Series 7 STC Fundamental Analysis (Ch. 16) Flashcards
If an adviser wants to measure a company’s short-term financial health, the adviser will be MOST interested in the:
Acid-test ratio
Debt-to-equity ratio
Earnings per share
Inventory turnover
Acid-test ratio
All of the following are a part of shareholders’ equity, EXCEPT:
Retained earnings
Interest payable
Paid-in-capital
Par value of preferred stock
Interest payable
The shareholders’ equity section of a balance sheet accounts for money that’s owed to a corporation’s common and preferred shareholders. When an investor buys either common or preferred shares from a corporation (e.g., through an IPO), the company accounts for the investment in two ways. Some of the investment goes into the par value (as determined by accountants) for the shares, while the remainder is then added to paid-in-capital. Retained earnings is often the largest part of shareholder’s equity and represents the historical earnings of the corporation. Each year, the corporation’s income will be added to retained earnings on the balance sheet. Interest payable is a short-term liability and is not found in the shareholders’ equity section of a balance sheet.
What’s the current ratio of a company that has current assets of $10, fixed assets of $20, current liabilities of $5, long-term liabilities of $5, and shareholders’ equity of $20?
5-to-1
0.5-to-1
0.25-to-1
2-to-1
2-to-1
Which of the following items is NOT included in an income statement?
Operating expenses
Revenue
Interest expense
Dividends payable
Dividends Payable
The income statement of a company includes its sales (revenues), less its operating expenses, less interest paid on its debt, which equals earnings before taxes. Taxes are then deducted to determine its net income, from which dividends may be declared. The income statement also includes non-recurring events such as the closing of a business or extraordinary items. The entry of dividends payable is found on a company’s balance sheet.
Which of the following items is NOT included in an income statement?
Goodwill
Selling and administrative expenses
Interest expense
Income taxes paid
Goodwill
The income statement of a company includes its sales (revenues), less its operating expenses (e.g., selling and administrative expenses), less interest paid on its debt, which equals earnings before taxes. Taxes are then deducted to determine its net income, from which dividends may be declared. The income statement also includes non-recurring events such as the closing of a business or extraordinary items. The amount of goodwill is found on a company’s balance sheet.
If a person is examining a balance sheet, what would she expect to see:
Income before interest and taxes
Taxes paid
The number of common shares outstanding
Capital expenditures
The number of common shares outstanding
The balance sheet contains three main categories: assets, liabilities, and net worth (stockholders’ equity). Within the net worth section, the number of common shares outstanding is found. Income before interest and taxes and taxes paid is found in the firm’s income statement. Capital expenditures are part of the statement of cash flows.
On a company’s balance sheet, what’s included in Shareholders’ Equity?
Cash dividends
Interest owed to bondholders
Operating income
Retained earnings
Retained earnings
The Shareholders’ Equity section of a balance sheet includes the cash that shareholders have paid to buy the company’s shares, as well as the cumulative earnings of company. The total cumulative income that a company has made is referred to as retained earnings and is a part of shareholders’ equity. Interest that a company owes its creditors (e.g., bondholders) is a part of liabilities. Both operating income and dividends are a part of an income statement, not a balance sheet.
What type of analysis examines a company’s earnings, dividend prospects, risks, and economic factors to determine its value?
Fundamental analysis
Technical analysis
Advance-decline ratio analysis
Trend line analysis
Fundamental analysis
Fundamental analysis examines a company’s financial reports and economic projections to determine its value. In other words, fundamental analysts study a company and its environment to estimate the current stock price. All other choices have to do with technical analysis, which studies pricing patterns and the behavior of the stock as it trades in the secondary market.
What’s the book value of an asset?
The price paid in excess of the accounting value of an asset
The market value of the company’ financial statements
The acquisition cost of an asset less depreciation or amortization
The expense on an income statement that accounts for preparing a company’ income statement and balance sheet
The acquisition cost of an asset less depreciation or amortization
The book value of an asset is the value of the asset that’s found on a company’s balance sheet (i.e., its books). Companies will initially value assets on their balance sheet at their acquisition costs (e.g., purchase price). However, as an asset ages, companies will write off (i.e., decrease) the value of their assets using a depreciation or amortization expense. As an asset’s value is depreciated, the book value will fall as well. The next time the company creates its balance sheet, its assets will be equal to the acquisition costs of the assets minus depreciation or amortization (Asset’s Book Value = Acquisition Cost - Depr./Amort.).
Which of the following choices is another way of expressing the earnings multiple?
Debt-to-equity ratio
Dividend payout ratio
Price-earnings ratio
Operating profit ratio
Price-earnings ratio
A fundamental analyst believes that:
A company’s financial statements, management, competitors, and standing in the marketplace are the best way to determine its value
At any given time, all public and non-public information about a security has already been included in a stock’s priced and that the market price accurately reflects the intrinsic value
Companies with low price-to-earnings ratios will outperform companies with high price-to-earnings ratios
Historical stock market data and trends are the best way to determine the intrinsic value
A company’s financial statements, management, competitors, and standing in the marketplace are the best way to determine its value
Fundamental analysis involves reviewing a company’s financial statements (i.e., balance sheet and income statement) to determine its financial health. A fundamental analyst will also examine a company’s management, its competitors, and its standing in the marketplace. On the other hand, technical analysts examine historical data and trends to predict the direction in which prices will move next. The strong from of the Efficient Market Hypothesis suggests that all information is reflected in the current market price of a stock. Value investors believe that companies with low price-to-earnings (PE) ratios will outperform companies with higher price-to-earnings ratios.
How is the book value of a company calculated?
Current Assets - Current Liabilities
Fixed Assets - Long-Term Liabilities
Total Assets - Total Liabilities
Current Assets - Inventory
Total Assets - Total Liabilities
Book value is calculated by taking all of a company’s assets and subtracting all of its liabilities. Notice that book value can also be referred to as total shareholders’ equity. The price-to-book ratio is a common way to identify overvalued and undervalued companies.
A company’s PE ratio has historically been 30, but it has recently dropped to 15. In this case, what has most likely happened to the company?
The earnings per share (EPS) has declined.
The price of the company’s stock has risen.
The price of the company’s stock has fallen.
The company has started paying common stock dividends.
The price of the company’s stock has fallen.
The price-to-earnings (PE) ratio is the price of a company’s stock divided by its earnings per share (EPS) (i.e., PE Ratio = Stock Price ÷ EPS). If the company’s PE ratio has fallen, this means that either the stock price has fallen or the EPS of the company has risen. Paying common shareholders a dividend doesn’t impact EPS and will most likely cause the stock’s price to rise.
For a client, the balance sheet equation is:
Total Assets - Total Liabilities = Capital Gains
Assets - Liabilities = Net Worth
Total Assets - Current Liabilities = Net Worth
Current Assets - Current Liabilities = Net Worth
Assets - Liabilities = Net Worth
At the beginning of the year, the price-to-earnings (P/E) ratio of ABC stock was 30, but three months later it fell to 15 because of bad news about the company’s future earnings projections. Which of the following explains the company’s lower PE ratio?
The stock price increased.
Earnings per share increased.
The stock price decreased.
Earnings per share decreased.
The stock price decreased.
The price-to-earnings (PE) ratio is typically calculated by taking the current market price of the company’s stock and dividing it by the earnings per share (EPS) from the last fiscal year. In this question, downgrading the future projections for the company’s earnings will not have any impact on last year’s EPS. However, the market price of the stock will fall due to the lower earnings projections, which explains how the P/E ratio fell from 30 to 15.
Which of the following is used to determine the debt-to-equity ratio?
The income statement
The balance sheet
The cash flow statement
The statement of retained earnings
The balance sheet
The debt-to-equity ratio is the amount of debt that’s been issued by a company in comparison to the amount of shareholders’ equity. The higher the ratio, the more leveraged the company. The ratio is calculated by taking total debt capital and dividing by equity capital, which are both found on the balance sheet.
On a balance sheet, what account shows the obligations that must be paid within one year?
Current liabilities
Total liabilities
Accounts receivable
Marketable securities
Current liabilities
Current liabilities are obligations of a business that are due within one year. Obligations that are due in more than one year are considered long-term liabilities. Total liabilities are simply the combination of current and long-term liabilities. Accounts receivable and marketable securities are both current assets.
A company’s total equity does NOT include:
Long-term bonds
Preferred stock
Common stock
Retained earnings
Long-term bonds
Preferred and common stock are both included in the equity section of a company’s balance sheet. Retained earnings represent all of the profits that have not been paid out as dividends and are also included in shareholders’ equity. Long-term bonds are debt securities and are listed as a liability (not equity) on the balance sheet.
A company has a debt-to-equity ratio of 1.0. What does this signify?
The market value of the company’ debt and stock are equivalent.
The value of debt and shareholders’ equity on the company’s financial statements are equal.
The company is overleveraged relative to other firms in their industry.
The company’ stock is more volatile relative to the overall economy.
The value of debt and shareholders’ equity on the company’s financial statements are equal.
The debt-to-equity ratio is a measure of how much a company has borrowed (i.e., financial leverage). If a company has a debt-to-equity ratio of 1.0, its debt is equal to its shareholders’ equity. Notice that shareholders’ equity is found on the company’s balance sheet and doesn’t represent the market value of the company’s stock. Debt-to-equity ratios differ across industries, but many firms have debt-to-equity ratios exceeding 2.0. A low debt-to-equity ratio is most likely a sign that a firm is underleveraged.
What type of investment analysis uses financial data that’s specific to one issuer to make investment decisions?
Discounted cash flows
Fundamental analysis
Technical analysis
Odd-lot theory
Fundamental analysis
Fundamental analysis involves an analysis of a company’s financial statements (i.e., balance sheets and income statements) in order to make investment decisions. Conversely, technical analysis uses pricing trends and patterns to make investment decisions. Discounted cash flow modeling involves projections of future cash flows (e.g., corporate earnings, bond interest payments) and uses the present value formula to discount them back to their present value.
