Exam 2 Flashcards
Common-size statements
A standardized financial statement presenting all items in percentage terms.
Common size income statement
- Expresses each item as a percentage of total sales
- Tells us what happens to each dollar in sales
Common Size Balance sheet
Expresses each item as a percentage of assets and liabilities/equity
The role of Financial ratios
Ways of comparing and investigating the relationships between different pieces of financial information
Financial ratios categories
- Liquidity ratios (Short-term solvency)
- Financial leverage ratios (Long-term solvency)
- Turnover ratios (Asset management)
- Profitability ratios
- Market value ratios
Short-term solvency, or liquidity, ratios
The firm’s ability to pay its bills over a short period of time
Current Ratio Formula
Current Assets/Current liabilities
Quick (or Acid-Test) Ratio Formula
Current Assests - Inventory/ Current liabilites
Cash Ratio Formula
Cash/Current liabilities
Conglomerates
owning more or less unrelated lines of business.
Problems with Financial statements analysis
There is no underlying theory to help us identify which items or ratios to look at and to guide us in establishing benchmarks
Do financial statements outside of the US conform to GAAP
No
Is profitability strongly affected by the regulatory environment?
Yes, so utilities in different locations can be very similar but show very different profits.
North American Industry Classification System (NAICS)
(NAICS) = Intended to replace older SIC codes
Aspirant group
The top firms in their industry
Standard Industrial Classification (SIC) codes
Four-digit codes established by the U.S. government for statistical reporting purposes
First digit in an SIC code establishes what?
the general type of business
Companies beginning with SIC code 602
are mostly commercial banks
Companies with an SIC code beginning with 6
Firms engaged in finance, insurance, and real estate
Companies beginning with SIC code 60
Are mostly banks
An example of a major competitor and natural peer group member in an industry may be scattered across the globe
Ex. Automobile industry
Peer Group Analysis
Identifying firms similar in the sense that they compete in the same markets, have similar assets, and operate in similar ways
SIC code
Standard Industrial Classification code
The website to know
www.reuters.com
Why evaluate financial statements?
We look at accounting information because we don’t have the market value information
ROE Formula
EAT/Total Equity
MTR
Marginal Tax Rate
Two examples of non-cash expenses
Depreciation & Depletion
IPP
Initial Purchase Price
What is more important accounting or market value?
Market Value
If payout ratio (PR) is 100% then?
there is no room for growth or investment
The two common size statements
- Common size balance sheet
- Common Size income statement
RR
Retention Ratio
Things to know about Walmart
- Acid ratio of 1.44
- Quick ratio of .23
- carries a lot of inventory therefore reflecting those ratio numbers
Do public utilities have high or low asset turnover ratio?
high
NPM
Net Profit Margin
Is low NPM favorable for a stock in the future?
NO, a high NPM is considered to be accretive for the valuation of the stock
What does every ratio have?
A numerator & a denominator
What happened to stock dividends during the pandemic?
Stable yet projected to be cut in half
When you buy stock do you want the PE to be high or low
low, because price is what you pay and earnings is what you get
If the expected future growth rate is down then PE is
down
What are margins driven by?
expectations
With selling stock you want a high or low PE?
high
The inverse of a PE
earnings yield
If the growth rate goes up then PE
goes up
If the PE goes up then
Interest goes down
How would the federal government handle a recession?
Cut interest rates
How are markets driven?
By expectations?
When Apply was almost bankrupt what was their PSR
1
High price of Apple
$180
Current price of Apple
$144
Who did the first Econ metrics?
Prof. William Barbee
Who has the largest Market Cap
Apple
EBITDA
Earnings Before Interest, Taxes, Depreciation, & Amortization
Is it possible for negative free cash flow to be positive for company stock?
Yes if it’s a new company and has high capital spending or if it’s being invested for future growth
Examples of free cash flow being invested for future growth?
- Walmart had negative Free CF and invested (risky)
- KMART had a positive free CF and went bankrupt
Purpose of the DuPont Identity
To break internal equity into 3 parts
- operation efficiency
- asset use efficiency
- financial leverage
Favorable financial leverage
increasing EAT, ROE, & EPS
What brings down the mean reversion growth rate?
competition
It’s a well-documented fact that when the mean reversion growth rate is high it…
eventually drops
It’s a well-documented fact that when the mean reversion growth rate is low it…
eventually goes up
1st & 2nd Constraint
1 - Basic Math
2 - Growth has to be financed
What does the sustainable growth rate do?
helps firms maximize growth rate if the debt-equity ratio is constant and there’s no external equity
External equity example
selling stock
Determinates the sustainable growth rate
ROE (Return on Equity) * RR (Retention Ratio)
Payout Ratio should be high or low?
low
Retention Ratio should be high or low?
high
PE
price to earnings
Depletion
- natural resources
- percent of sales
- not related to the amount spent
Depreciation
- related to capital expenditures
- applies to fixed assets
The government had what type of allowance?
The depletion allowance
When is a low-profit margin considered ok and not bad
Companies having low sales prices but high unit volume
How is operating efficiency measured
As measured by profit margin
How is Asset use efficiency measured
As measured by total asset turnover
Financial leverage is measured by
As measured by the equity multiplier
Why PE varies
Differences in the expected future earnings growth
Trailing earnings is used for
Used for four quarters of earnings
Forward earnings is used to
Project earnings
Two ways to increase the sustainable growth rate
- Anything that increases ROE through the Dupont Identity ( PM x TAT x EM)
- Increasing the plowback ratio(retention ratio
The firm has the ability to sustain growth depends on these four factors
- Profit margin
- Total asset turnover
- Financial policy
- Dividend Policy
Time-Trend Analysis (Time Series)
Using history as a standard
