Indian Institute of Management Bangalore
Financial Statement Analysis and Valuation
PGP Elective Term 4 2012
Course Outline
I LEARNING OBJECTIVES
1. To develop a framework for using financial statement information in a variety of business
analysis and valuation contexts.
2. To differentiate between good accounting and bad accounting.
3. To write an equity research report, credit evaluation report or internal management report
based on analysis of financial statements and other relevant reports.
4. To analyze business strategies to understand the value that they add.
5. To integrate accounting principles and finance concepts.
II COURSE CONTENTS
Session
1
June 14
Topic
Part I OVERVIEW OF FINANCIAL STATEMENTS
Introduction to Investing and Valuation
Investment Styles and Fundamental Analysis
The Role of Financial Reporting in Capital Markets
Stock Market Bubbles
The Professional Analyst and the Investor
Business Analysis
Valuation Technology
Read: Chapter 1 of SP.
Assignment: E1.5; E1.6; CP M1.1. America Online Inc.
2
June 15
Introduction to the Financial Statements
The Financial Statements: Income Statement, Balance Sheet, Statement of
Cash Flows, etc.
Measurement in the Financial Statements
Comparisons using Financial Statements
Read: Chapter 2 of SP.
Assignment: E2.10; E2.13; CP M2.1. Nike Inc
3
June 21
How Financial Statements are Used in Valuation
Multiple Analysis
Asset-Based Valuation
Fundamental Analysis
The Architecture of Fundamental Analysis
Dividend Discount Model
Read: Chapter 3 of SP.
Assignment: E3.7; E3.12; E3.16; CP M3.1. Cordant Technologies and
Howmet International
4
Cash Accounting, Accrual Accounting, and Discounted Cash Flow
Valuation
The Discounted Cash Flow Model
June 22
1
The Statement of Cash Flows
Cash Flow, Earnings, and Accrual Accounting
Read: Chapter 4 of SP.
Assignment: E4.3; E4.9; E4.10; CP M4.1. Coca-Cola and Home Depot Inc.
5-6
June 28
June 29
7
July 5
8
July 6
Accrual Accounting and Valuation: Pricing Book Values
The Concept Behind the Price-to-Book Ratio
Prototype Valuations
A Model for Anchoring Value on Book Value
Read: Chapter 5 of SP.
Assignment: E5.3; E5.6; E5.12; E5.17;; E5.18; M5.2; CP M5.3. KimberlyClark
Accrual Accounting and Valuation: Pricing Earnings
The Concept Behind the Price-to-Earnings Ratio
Prototype Valuation
A Model for Anchoring Value on Earnings
Read: Chapter 6 of SP.
Assignment: E6.1; E6.5; E6.11; E6.12; E6.16; CP M6.3. Google
PART II THE ANALYSIS OF FINANCIAL STATEMENTS
Business Activities and Financial Statements
Business Activities and Reformulating Statements
Accruals
Read: Chapter 7 of SP.
Assignment: E7.1; E7.5; E7.7
9
July 12
Analyzing the Statement of Shareholders’ Equity
Reformulating the Statement of Owners’ Equity
Clean Surplus and Dirty Surplus
Read: Chapter 8 of SP.
Assignment: E8.7; E8.8; E8.14; CP M8.1. Microsoft Corporation
10
July 13
Analyzing the Balance Sheet and the Income Statement
Reformulation of the Balance Sheet
Reformulation of the Income Statement
Comparative Analysis
Read: Chapter 9 of SP.
Assignment: E9.5; E9.9; E9.10; CP M9.2. Chubb Corporation
July 17 MID-TERM EXAMINATION
11
July 20
Analyzing the Cash Flow Statement
Free Cash Flow
Reformulating Cash Flow Statements
Read: Chapter 10 of SP.
Assignment: E10.3; E10.10; E10.11; CP M10.1. Dell Inc
2
12
July 26
Analyzing Profitability
Effect of Leverage
Drivers of Profitability
Read: Chapter 11 of SP.
Assignment: E11.1; E11.4; E11.10; CP M11.1. Procter & Gamble II
13
July 27
Analyzing Growth and Sustainable Earnings
What is Growth?
Analyzing Changes in Profitability and Sustainable Earnings
Analyzing Growth in Investment
Read: Chapter 12 of SP.
Assignment: E12.4; E12.5; E12.10; E12.11; CP M12.2. Microsoft
Corporation
14
Aug. 2
PART III FORECASTING AND VALUATION ANALYSIS
Valuation of Operations and Analysis of Price-to-Book Ratios
Forecasting and Valuation with Balance Sheets
Modifying Residual Earnings
The Cost of Capital in Valuation
Read: Chapter 13 of SP.
Assignment: E13.9; E13.12; E13.13; E13.18; CP M13.1. Chubb
Corporation
15
Aug. 3
Simple Forecasting and Simple Valuation
Simple Forecasts and Simple Valuation
Simple Forecasts of Growth and Return on Net Operating Assets
The Applicability of Simple Valuations
Simple Valuation as an Analysis Tool
Read: Chapter 14 of SP.
Assignment: E14.7; E14.10; E14.13; CP M14.2. Cisco Systems Inc
16
Aug. 9
Full-Information Forecasting and Valuation
Knowing the Business
Financial Statement Analysis: Focusing the Lens on the Business
Full-Information Forecasting and Pro Forma Analysis
Value Generated in Share Transactions
Read: Chapter 15 of SP.
Assignment: E15.4; E15.5; E15.8; E15.9; E15.14; CP M15.2. Dell Inc
17
Aug. 10
PART IV ACCOUNTING ANALYSIS AND VALUATION
Creating Accounting Value and Economic Value
Value Creation and the Creation of Residual Earnings
Accounting Methods, PB Ratios, PE Ratios, and Valuation
Hidden Reserves
Conservative and Liberal Accounting
Read: Chapter 16 of SP.
Assignment: E16.4; E16.5; E16.6; CP M16.1. E*Trade
3
18
Aug. 16
19
Aug. 17
20
Aug. 23
Analyzing the Quality of Accounting
Accounting Quality
Earnings Quality
Detecting Accounting Manipulation and Transaction Manipulation
Disclosure Quality
Read: Chapter 17 of SP.
Assignment: E17.7; E17.10; E17.15; CP M17.1. Xerox Corporation
PART V ANALYZING RISK
Analyzing Equity Risk and the Cost of Capital
Understanding Risk
Betas
Price Risk
Read: Chapter 18 of SP.
Assignment: E18.1; E18.4; E18.5.
Analyzing Credit Risk
Ratio Analysis for Credit Evaluations
Forecasting and Credit Analysis
Liquidity Planning and Financial Strategy
Read: Chapter 19 of SP.
Assignment: E19.1; E19.2; E19.4; CP M19.1. Fruit of the Loom
END-TERM EXAMINATION
III EVALUATION AND SCHEDULE
Component
Description/Scope
Weight
(%)
10
Case
Presentation
Presenting in class
cases from those
marked CP in the
course outline.
Project
Study of financial
statements or a
research topic.
20
Mid-term
examination
Chapters 1 to 9.
30
Date
Will be
scheduled
through the
course.
 Proposal:
5 p.m. on
Friday, June
29, 2012;
 Report:
Friday,
August 24,
2012.
Wednesday,
July 17, 2012.
Method
Student teams (same teams
of five for cases and projects)
present a case in ten minutes.
Evaluation criteria:
 content;
 clarity; and
 presentation.
Student teams present a
written report containing the
results of their study.
 Test of understanding and
application of principles.
 Detailed problems.
 Duration: three hours.
4
End-term
examination
Analysis of
company financial
statements, analyst
reports and other
material.
40
Saturday,
August 28,
2012.
 Annual report will be
distributed in advance.
 Test of understanding of
the annual report focusing
on reformulation,
forecasting and valuation.
 Duration: three hours.
Tests and exams are open-book. The student may bring anything except laptop and mobile
phone.
IV READING MATERIAL
Prescribed Reading:
1. Stephen Penman. 2010. Financial Statement Analysis and Security Valuation 4e.
McGraw-Hill (SP for short).
2. 2012 annual report of Hindustan Unilever Limited.
In addition, selected articles will be distributed.
Additional Reading:
1. Krishna Palepu, Paul Healy and Victor Bernard. Business Analysis & Valuation Using
Financial Statements, Fourth Edition. Cincinnati, Ohio: South-Western College
Publishing, 2008.
2. Sidney Cottle, Roger F. Murray, and Frank E. Block. Graham and Dodd's Security
Analysis. Reprint by Tata McGraw-Hill, 2002. This is a FSA classic.
3. Financial Analysts’ Journal, Journal of Applied Corporate Finance.
Popular Reading:
1. Alex Berenson. The Number. New York: Random House, 2003.
2. Howard Schlitz. Financial Shenanigans. Second edition. Reprint by Tata McGraw-Hill,
2003.
V MARKING, COMPLAINTS, REVIEW, AND GRADING
Answer-sheets will be marked within one week from the date of the test or examination.
Students will have the opportunity of inspecting their respective answer scripts and the
instructor's model answers at the instructor's office. Students must not remove answer scripts
and instructor's model answers.
Any complaint regarding marking should be given in writing in a brief and precise note
immediately after inspecting the answer script. Complaints regarding matters other than
totalling errors cannot be considered. The instructor will examine the complaint and revise
the marks, if appropriate. The instructor is not able to discuss (in person, over the phone or
by e-mail) marking or grading matters.
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On the basis of the student’s total marks in the course, there will be an overall grade and a
grade point average. The various components of evaluation will not be graded separately.
Attendance: Students’ attendance is not mandatory.
VI INSTRUCTOR
R. Narayanaswamy
Office:
A Block 2nd Floor Room # 205
 080 2699 3135
 narayan@iimb.ernet.in
Office hours: To be announced.
VII WEBSITE
The course is on http://moodle.iimb.ernet.in. Students must register as soon as possible. All
submissions will be via the site. Marks will be posted on the site.
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