Financial Analysis
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Credit Analysis
Equity Analysis
Creditors
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What is the borrowing cause?
What is the firm’s capital structure?
What will be the source of debt
repayment?
Credit Rating
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Business Risk
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Industry characteristics
Company position
Management
Financial Risk
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Financial characteristics
Financial Policy
Profitability
Capital Structure
Cash Flow Protection
Financial flexibility
Standard & Poor’s rating
method
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2.
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8.
EBIT interest coverage
EBITDA interest coverage
Funds from operations/Total debt %
Free operating cash flow/Total debt %
Return on capital %
Operating income/Sales
Long-term debt/Capital
Total debt/Capital
Standard and Poors Corporate
Ratings
Financial distress
The deterioration in a company’s
financial condition such that its ability to
repay debt is impaired
Prediction of financial distress
Univariate models
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Beaver (1966) relied on
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Cash flow to total debt
Net income to total assets
Total debt to total assets
Working capital to total assets
Current ratio
No-credit (defensive) interval
Prediction of financial distress
Multivariate models
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Altman Z-score
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(Current assets – current liabilities)/total
assets (weight-1,2)
Retained earnings/Total assets (weight-1,4)
EBIT/Total assets (weight-3,3)
Preferred and common stock market
value/Book value of liabilities (weight-0,6)
Sales/Total assets (weight-1,0)
Altman Z-score
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Z> 2,99  Not in financial distress
Z< 1,81  In financial stress
2,99>Z>1,81 Uncertain
Altman Z score Anadolu Cam
Altman Z-score
Ratio 1
Ratio 2
Ratio 3
Ratio 4
Ratio 5
Altman Z-score
2006
0,04
0,11
0,04
1,60
0,55
1,85
A. Cam
2005
2004
0,08
0,14
0,12
0,10
0,07
0,12
2,27
2,97
0,51
0,61
2,36
3,08
Additional considerations
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Mezzanine items
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Could be debt or equity
Off-balance-sheet liabilities
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Operating leases
Contingent liabilities
Environmental liabilities
Equity Analysis
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Buy-side
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Work for an institutional investors (mutual fund)
Make internal recommendations regarding the
purchase of equity securities
Might review reports of sell-side analysts
Sell-side
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Work for brokerage firms
Issue reports for retail and institutional customers
Valuation
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Current value V0 is a function of
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Present value of next year’s cash flow, CF1
Required rate of return, r
Expected constant growth rate, g
V0
CF1
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r  g
Equity Analysis
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2.
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Provides information regarding
The future cash flow generating ability
of the firm
The growth (or lack thereof) of those
cash flows
The risk of those cash flows, and
The risk-free rate commanded by the
market
Top-Down Analysis
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Begin at highest (economy) level
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Allocation between domestic and
international equities
Market sectors
Industries (within a sector)
End with evaluation of specific
companies
Bottom-Up Analysis
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Begin with individual companies
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Screen large data bases for attractive
characteristics
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Look for key strengths
Compustat, Bloomberg, Baseline
Search for a combination of
characteristics
Macroeconomic Analysis
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Gross Domestic Product (GDP): total value of
all final goods and services produced within a
country.
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Nominal, measured in current dollars
Real, adjusted for changing prices
Gross National Product (GNP): total value of
all final goods and services produced by
factors of production owned by citizens of a
country regardless of production location
Growth rates of both can be used as an initial
estimate of a firm’s growth rate
Business Cycle
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Expansion
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Period of economic growth
Increased need for PP&E, labor, inventory
Peak – high point following expansion
Recession
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Contraction following a peak
Rising unemployment, decreased need for factors of
production
Two quarters of falling real GDP
Business Cycle
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Trough – low point following recession
Depression
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Prolonged and severe recession
Some sectors and industries will perform better
in some stages of the cycle than in others.
Cyclical firms are sensitive to stages of the
economic cycle.
Inflation
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Consumer Price Index (CPI) measures
inflation of a market basket of consumer
goods
Producer Price Index (PPI) measures inflation
at the wholesale level
Higher inflation, higher required risk-free rate
of interest
Impacts all companies and all industries (to
varying degrees)
Economic Indicators
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Leading indicators
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Lagging indicators
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Move in advance of the business cycle
Unemployment claims, new orders
Follow behind the business cycle
Average duration of unemployment, average prime
rate
Coincident indicators
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Move with the business cycle
Industrial production
Sector/Industry Analysis
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Assess the ability of companies within
the industry to generate cash flow
Assess the potential growth of that cash
flow
Assess the risks related to receipt of
those cash flows
Assess the industry’s ability to grow
relative to the overall economy
Porter’s 5 Competitive Forces that
determine industry profitability
1.
Threat of New Entrants
- Capital requirements, government policy, access to distribution
2.
Bargaining Power of Suppliers
- Supplier concentration, switching costs, differentiation of inputs
3. Bargaining Power of Buyers
- Buyer concentration, price sensitivity, brand identity
4. Threat of Substitute Products or Services
5. Rivalry Among Existing Firms
- Industry growth, barriers to exit, current industry concentration
Company Analysis
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Understand the business
Evaluate past performance
Forecast performance
Value the company
Make an investment recommendation
Understanding the Business
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Gain an understanding of the products and
services provided by the company and the
market for those products and services
Talk to employees, suppliers, competitors
Interview customers
Utilize the company’s products or services
Evaluating Past Performance
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Understand reported financial information
Common size and ratio analysis
Consider efficiency, liquidity, solvency, cash
flow and relative valuation
Understand US GAAP and IAS
Financial reporting quality and conservatism
Forecasting Performance
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Based on evaluation of past
performance, economic/industry
conditions and expected changes
Pro-forma (projected) financial
statements
Projection of future earnings
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Use earnings model or statistical projection
Valuing the Company
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Determine the appropriate price for
making an equity investment
Is the intrinsic value higher or lower
than the current market price?
Specific methods
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Discounted cash flow
Market-multiple
Residual income
Making an Investment
Recommendation
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Current price of subject company’s securities
Results of valuation
Risks of investment
Investor’s risk tolerance, objectives and time
horizon
Buy/Attractive
Hold/Market Perform
Sell/Market Under perform
Five Steps of a Financial
Statement Analysis
Step 1
Establish objectives of the analysis
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Who are you and why are you interested
in this company?
What questions would you like to have
answered?
What info is vital to the decision at hand?
Five Steps of a Financial
Statement Analysis (cont.)
Step 2
Study the industry in which the firm
operates and relate industry climate to
current and projected economic
developments
Five Steps of a Financial
Statement Analysis (cont.)
Step 3
Develop knowledge of the firm and
the quality of management
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How well does this firm appear to be run?
Are they taking advantage of
opportunities?
Are they innovative, forward-looking, etc?
Five Steps of a Financial
Statement Analysis (cont.)
Step 4
Evaluate financial statements–tools include:
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Common-size financial statements
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Key financial ratios
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Trend analysis
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Structural analysis
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Comparison with industry competitors
Five Steps of a Financial
Statement Analysis (cont.)
Step 4
Evaluate financial statements–areas include:
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Short-term liquidity
Operating efficiency
Capital structure and long-term solvency
Profitability
Market ratios
Segmental analysis (when relevant)
Quality of financial reporting
Five Steps of a Financial
Statement Analysis (cont.)
Step 5
Summarize findings based on analysis
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Reach conclusions about the firm
relevant to your established objectives
What we have accomplished
Turned Maze
Statement of Cash Flows
Balance Sheet
MD&A
Income Statement
Notes
Auditor’s Report
Statement of Shareholders’ Equity
Financial Statements
An Overview
Map