Company Analysis Flashcards
What is a Business Model?
A business model is basically a company’s plan for how it will generate revenues and make a profit which explains:
- What products or services the business plans to manufacture and market, as well as its sources of financing, target customer base and marketing strategy.
- The value proposition for the business to exist. This refers to what the company offers in the form of goods and services that is of value to potential customers, ideally in a way that differentiates the company from its competitors (eg. fulfilling client needs at a competitive price and sustainable cost).
This suggest that two primary levers of a company’s business model which analysts pay attention to are a company’s:
1. Pricing power
2. Ability to control costs
What is the difference between Company Analysis and Stock Analysis?
Company Analysis is concerned with answering the question “How good is a company?”. It involves forecasting fundamental measures of how well a company will perform in terms of sales & earnings growth, financial strength, competitive strategies, quality of management, etc.
Stock Analysis is concerned with answering the question “Is the stock a good investment?”. It goes beyond Company Analysis into valuation issues like “What is the intrinsic value of the stock versus its market price?”. The aim of stock analysis is to identify stocks whose market prices are below their intrinsic value.
The stock of a wonderful firm with superior management, strong sales and earnings growth can be priced so high that its intrinsic value is below its current share price. As a result, an investor buying its shares at the current high share price is more likely to lose money.
In contrast, the stock of a company whose fundamentals appear less attractive may be trading substantially below its intrinsic value. This is likely to be a more successful investment compared to the over-priced stock of a great company.
What is ROE and ROA?
ROE is extremely important to investors as it indicates the rate of return that management has earned on the capital provided by shareholders after accounting for payments to all other capital suppliers such as bondholders.
Investors would want to invest in companies whose management are able to sustain or improve ROE. Generally, the higher the ROE, the higher the market value of the firm as measured by share price.
ROA indicates the rate of return that management has earned on all the assets of the company, independent of whether those assets were financed with debt or equity.
Financial analysts often make use of an analytical tool known as Dupont Analysis to better understand how a company achieves its earnings.
Dupont Analysis breaks down a company’s ROE into various components which enables an analyst to determine if the causes of change in a company’s ROE are due to changes in:
1. Profit margins
2. Efficiency in asset utilisation
3. Financing structure
What is the Extended Dupont Analysis Formula?
ROE = [100% - Tax/Pre-Tax Profit] x [(EBIT/Sales x Sales/Assets) - Interest Expense/Assets] x Assets/Equity
ROE = Net Profit/Equity
How do we calculate ROA?
EBIT/Sales x Sales/Assets
[Operating Margin x Asset Turnover]
In ROA Analysis, we should take into account the differences in operating characteristics of different industries
What are the two major sources of funds available?
Two major sources of funds available to firms are:
1. Debt financing/loans where the explicit cost of financing is interest cost.
2. Equity financing where the explicit cost of financing is dividends and the implicit cost, the pressure on management to deliver higher share prices as investors expect to make capital gains.
