CHAPTER 12
FINANCIAL STATEMENT ANALYSIS:
APPLICATIONS
Presenter’s name
Presenter’s title
dd Month yyyy
EVALUATION OF A COMPANY’S PAST
PERFORMANCE
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EVALUATION OF A COMPANY’S PAST
PERFORMANCE: APPLE
$ (millions)
$70,000
Sales
$60,000
Gr. Profit
$50,000
Net income
$40,000
$30,000
$20,000
$10,000
$0
2007
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2008
2009
2010
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EVALUATION OF A COMPANY’S PAST
PERFORMANCE: APPLE
Fiscal Year
($ millions)
2010
2009
2008
2007
Net sales
$65,225
$42,905 $37,491 $24,578
Gross margin
25,684
17,222
13,197
8,152
Net income (NI)
14,013
8,235
6,119
3,495
2010
Gross margin (% sales)
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39%
2009
40%
2008
35%
2007
33%
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EVALUATION OF A COMPANY’S PAST
PERFORMANCE: APPLE
Panel A: Data for Apple Inc.
Fiscal Year
($ millions)
2010
2009
2008
2007
$51,011
$33,992
$24,490
$15,386
41,678
31,555
30,006
21,956
75,183
47,501
36,171
24,878
20,722
11,506
11,361
9,280
Cash and marketable securities
Total current assets
Total assets
Total current liabilities
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EVALUATION OF A COMPANY’S PAST
PERFORMANCE: APPLE
100%
90%
80%
70%
Peripherals and other hardware
Software, service and other sales
60%
Other music related
50%
iPad & related
iPod
40%
Total Mac
30%
iPhone & related
20%
10%
0%
2007
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2008
2009
2010
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FORECASTING
• Sales Forecast
• Expenses
• Gross Profit
• Operating Profit
• Assets
• Liabilities
• Cash Flow
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FORECASTING
• Sales Forecast
• Expenses
• Gross Profit
• Operating Profit
• Assets
• Liabilities
• Cash Flow
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FORECASTING
• Sales Forecast
• Expenses
• Gross Profit
• Operating Profit
• Assets
• Liabilities
• Cash Flow
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FORECASTING
• Sales Forecast
• Expenses
• Gross Profit
• Operating Profit
• Assets
• Liabilities
• Cash Flow
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ITERATIONS IN FORECASTING
• Sales Forecast
Forecast
Debt
Forecast
Interest
Expense
Forecast
Cash Flow
Forecast
Income and
Taxes
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• Expenses
• Gross Profit
• Operating Profit
• Assets
• Liabilities
• Cash Flow
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FORECASTING OPERATING PROFIT BASED ON
HISTORICAL MARGINS
Johnson & Johnson
(NYSE: JNJ)
• U.S. health care conglomerate,
founded in 1887.
• 2009 sales of around $61.9
billion from its three main
businesses: pharmaceuticals,
medical devices and diagnostics,
and consumer products.
• For the four years prior to 2009,
average operating profit margin
was approximately 25.0%.
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Baidu (NASDAQ: BIDU)
• Chinese language internet
search engine, established in
2000 and went public on
NASDAQ in 2005.
• Revenues for 2009 were 4.4
billion renminbi (RMB), an
increase of 40% from 2008 and
more than 14 times greater than
revenues in 2005.
• For the four years prior to 2009,
average operating profit margin
was approximately 27.1%.
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FORECASTING OPERATING PROFIT BASED ON
HISTORICAL MARGINS
Johnson & Johnson
Baidu (NASDAQ: BIDU)
• 2009 sales were $61.9 billion.
• 2009 revenues were 4.4 billion
renminbi (RMB).
• For the four years prior to 2009,
average operating profit margin
was approximately 25.0%.
• For the four years prior to 2009,
average operating profit margin
was approximately 27.1%.
• Actual operating profit for 2009
was $15.6 billion.
• Actual operating profit for 2009
was RMB1.6 billion.
• Actual operating profit margin for
2009 was 25.2%.
• Actual operating profit margin for
2009 was 36.4%.
(NYSE: JNJ)
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ASSESSING CREDIT QUALITY
• Credit risk: Risk of loss caused by a debtor’s failure to
make a promised payment
• Credit analysis: Evaluation of credit risk
- Risk in a particular transaction or for a particular security
- Obligor’s overall creditworthiness
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TECHNIQUES FOR ASSESSING CREDIT
QUALITY
• Credit scoring—statistical techniques
• Period-by-period cash flow projections
• Analysis of business and financial risk factors
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ASSESSING CREDIT QUALITY: EXAMPLE
Bombardier
Inc.
BAE
Systems
plc
7.5%
10.1%
3.9
3.1
Retained cash flow to debt
6.1%
13.7%
Free cash flow to net debt
–7.0%
7.7%
EBITDA/Average assets
Debt/EBITDA
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STOCK SCREENING
Universe of Stocks
Stocks Meeting
Criteria
Selection
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EXAMPLE OF STOCK SCREENS
Stocks Meeting Criterion
Criterion
Number
P/E <15
Percent of Total
1,471
28.36%
880
16.97%
NI/Sales > 0
2,907
56.04%
Dividend yield > 0.5%
1,571
30.29%
101
1.95%
Total debt/Assets ≤ 0.5
Meeting all four criteria simultaneously
Source for data: http://google.com/finance/
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SCREENS AND BACK-TESTING
• Valuation metrics + Accounting metrics
• Evaluation of screen using “back-testing”
• Caveats when back-testing:
- Survivorship bias
- Look-ahead bias
- Data-snooping bias
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TWO HYPOTHETICAL SCREENING STRATEGIES
Strategy A
Strategy B
Invest in stocks that are
components of a global
equity index, have an ROE
above the median ROE of all
stocks in the index, and
have a P/E less than the
median P/E.
Invest in stocks that are
components of a broadbased U.S. equity index,
have a ratio of price to
operating cash flow in the
lowest quartile of companies
in the index, and have
shown increases in sales for
at least the past three years.
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TWO HYPOTHETICAL SCREENING STRATEGIES:
AVOID UNINTENTIONAL SELECTIONS
Strategy B
Invest in stocks that are
Invest in stocks that are
components of a broadcomponents of a global
based U.S. equity index,
equity index, have an ROE
have a ratio of price to
above the median ROE of all operating cash flow in the
stocks in the index, and
lowest quartile of companies
have a P/E less than the
in the index, and have
median P/E.
shown increases in sales for
at least the past three years.
Strategy A
What if Net income was < 0
and Equity < 0?
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What if operating cash flow
was < 0?
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ANALYST ADJUSTMENTS
• Importance (materiality). Is an adjustment to this item likely to affect the
conclusions? In other words, does it matter? In an industry where
companies require minimal inventory, does it matter that two
companies use different inventory accounting methods?
• Body of standards. Is there a difference in the body of standards being
used (U.S. GAAP versus IFRS)? If so, in which areas is the difference
likely to affect a comparison?
• Methods. Is there a difference in accounting methods used by the
companies being compared?
• Estimates. Is there a difference in important estimates used by the
companies being compared?
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INVESTMENTS
• Investments
- Unrealized gains and losses on the income statement
versus
- Unrealized gains and losses not on the income statement
but instead recognized in equity.
• If two otherwise comparable companies have significant
differences, it may be useful to adjust.
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INVENTORY: EXAMPLE
Company A
(FIFO)
Current assets (includes inventory)
LIFO reserve
Current liabilities
Company B
(LIFO)
$300,000
$80,000
NA
$20,000
$150,000
$45,000
NA = not applicable
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INVENTORY: EXAMPLE
Company B
Company A
(FIFO)
Unadjusted
(LIFO basis)
Adjusted
(FIFO basis)
Current assets
(includes inventory)
$300,000
$80,000
$100,000
Current liabilities
$150,000
$45,000
$45,000
2.00
1.78
2.22
Current ratio
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GOODWILL AND
INTANGIBLE ASSETS
Market capitalization on January 2010 (market
price per share times the number of shares
outstanding)
Total shareholders’ equity as of most recent
quarter
SCHW
AMTD
$21,871
$11,525
$5,073
$3,551
$528
$2,472
$23
$1,225
Goodwill
Other intangible assets
The MV/BV for the companies is
SCHW
$21,871/$5,073 = 4.3
AMTD
$11,525/$3,551 = 3.2
Note: MV/BV equals the total market value of the stock (the market capitalization)
divided by total stockholders’ equity. It is also referred to as the price-to-book ratio
because it can also be calculated as price per share divided by stockholders’ equity per
share.
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GOODWILL AND INTANGIBLE ASSETS
Total stockholders’ equity
Less goodwill
Book value, adjusted
Adjusted MV/BV
Total stockholders’ equity
Less goodwill
Less other intangible assets
Tangible book value
MV/tangible book value
($ millions)
SCHW
AMTD
$5,073
$3,551
$528
$2,472
$4,545
$1,079
4.8
10.7
($ millions)
SCHW
AMTD
$5,073
$3,551
$528
$2,472
$23
$1,225
$4,522
($146)
4.8
NM
NM = not meaningful
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OFF-BALANCE-SHEET FINANCING
• Use disclosures to assess a company’s financial position as if offbalance-sheet obligations (e.g., operating leases) were included in its
total liabilities.
• Steps:
- Determine present value of future operating lease payments.
- Add present value of future operating lease payments to total debt
and to total assets.
- Adjust expenses to
- Include depreciation expense, interest expense.
- Exclude rent expense.
• The adjustments for operating leases essentially treat the transaction
as if the asset subject to the operating lease had been purchased
rather than leased.
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SUMMARY
Financial statement analysis applications discussed in this
presentation include
• Evaluating a company’s past performance.
• Projecting a company’s future performance.
• Assessing the credit quality of a potential debt investment.
• Screening for potential equity investments.
• Adjusting a company’s financial statements to facilitate
cross-sectional comparison.
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