Chapter 2 - Fundamental analysis Flashcards
what is fundamental analysis
- determining the intrinsic value of shares by considering the current and expected value of financial performance
- current market value > over valued
- current market value < under valued
- determines which shares to buy
Intrinsic value
discounting future income and dividends
Stakeholders in financial analysis
shareholders
debt
management
diverse groups
current and potential shareholders
potential earnings and dividends per share
interested in ability to generate income
risk associated with income generated
current and potential providers of debt capital
current amount of debt in the capital structure and if the business can settle capital and interest payments
management and employees
to ensure efficient internal decision making - continuously informed about financial position
ability to survive long term
Diverse groups
not directly involved in activities
customers, providers, competition, stockbrokers
Financial statements
statement of financial position
statement of profit and loss
Statement of profit or loss
summary of enterprise performance for a specific period of time
does not necessarily represent cash flow as non cash flow items are also represented
Revenue
represents all compensation received for products pr services provided
- Sales
Cost of Sales
costs directly incurred in order to generate revenue
- opening inventory + purchases - closing inventory
Gross Profit
calculated by subtracting COS from the revenue
Operating Profit
GP - Operating expenses
indication of the profit generated by primary activities
Profit before tax
investment income (interest and dividends received) + operating profit + non-recurring profits (gain) - Non recurring profits (loss) - finance costs
Profit after tax
profit before tax - tax
attributable earnings
portion of profit that remains after tax and preference dividends have been subtracted
available for ordinary shareholders and paid out as ordinary dividends
Retained earnings
portion of earnings not paid out as dividends and reinvested in the enterprise
- part of enterprise reserves and utilised to finance activities
Statement of financial position
summary of enterprises financial position on a specific date
- 2 sections assets ( indication of how much capital is invested in assets), equity and liability ( different sources of capital).
Assets
represent a capital investment in items
utilise items to generate income
non current and current
Non- current assets
used for a relatively long period of time (more than 1 year)
fixed property of enterprise
what is Property plant and equipment at cost price and why is it a problem ?
non-current asset
all physical non current assets such as vehicles, equipment, property, buildings , production facilities
usually shown at cost price - weakness of FP as it is not an accurate indication due to depreciation
Solve problem: include replacement values
- reevaluation reserve
Accumulated depreciation
the total amount of depreciation they had born provided for PPE
PPE at carrying value
PPE at cost price - depreciation
proceeds compared to carrying value to determine gain/loss when PPE is sold
Intangible assets
goodwill and patents
property of enterprise and can be used to generate income
difficult to allocate monetary value
financial assets
indicated at their original price while current market price can also be included
investments
loans to other parties
Current assets
used for a relative short period of time (less than 1 year)
included in physical production process of an enterprise
Non current vs Current assets
Turnover period (<1
Inventories
stock necessary for continuous operation
production vs. retail
trade receivables
outstanding portion of credit sales
Cash
all cash held by enterprise
petty cash and cash in bank accounts
cash equivalents
Prepayments
paid an expense before payment was required
Payments made for transactions that will only occur in the following accounting period
decrease future liabilities
shareholders Equity
all capital provided by shareholders
ordinary share capital
proceeds from sale of ordinary shares
represent shareholders stake in management
issued no. ordinary shares x average issue price of shares
non-distriubutable Reserves
reserves that cannot be paid out to the ordinary shareholders
reevaluation reserves and capital redemption reserves
distributable reserves
reserves distributable to ordinary shareholders
retained earnings
ordinary shareholders equity
total shareholding
ordinary share capital
no distributable
distributable reserves
preference share capital
capital obtained by selling preferences shares to investors
Preference right above ordinary shareholders to receive dividends
Fixed dividend proceed, guarantee of dividend payout
non-current liabilities
long term debt capital
interest bearing borrowings: long term debt capital
long terms loans, mortgage loans, debentures
current liabilities
short term debt capital
trade payables, bank overdraft , short term loans, dividends payable, current tax liabilities
return on total assets
how effectively total assets are used to generate income
operating profit + investment income / average total assets x 100
return on equity
indication of return generated on equity invested in the company
operating profit + investment income - finance costs / average equity x 100
cost of debt (return on debt capital)
average cost associated with debt capital used by the company.
Debt capital = current liabilities and non current liabilities
finance costs/aver debt capital x 100
return on financial assets
indication of average return earned on company’s external investments
investment income/ average financial assets x 100
gross profit margin
indication of the portion of the enterprises revenue that realise as GP
GP/revenue x 100
operating profit margin
percentage of revenue realised as profit after provision has even made for all normal expenses
operating profit/revenue x 100
EBIT margin
indication of the profit realised before taking any finance costs and tax into consideration
profit before tax +finance costs/ revenue x 100
Net profit margin
which part of the revenue is available to the SH
Profit after tax/ revenue x 100
current ratio
current assets compared to current liabilities to maintain adequate levels of liquidity should be at least 2
current assets / current liabilities
acid test ratio
current assets - inventory - prepayments /current liabilities
Turnover ratio and time of current assets
number of times per year current asset is converted to revenue and how long it takes to compete a conversion cycle
Turnover ratio: net revenue / average current assets
Turnover time : average current assets/ net revenue x 360
turnover ratio and time of PPE
higher the ratio the more times converted into revenue
ratio: net revenue/ average PPE @ carrying value
time: Average PPE @ carrying value / net revenue x 360
turnover time of trade receivables
ratio: credit revenue/ average trade receivables
time: average trade receivables/ credit revenue x 360
Turnover ratio and time of inventory
ratio: COS/average inventory
time: Average inventory/ COS x 360
Debt-to-assets ratio (debt ratio)
debt capital/total assets x 100
or
debt capital/ total capital x 100
Finance cost coverage
profit before finance cost and tax/ finance costs
ordinary dividend coverage
earnings per share/ dividend per share or profit after tax- preference share dividends/ ordinary share dividends or earnings yield/ dividends yield
earnings per share
attributable earnings/ average number of ordinary shares issues
earnings yield
earnings per share/ market price per share x 100
dividend per share
ordinary dividends declared/ average number of ordinary shares issued
dividend yield
dividend per share/market price per share x 100
price earnings ratio
market price per share/ earnings per share
book value per share
SH equity - PS - intangible assets/ no. OS issued
