Chapter 7 - Company Analysis and Valuation of Equity Securities Flashcards
What is the difference between GAAP and IFRS?
GAAP had been the standard for over 75 years in the US and Canada.
Canadian publicly accountable enterprises gave up on GAAP and switched to IFRS (International Financial Reporting Standards) in 2011.
IFRS is almost entirely principles-based while US GAAP is primarily rules-based.
How does principles-based accounting differ from rules-based accounting?
Guidelines are more general with principles-based accounting as the goal is to have the completed statements achieve a set of good reporting objectives, such as sufficient disclosure of data.
Rules-based accounting is more rigid, meaning specific procedures are observed when preparing statements. This results in less ambiguity, but also increases complexity as it’s difficult to find rules that fit every situation.
What are the 4 major financial statements from a company?
- Statement of financial position
- Statement of cash flows
- Statement of changes in equity
- Statement of comprehensive income
What are the 3 general categories of sources/uses of a company’s cash?
- Cash flow from operating activites - revenues - cash used to generate revenue
- Cash flow from investing activities - cash from sale of long-term assets minus cash used to buy long-term assets plus any dividends received
- Cash flow from financing activities - cash received from sale of new shares or issuance of debt minus cash paid to buy back shares, repay debt, or pay dividends
How do you calculate a change in a company’s cash from one period to the next as reported on the statement of financial position?
Cash flow from operating activities + cash flow from investing activities + cash flow from financing activities
How do companies listed on a Canadian stock exchange file audited annual financial statements?
Through SEDAR (System for Electronic Document Analysis and Retrieval)
What must companies listed on Canadian stock exchanges file in additional to audited annual financial statements?
Interim anaudited financial statements.
What are the 3 factors that determine the degree of a company’s sustained competitive advantage?
- Low costs - low cost structure
- Differentiation - unique products/services
- Focus - underserved customer base
Which 4 areas of a company’s operations does qualitative analysis consider to determine whether a company has a sustained competitive advantage?
- Corporate issues
- Products and markets
- Production and distribution
- Level of competition
What are some factors that qualitative analysis considers to determine whether a company has a sustained competitive advantage in the area of products and markets?
Qualitative analysis looks for companies with a variety of well differentiated products with healthy R&D budgets and a diverse customer base with sufficient marketing strategies and excellent customer service.
How is financial statement analysis performed?
Spreadsheet models of a company’s historical and projected financial results are used, often mapping data and relationships among several worksheets and files.
What are a company’s ‘key drivers’?
Key drivers can include revenue, cost of sales, depreciation and capital expenditures. Analysts are particularly interested in identifying and analyzing these key drivers of a company’s performance.
What are the 4 general categories of ratios for analyzing company performance?
- Liquidity analysis
- Risk analysis ratios
- Operating performance ratios
- Value ratios
What are liquidity ratios?
Measure a company’s ability to meet its short-term obligations. These include the current ratio and the quick ratio.
What are risk analysis ratios?
Used to determine how well a company deals with its debt obligations. These include asset coverage, debt-to-equity ratio, cash flow to total debt, and interest coverage.
What are operating performance ratios?
Determine a company’s long-run growth and survival prospects by measuring how well the company uses its resources. These include gross profit margin, net profit margin, net return on common equity, and inventory turnover.
What are value ratios?
These guage the market’s perception of the value of a company’s shares relative to its dividends, earnings, or other measures. These include the percentage of available earnings paid out as common dividend, earnings per common share, dividend yield, P/E ratio, equity value per common share.
Which type of company forecast made by an equtiy analyst is given the most attention?
The earnings forecast.
What is ‘earnings season’?
A large number of companies report earnings in the weeks following the end of March, June, September and December.
How is earnings per share calculated at the most basic level? (Basic EPS)
Profit divided by the weighted-average number of common shares outstanding.
How is fully diluted EPS calculated and how is it different than basic EPS?
It includes all stock options, unexpired warrants, shared that could be issued from other convertible securities in addition to the weighted average number of common shares outstanding.
Fully diluted EPS is essentially a hypothetical number that reflects all granted and unexpired claims for potential common shares.
What would the weighted average number of shares outstanding be if there were 1,000,000 shares outstanding on January 1 and 400,000 were issued on June 1?
1,000,000 x 5/12 = 416,667
1,400,000 x 7/12 = 816,667
= 1,233,334
What is the purpose of calculating the weighted average number of shares outstanding?
Factors in the length of time shares were issued and outstanding during the fiscal time period.
What is ‘return on equity’ (ROE)?
Company’s return on common equity. This is the retained earnings that represent the cumulative profit or loss that accrues to the company’s common shareholders.
Why do analysts often break down the ROE number into components and comment on each one?
The purpose of breaking down ROE is to determine where either a growth or decline in a company’s ROE came from.
What is the DuPont Model for ROE breakdown?
This is commonly used by analysts to break down a company’s ROE. It’s net profit margin x total asset turnover x financial leverage.
What is total asset turnover?
Revenue / total assets
Total revenue a company generates for the amount of total assets. Analysts look for a trend that points towards an increasing revenue relative to the company’s total assets.
What is a company’s financial leverage?
Total assets / common equity
What is a company’s net profit margin?
Profit / revenue
Measures a company’s rate of profit after allowing for all expenses and taxes.
Why would a higher ROE due to higher financial leverage be concerning?
Financial leverage is total assets / common equity. Higher financial leverage means the company has more debt, and therefore potentially more risk.
What is the ‘sustainable growth rate’ for either a company’s earnings or dividends?
How is it calculated?
Estimated growth rate of earnings and dividends that the company can sustain for a given level of ROE based on the company’s capital structure remaining constant and no additional common stock being issued.
Calculated as the earnings retention rate (opposite of dividend payout ratio) x ROE