated as either borrowings (usual) or as equity.
Define and describe earnings per share (EPS).
Earnings per share (EPS)
(Subject SP5): CH 11 Fundamental Analysis
EPS = earnings on ordinary activities / number of issued ordinary shares
Businesses whose shares are publicly traded are required to disclose two versions:
* basic EPS – reflecting number of shares currently in issue
* diluted EPS – reflecting all dilutive potential shares, eg those under convertibles or share option schemes.
EPS can be based on either historical or prospective earnings.
Comparing EPS values can be difficult because the number of shares is arbitrary.
Define price earnings ratio (PE) and explain the significance of a company having a high PE relative to other similar companies.
Price earnings ratio (PE or P/E ratio)
PE = market price of an ordinary share / EPS
A high PE relative to other similar companies may mean:
* the market believes that the earnings will grow rapidly in the future * the market believes that the company is a relatively low risk investment
* the share is overvalued
* earnings are unusually low this year.
Define dividend yield and explain the significance of a company having a low dividend yield relative to other similar companies.
Dividend yield (DY)
DY = Dividends per share /market price of an ordinary share
A low dividend yield relative to other similar companies may mean:
* the market believes that the dividends will grow rapidly in the future * the share is overvalued.
Define and describe dividend cover.
Dividend cover
= EPS / DPS
A company with a high level of dividend cover has more scope to increase dividends in the future.
So, for a given dividend yield on a share, a high dividend cover figure suggests better value for money than a share with low dividend cover.
Inverse of this is the payout ratio.
Define EBITDA and explain why some analysts look at EBITDA in addition to operating profit.
EBITDA is Earnings Before:
* Interest
* Taxation
* Depreciation
* Amortisation
Some analysts look at EBITDA as they feel that depreciation and amortisation can be misleading in the statement of profit or loss because they are discretionary / subjective.
Also, tax is out of the company’s control and interest is affected by the gearing / financing decision.
Define net asset value per share (NAV) and describe how it is used.
Net asset value (NAV) per share
= (Ordinary shareholders’ equity - intangible assets) / number of ordinary shares issued
NAV per share shows the value on the statement of financial position of the tangible assets backing each share, net of all liabilities.
It is approximately what the ordinary shareholders would receive for each share they hold if the company was immediately wound up.
It is often compared with the share price to assess whether shares are undervalued or overvalued.
he main problem with NAV per share is that the values on the statement of financial position don’t necessarily reflect the market or true values of the assets.
Give the TWO main definitions of return on capital employed.
Return on capital employed (ROCE)
= PBIT / (Share capital + reserves + LT debt) * 100
and
= PBT / (Share capital + reserves) * 100
NB: Consistency in values between numerator and denominator.
Consistency between denominator and numerator is crucial. If you remove debt from the denominator, you must remove interest on that debt from the numerator.
State how ROCE can be broken down into TWO secondary ratios.
Breakdown of ROCE
- Asset utilisation ratio:
– reflecting the intensity with which assets are employed
= revenue (turnover) / (Share capital + reserves + LT debt) - Profit margin (or return on sales ratio)
– an attempt to look at profit per unit of sales
= PBIT / Revenue
Profit margin often is x100, ie expressed as %.
Define and describe inventory turnover period.
Inventory turnover period
= Inventories / CoS * 365
The ratio attempts to show how long inventory is held for on average.
An inventory turnover period that is less rapid (ie higher) than other companies in the same industry might indicate an inefficiently large inventory holding.
An increasing period might indicate that sales were slowing down resulting in stockpiling of unsold goods.
Define and describe trade receivables turnover period.
Trade receivables turnover period
= Trade receivables / Credit Sales * 365
Better for this period to be low. Important to compare this period with the length of the credit period usually extended to customers.
However, it can be difficult to press for speedier payment as doing so could damage the company’s relationship with its customers.
Define and describe payables turnover period.
Payables turnover period
= payables / credit purchases * 365
A higher value is usually better. However, it is important to compare the figure with the credit period usually granted by the company’s suppliers.
It can be difficult to calculate this ratio in the real world because companies do not disclose their purchases figures.
In this case, it is possible to obtain a crude estimate by dividing by cost of sales.
List 14 investment and risk characteristics of direct property.
Investment and risk characteristics of direct property
- Risk of voids (periods where property not let) and tenant default
- Risk of political interference
- Risk of obsolescence and need for refurbishment
- Real return, broad inflation hedge
- Higher expected return than government issued bonds
- Income forms a ‘stepped’ pattern over time
- Running (rental) yield varies by the type of property
- Volatile capital values in long term, stable capital values in short term
- Subjective, infrequent valuations, lack of information
- High dealing costs and management costs
- Very unmarketable
- Large unit size, indivisibility
- Uniqueness
- Characteristics can be changed by owner, eg redevelopment
On what factors would a prime property score highly?
(#CALL STreet);
(#CALL ST)
Prime property
(#CALL ST)
Comparable properties for rent reviews and valuations
Age, condition and flexibility of use
Location
Lease structure
Size
Tenant quality
(The acronym is CALL STreet.)
List the factors that an investor with liabilities should consider before designing an investment strategy using the acronym.
(#SOUNDER TRACTORS)
SOUNDER TRACTORS
Size of fund – both in absolute terms and relative to the liabilities
Objectives of investment
Uncertainty of existing liabilities
Nature of existing liabilities
Diversification
Existing portfolio
Risk appetite
Term of existing liabilities
Restrictions on investment
Accrual of future liabilities
Currency of existing liabilities
Tax
Other funds (eg, expertise)
Returns on different asset classes
Statutory solvency, accounting & valuation
