Etrevista de banca de inverison
horarios de comida y en las cossa que ingiero e
Mi nombre is italo caballeero arbulu estudio
eoncmia en la up me enccunetro en 9 ciclo y tengo
planeado culminar este ao. me gustan las
finanzas en especial las inversiones he relziado un
diplomado en la de analis de inversiones y
unsmeinario de politca de divnidnendos en la bolsa
de vlaores de lima, me gustas ver notaicas
eocnmis y de finanzas tcomplete el cruso de
bloomberg market concepst. Tambin me genera
curiosidad la infromatica he llevado ucrsos de
prgamicon en cibertec e infromatica para
ocnmicasta en la up. Asimismo he practica en una
consultaor de assocone spublico privadas en la
que yo junto a un eqeuip e proeycto multidisplianrio
comformado por eocnmistas admiasntradors y
abogaso, elabore modelso financirro tanto para la
valroizaod de los proyectos con le mtodo de flujo
de caja descontado y la evaluacion de
financiamientos de los proyectos para los fondos
de inersion. Adiconalmente elabroe reportes de
noticoas eoncmic y sectpriales
Y prestancion en espaol en ingles sobre los
proyectos de inverison apr apotenciales
inverisonistas y finalamente genera reuns para el
qeuipo de proeucytos con los ejefes de
proinverison
Planeo seguir en la rama deifnainzas ahora postulo
al rea de deals que es me intersa poruqe se ven
valorizaicones de mepresas es un arear que me
gustaria profunfizar y concer. Este ao tambin en
diciembre planeo postular al nivel 1 del cfa para
consolidar mas mi aprendizaje en fiannzas.
Y por ultimo me gustan mucho los deportes desde
pequeo practique futbol, basket, vley, por el
momento practico tenis de 2 a tres veces por
semna y soy voluntario en una ong llamada x-
runner que brinda serviciso saneamiento a familais
pobres en lima.
Banca de inversin Preguntas Entrevista
Ronda de persona
* Describir algunas de sus ventajas y desventajas?
Oportundiades de mejora: 3
1)Uno de mis retos es mejorar la disciplina de mis
salud fsica para ello hacer mas ejericio durante la
semana es asi que estoy llendo mas seguido al
gimnasio para mantenerme mas en forma y
sentrime mejor conmigo mismo.
2)Ademas de eso poner mas atencin en mis
sun aspecto fiundmaental en el mi rendiemnto
acadamico y laboral, ne genral para todo el dia
3) otr aspecto es que anteriormente
inverta cuota importante de tiempo
en un solo curso complicado pero el
ao pasado se me dio la oportunidad
de llevar cursos pesados con otro
cruso mdeianamente fuertes y he
aprendido ser ms eficiente y a
organizar mejor mi tiempo,
estabelciendo horarios desde la hora
en que me leveantaba hasta que me
acostaba y es verdadermente
sorpredente todo el tiempo que se
puede aprovechar si estabelces una
buena rutina.
4)aveces suele ser un poco impaciente, quiero que
las cosas se den rpido o a mi ritmo, sin embargo
luego que he tenido disititnas experuincias de
voluntariado y de un intensivo trbajo en eqeuipo
he aprendido ponerme mejor en el lugar de las
personas, conocer sus inquietudes y sus
problemas
Fortalezas:
I)perseverancia : para mi estudiar eocnomia en la
up y relizar otras actividades extrcurrilaares tanto
deportivas en el caso de tenis o realizar
voluntariods en ongs ha sido un importnisimo
deasfioi en que el he pdoido descubrir que puedo
traspasr mis limites de tiempo o nergia y lograr
mantener un eqeuilibrio entre todas mis actividades
dairias
III) trabajr en eqeuipo :
Estoy convencido que equipo cmodmromado por 2
o mas personas peude lograr resultados
etraordinarios, lo he vivido cunado relice practicas
en la consultaro eramos un grupo comfrimado por
admisntradores, eocnomistas y abogados que
ofreciadn deiversas arsitads de los posiblems
problemas o solucines a conflictos que ocurran
en los proyectos.
IV)coimprometido
Creo que desde pequeo cuando estba en la
secudanrio me empee bastante en trzarme
algunos objetivos entre ellos ser tercio superuos
para estuida roenmia en la up y luego la up tb ha
adicionado en mi un extra importante de compriso,
dedicaicon y repsonsabilida hacia las cosas que
hago y como las hago que son los pasos
trascendentales para pbtenr un resultados ptimos.
Dibujar algo bonito que nos guste ver o hacer:
Un campo de tenis y yo con una raqueta jugando
dobles en una cancha de arcilla uqe quedan cerca
de mi casa y una pantalla viendo noticias
economicas y faincnieras nacional y del mundo.
El tenis implica mucha concentracin, persevancia
y fuerza mental para ganar a tus oponentes,
requiere de mucho entremaient y disicplina y
estartegia, asi como un poco de habilidad
deportiva. En el tenis se prioriza mucho la precisin
un movimiento mal hehco o una tecnia mal
empelada puede lelvar rpidamente a un error no
forzado o una bola en una psoicion desfavorable
que de te deja expuesto ante el rival. El jugar en
parejas en dobles reqeuire de habildiads
adiconales que en singles, se encsita mayor
corrodinaicon y comunaicon con tu compaero
conocerse perfectamente, saber como peinsa y
cuales son sus fortaleza y debildiades y como
podemos complementarnos
En una mepresa como el A la cual eta fromada
por un grupo de profesionales de gran nivel y
reputaicon en los servicios financieros y en la
amplia trayectoria y posicionamiento que ha tneido
el grupo como organizaicion tanto en el mecrado
nacional e internacional creo que precisa de varias
de estas habildiades. Y mas especifiacmente en las
reas que me gustaria dedesarrollar que son las
finanzas en espcial en als reas de inversiones y
CI&B creo que la cruva de aprednizaje es muy alta
y empinada lo cual indica que no solo se aprende
bastante sino tambin rpidamente. En estas reas
me gustara parender bastante sobre vlaoriziacon
de empresa, los procesos de compra y de venta de
empresas o acciones y manejod e potrtafolisod e
inversin, admeas otro aspecto es creo que puedo
crecer tanto en la empresa profesionalmente como
persona en cuanto mis habildiades y
conocmientos, con capcitaciones, ganar
experiencia en tranciones y ver los posible
s tendencioan fuutras de als industria y negociaos
y por ultimo una oportunidad de lnea de carrera
asumiendo mas responsabilidades
Ganas de aprender
Respeto con los dems jugadores
La habilidad de enfocarte cunado la rpesion es alta
Ocnstancia de nunca darte pro evencido
* Cul es tu mayor logro en la vida?
Un gran logro en en mi exepriencai priogesional
que fue mas bien compratidio con un eqeuipo
Trbajo multidispcilinario fue la obtencin dela
buena proc ed un proeycto comercia y
penitenciario.
Era un proeycto que se encargba de la
infraestrucutra epoenitneciaria, disei y
conctruccion de un nuevo penal para la ciduad de
lima a cambio de recibir el terrno del penal san
Jorge para que le consosrico tnega el derecho de
la cosntruccion e implementacin de un proecy
tocomercial compuesto pro galaerias, vivienda
estabelcimeinto comerciale, y tiendas
Tanto el costo de la conturcion del neuvo penal(54)
y el proecyo comecial(45) era de 100 MMde
doalres en un palzo de ejcucion de 3 aos., .
Los beneficios del estado eran obtener un nuevo
penal totalemnte eqeuipo y con mayor segurairad,
la renovaicon urbana en elc ecrdao delima, una
contribucin a la formalizaion del comrcio, y la
apmliaicond e vacante de reclusos
Deje mi enteorio trbajo porque sent que quera
trbajr en una mepresa una consultora mas grande
con mas proyectos, responsabilidades y
aspiraicones de lnea de carrera.
* Cul es la definicin de xito en sus trminos?
Hacerclo que mas tegusta y hacerlo lo mejor
posible
Preguntas tcnicas en una entrevista en banca
de inversin
Qu es un DCF? Explcame como haras uno.
Cules son los diferente mtodos de
valoracin?
Cul es la diferencia entre un LIFO y un
FIFO?
Cundo emitiras deuda y cundo acciones?
Qu es el EBIDTA?
 Cmo vara el capital circulante si tus
proveedores te dan ms plazo para pagarles?
1532?
Cmo calculas el FCF?
Explcame lo que es la crisis en 5 minutosy
en ingls
Cmo calculas la depreciacin?
5 preguntas para ganarte al recruiter en una
entrevista de banca
1)pregutna la iuntimo de la entrevista, ks tienes
alguna pregunta?
Como se siente en banca d einveriso ne le
citibank?
1. Qu porcentaje del trabajo de un
analista/asociado (segn la posicin para la
que te ests entrevistando) es pitching y que
nivel de exposicin a la realizacin de modelos
puedo esperar?
2. Le hace poco acerca de una operacin que
desarrollo su grupo con la empresa X. Durante
esta operacin, quin facilito la financiacin
del deal y cun a menudo utiliza su grupo a
otros bancos como medio de financiacin?
4. Qu le influy a usted a la hora de decidir
desarrollar su vida profesional en este banco y
no en otro?
5. En este trabajo el horario puede ser muy
exigente y a veces puede ser difcil compaginar
vida personal y vida profesional Cmo lo hace
usted para compaginar la vida profesional y la
vida privada y familiar?
Bancos americanos: Goldman Sachs, JP Morgan,
Morgan Stanley, Merril Lynch, Citigroup
Resto de Bancos: UBS, Deutsche Bank, Barclays,
Nomura, Socit Gnrale, etc.
Boutiques de M&A: son asesores con un foco
local que no pueden prestar financiacin a sus
clientes. Suelen tener un tamao ms pequeo
y encargarse de operaciones a nivel nacional.
Se podra dividir en:
Internacionales: Rothschild, Lazard, Mediobanca,
etc.
Nacionales: Montalbn Atlas Capital, GBS
Finanzas, Arcano, AZ Capital, 360 Corporate, etc.
Big Four: las multinacionales denominadas Big
Four (PwC, Deloitte, E&Y y KPMG) tambin tienen
sus departamentos de M&A. Suelen tener
mandatos ms pequeos que, en ocasiones,
vienen derivados de un mandato de Due
Diligence Comercial o Financiero.
La banca d inverison tinee que ver con al gestiond
e colaboradores empresariales, adquisiones,
obtencin de capital, garantas coemrciales,
fonsods de inverison.
Reiben al mayor aprte de sysu ganancias por lso
bonos que aseguran, emisin y la venta de valores
en los mercados y prestacin de aseosamiento
profesional en colaboraicones ya dquisicones.
Banca de inversin Preguntas Entrevista
Ronda de persona
* Describir algunas de sus ventajas y desventajas?
Oportundiades de mejora: 3
Uno de mis retos es mejorar la disciplina de mis
salud fsica y para ello estoy llendo mas seguido
al gym para parasa car mas cuerpo y que me
entalle mejor la ropa. Ademas de eso poner mas
atencin en mis horarios de comida y en las cossa
que ingiero.
3 otr aspecto es que anteriormente
inverta demasiado tiempo en un solo
curso pero en este ao que se dio la
oportunidad de llevar cursos pesados
con otro cruso mdeianamente fuertes
y he aprendido ser ms eficiente y a
organizar mejor mi tiempo,
estabelciendo horarios desde la hora
en que leveantaba hasta que me
acostaba y es verdadermente
sorpredente todo el tiempo que se
puede aprovechar si estabelces un
buen horario.
Terco cuando hago un trbajo en unvierad tnego
algunas ideas y trato simrpe de buxcarles
susutento y ahcerlas de determinada manera, sin
embargo comrpafno con otro compaleros me
ehfado cuenta que hay otras formas de lllgar al
mismso resultados
Fortalezas: I)perseverancia III) trabajr en eqeuipo
IV)coimprometido

* Cul es tu mayor logro en la vida?
Un gran logro en en mi exepriencai priogesional
que fue mas bien compratidio con un eqeuipod e
trbajo fue la obtencin dela buena proc ed un
proeycto comercia penitenciario.
Era un proeycto que se encargba de la
infraestrucutra epoenitneciaria, disei y
conctruccion de un nuevo penal para la ciduad de
lima a cambio de recibir el terrno del penal san
Jorge para la cosntruccion e implementacin de un
proecytocomercial compuesto pro galaerias,
vivienda estabelcimeinto comerciales)
Tanto el costo de la conturcion del neuvo penal y el
proecyo comecial era de 72 MMde doalres en un
palzo de ejcucion de 3 aos el costo del penal era
de 37 mm aproximiademente, .
Los beneficios del estado eran obtener un nuevo
totalemnte eqeuipo y con mayor segurairad,
renovaicon urbana en elc ecrdao delima,
contrubion a la formalizaion del cemrcio, y la
apmliaicond e vacante de reclusos
* Cmo hacer frente a la crtica, en el trabajo y en
la vida personal?
* Cmo hacer frente con o superar las fallas?
* Cree usted, hay un lder en ti?
* Qu tanto cree en el trabajo en equipo?
* Cul ha sido el mayor fracaso de su vida, hasta
hoy?
* Dnde te ves 5 a 10 aos por delante en su
carrera?
en tres aos haber temrniado e l prgoram del CFA
y en 5-7 aos haciendo un MBA en una buena
undiversidad de USA, continuar trbajndo en banca
d einversion.
* Por qu eligi la banca de inversin como una
opcin de carrera?
Me gusto porque
Por qu deberamos contratarte?
Porque en primeri lugar tengo enormas ganas de
aprender sobre finanzas inverisons y mecado d
ecapitales, adems porque creo que re
Me gusta citibank porque adems de ser un
empresa muntinaiconal y super concida en el
mundo de la finanzas por su calidad en la
consultoria financiera e inversiones, cme parece
que tiene un buen ambiente de trbajo que permite
un buen desarrollo profesional y personal. Tnego
amigos que practicaron enel citbank y me
comentan de uss beuenas experiencias en el
banco tanto porque predenitron bastante y porque
el ambienta laboral era bueno.
Deje mi enteorio trbajo porque sent que quera
trbajr en una mepresa mas grande y en una
entidad financeira con ello tener mayores retos y
aspiraicones de lnea de carrera.
Bootom- up Top D
Ambos of these approaches have the ssame goal to know s
statetegies to selecto companies in which to invest
-pasa por alto el la condiciones econmicos y sector -Involv
sino mas bien on selecting a stock base don the Look a
indidivual attirubutes of a Company. foreca
-This kind of investors simply seek strong genea
companies with good porospects regarldless(sin -Else i
iportar) of industry or macroenomic factors. indivu
Conversely(inversamente) chose
-That constitutes good prospects however is a to thei
mater of a opinion based: Ej: sup
-looking earnings growth be a d
-find companies with low Per ratios attractive. Using
-Based in these fundamentasl might
-as long as the companies are strong, the business buildin
cycle or industry conditions are of no concern. most f
chang
search
Comp
-
1. How do you value a
company?
I know two valuation
methodologies: Intrinsic value
(discounted cash flow valuation),
and Relative valuation
(comparables/multiples valuation).
Intrinsic value (DCF) The DCF says
that the value of a productive asset =
the present value of its cash flows.
The iunvement horizont could be for 5-
20 years, depending on the availabl
information, and then calculate a
 terminal value. It is necessary to
consider thath at the ende of the
projeccion period the company ahs a
terminal value or liquidation value of
assets.-->this can be uequal to
perpetuity of the last cash flows of the
proejeccion
Discount both the free cash flow
projections and terminal value by an
appropriate cost of capital (weighted
average cost of capital for
unlevered DCF and cost of equity
for levered DCF).
Unlever beta ahs to be asjuted for
financia leverage, becasude diffrente
comnay has tdiefrenc capital strucutres
and also the taxes rules are diffrefeen.
In an unlevered DCF (the more
common approach) this will yield the
companys enterprise value from which
we need to subtract net debt to arrive
at equity value. Divide equity value by
diluted shares outstanding to arrive at
equity value per share.
Relative valuation (Multiples):
he multiples approach is a valuation theory
based on the idea that similar assets sell at
similar prices. This assumes that a ratio
comparing value to some firm-specific variable
(operating margins, cash flow, etc.) is the
same across similar firms.
In other words, the theory is that when firms
are comparable, we can use the multiples
approach to determine the value of one firm
based on the value of another.
The second approach involves
determining a comparable group of
companies that are in the same
industry with similar operational,
growth, risk, and return on capital
characteristics. Truly identical
companies of course do not exist, but
you should attempt to find as close to
comparable companies as possible.
Calculate appropriate industry
multiples. Apply the median of
these multiples on the relevant
operating metric of the target
company to arrive at a valuation.
Common multiples are
EV/Reventreprice value to sales or
revnues, EV/EBITDA:enterprise
multiple, P/E, P/Book,price to FCF
although some industries place more
emphasis on some multiples vs. others,
while other industries use different
valuation multiples altogether. It is not
a bad idea to research an industry or
two (the easiest way is to read an
industry report by a sell-side analyst)
before the interview to anticipate a
follow-up question like tell me about a
particular industry you are interested
in and the valuation multiples
commonly used.
Comparable company analysis starts with
establishing a peer group consisting of similar
companies of similar size in the same industry
and region. Investors are then able to
compare a particular company to its
competitors on a relative basis. This
information can be used to determine a
company's enterprise value and to
calculate other ratios used to compare a
company to those in its peer group
-se relative comparisons allow the analyst to
develop an industry benchmark or average
Priece to FCF=Market capitalziaicon/FCF
If the company's valuation ratio is higher
than the peer average, the company is
overvalued
-If the company is lower than the peer
average, the company is undervalued.
Used together, intrinsic and relative
valuation models provide a ballpark
measure of valuation that can be used to
help analysts gauge the true value of a
company.
This valuation metric is calculated by
dividing a company's "enterprise value" by
its earnings before interest expense, taxes,
depreciation and amortization (EBITDA).
Overvalued undervalued
Enterpreise value
multiple=enterprise
value/EBITDA
2. What is the appropriate
discount rate to use in an
unlevered DCF analysis?
Since the free cash flows in an unlevered
DCF analysis are pre-debt is a ccompnay
cash flow before taking interest
payments into account.(think of
unlevered cash flows as the companys
cash flows as if it had no debt so no
interest expense, and no tax benefit
from that interest expense), the cost
of the cash flows relate to both the
lenders and the equity providers of
capital. Thus, the discount rate is the
weighted average cost of capital to
all providers of capital (both debt and
equity).
The cost of debt is readily observable
in the market as the yield on debt
with equivalent risk, while the cost
of equity is more difficult to estimate.
Cost of equity is typically estimated
using the capital asset pricing model
(CAPM), which links the expected return
of equity to its sensitivity to the overall
market (see WSPs DCF module for a
detailed analysis of calculating the cost
of equity).
3. What is typically higher the
cost of debt or the cost of
equity?
The cost of equity is higher than the
cost of debt because the cost
associated with borrowing debt
(interest expense) is tax deductible,
creating a tax shield. Additionally, the
cost of equity is typically higher because
unlike lenders, equity investors are
not guaranteed fixed payments, and
are last in line at liquidation.
4. How do you calculate the cost
of equity?
There are several competing models for
estimating the cost of equity, however,
the capital asset pricing model
(CAPM) is predominantly used on
the street. The CAPM links the
expected return of a security to its
sensitivity the overall market basket
(often proxied using the S&P 500). The
formula is: Cost of equity (re) = Risk free
rate (rf) + x Market risk premium (rm-rf
)
Risk free rate: The risk free rate should
theoretically reflect yield to maturity of the betas of comparable companies
a default-free government bonds of are distorted because of different
equivalent maturity to the duration of
each cash flows being discounted. In rates of leverage, we should unlever
practice, lack of liquidity in long term
bonds have made the current yield on 10- the betas of these comparable
year U.S. Treasury bonds as the preferred
proxy for the risk-free rate for US companies as such:
companies.
Market risk premium: The market risk Unlevered = (Levered) / [1+ (Debt/Equity)
premium (rm-rf) represents the (1-T)]
excess returns of investing in stocks
over the risk free rate. Practitioners
often use the historical excess returns
Then, once an average unlevered beta is
method, and compare historical spreads calculated, relever this beta at the target
between S&P 500 returns and the yield on
10 year treasury bonds. companys capital structure:
Beta (): Beta provides a method to
estimate the degree of an assets Levered = (Unlevered) x [1+(Debt/Equity)
systematic (non-diversifiable) risk. (1-T)]
Beta equals the covariance between
expected returns on the asset and on
the stock market, divided by the
variance of expected returns on the 6. How do you calculate
stock market. A company whose equity
has a beta of 1.0 is as risky as the unlevered free cash flows for
overall stock market and should therefore DCF analysis?
be expected to provide returns to investors
that rise and fall as fast as the stock
market. A company with an equity beta of Free cash flows = Operating profit
2.0 should see returns on its equity rise
twice as fast or drop twice as fast as the (EBIT) * (1 tax rate) + depreciation
overall market.
& amortization changes in net
working capital capital
5. How would you calculate beta expenditures
for a company?
Levered cash flows are also known
as equity cash flows, because it values just
Calculating raw betas from historical
the equity claim in the business. unlevered
returns and even projected betas is
cash flows are also known as firm cash
an imprecise measurement of future flows because it values the entire
beta because of estimation errors (i.e. enterprise.I am more accustomed to referring
them as equity or firm cash flows thus I will be
standard errors create a large
referring to them in that format for the
potential range for beta). As a
remainder of the article.
result, it is recommended that we
use an industry beta. Of course, since Equity cash flows are considered as cash
flows after debt payments and after
making reinvestments needed for future
growth. The discount rate used for these cash
flows when preparing a DCF model is the
cost of equity.
Free Cash Flow to Equity = Net Income -
CapEx + Depreciation - Change in Non-
Cash Working Capital +(New Debt Issues -
Debt Payments)
7. What is the appropriate
numerator for a revenue
multiple?
The answer is enterprise value.
Equity value = Enterprise value Net
Debt (where net debt = gross debt

Firm cash flows are prior to any debt and debt equivalents excess
payments but after the firm has cash). For more on this equation see
reinvested earnings to grow its assets. WSPs article
The discount rate used for these cash flows
at www.wallstreetprep.com/blog/.
reflects the cost of equity and debt, also known
as the weighted average cost of capital
EBIT, EBITDA, unlevered cash flow, and
(WACC).
revenue multiples all have enterprise
Free Cash Flow to Firm = EBIT*(1-tax rate) value as the numerator because the
- CapEx +(Depreciation + Amortization) -
denominator is an unlevered (pre-
Change in Non-Cash Working Capital
debt) measure of profitability.
In a DCF model the present value of equity Conversely, EPS, after-tax cash flows, and
cash flows reflects only the value of equity
book value of equity all have equity value
claims on the firm where as firm cash flows
as the numerator because the
reflect the value of all claims on the firm.
denominator is levered or post-debt.
How to Convert from Firm to Equity Cash
Flows 8. How would you value a
company with negative historical
This calculation is very simple. To get from firm
cash flow?
value to equity value simply subtract out the
market value of all debt and all other non-
Given that negative profitability will
equity claims in the firm.
make most multiples analyses
Present Value of Debt - Market Value of
meaningless, a DCF valuation
Debt = Present Value of Equity
approach is appropriate here.
9. When should you value a
company using a revenue
multiple vs. EBITDA?
Companies with negative profizts and
EBITDA will have meaningless
EBITDA multiples. As a result, Revenue
multiples are more insightful.
10. Two companies are identical
in earnings, growth prospects,
leverage, returns on capital, and
risk. Company A is trading at a
15 P/E multiple, while the other
trades at 10 P/E. which would
you prefer as an investment?
10 P/E: A rational investor would
rather pay less per unit of ownership
The DCF says that the value of a productive
asset equals the present value of its cash
flows. And the.
Levered cash flows are also known as equity
cash flows, because it values just the equity
claim in the business. On the other hand,
unlevered cash flows are also known as firm
cash flows because it values the entire
enterprise.I am more accustomed to referring
them as equity or firm cash flows thus I will be
referring to them in that format for the
remainder of the article.
Equity cash flows are considered as cash flows
after debt payments and after making
reinvestments needed for future growth. The
discount rate used for these cash flows when
preparing a DCF model is the cost of equity
Free Cash Flow to Equity = Net Income -
CapEx + Depreciation - Change in Non-
Cash Working Capital +(New Debt Issues -
Debt Payments)
Firm cash flows are prior to any debt payments
but after the firm has reinvested earnings to
grow its assets. The discount rate used for
these cash flows reflects the cost of equity and
debt, also known as the weighted average cost
of capital (WACC).
Free Cash Flow to Firm = EBIT*(1-tax rate)
- CapEx +(Depreciation + Amortization) -
Change in Non-Cash Working Capital
In a DCF model the present value of equity
cash flows reflects only the value of equity
claims on the firm where as firm cash flows
reflect the value of all claims on the firm.
How to Convert from Firm to Equity Cash
Flows
This calculation is very simple. To get from firm
value to equity value simply subtract out the
market value of all debt and all other non-
equity claims in the firm.
Present Value of Debt - Market Value of Debt =
Present Value of Equity
Poltica de dviiendnos:
4 practicas:
-reparto de diveindndos en efectivo
-Reparto en acciones: Por cada accin que
tien un accionesta recibir una fraccin de
accin.(acciones liberadas:por cada 4
acciones recibe una accin) en acciones
-recompra d acciones: puede indicar que la
accin esta depreciada.
3 frmas de die vesittures: plata para pagar dividendos por que
proemdio pagara dividiendos o cierto monto
-stock plit: par aumentar la liquidez de de divindos.
acciones es una particin accionario, la
cpaitlaizicon burstil no cmabia. Didinde yield = diiv/pricerd
100*10=1000 Retention ratios: = 1-divi/NI=1-d
200*5=1000 Cada empresa debe deicsdir su polticia de
dividndedos particular
-es la venta de una unidad e negocio peude
srr una porcin minoriata o mayoriatariiia.
I es minoriataria es un equity carve-out:
venders una propocion unitaria de negocio
pero sigues con la psocion mayoriataria
Spin out_: te quedas con una psoicon
minoritaria y vendeas la mayoriataria son
ventas de unida de negocio
Le das la opcin al que comrpa las acciones
que intercambia unas acciones con la
accines de la empresa que vendekk IFRS USGAAP
Cato mas capital concentrado tenia la The standards that govern
compia menso posibilidad tenia la finantial reporting and
compaa. accounting vary from cpuntry
to country.
4 pregntas sobre poltica de dividendosa In the USA finantial rrproting
1)deben ser altos o bajos: practicaes ar set forth by the
Finanical acounting standard
2)estables o irregulares: board(FASB). And organizaed
wothin the framework of the
3])detemrino la frecuencia: de anunciar la
generally accpeted acounting
politia la merado o no: es buena noticia par
prinicple or GAAP.
los accionistas: entonces la accin sube. Deb
cumplir sino riesgo de discrcion. Si cmabias
Both has differencesin details
la opcionde a promesa la ccion cae.
and interpretations.
The emeotdology is the
rpimary deifencen between
4)debera ser anunciada la polticia: the 2 systems.:
Para una empresa epequea que reparte -
dividendos es mala noticeia porque not ien
proeeycts rentbales en lugar de repartir
dividendos.
Is las mepresas tienen mas ebenficios van a
comrpara acciones, si el rpecio no cmabia y
la mepresa tiene mas ebenficios la empresa
esta subvaluada.
Rarios importantes del pago de diviendos:
Didinden pay put= dididnedos/NI, cuando se
paga ams del 100% de dividndos pay out:
para mantenr el rpeico de la accin.se presta
The -inventry costs: IFRS Comprehensive
accoun GAAP is rules based. guideli
Income
ting -GAAPS rules allow nes
standa for LIFO(UEPS), provid Comprehensive
rd FIFO(PEPS) and the e income is used to
used in Weighted average much measure the change
more cost method(WACM) less
tan GAAP doesno allow overall in an owner's interest
110 fro inventary detail in a business. This is
cpuntri reversals, while IFRS tan done by charting the
es. permits tthem under GAAP
change in a
-is centain conditions. So the
more -GAAP requires theoriti company's net
princi financial statments cal assets from
ples to include a frame
nonowner sources,
based statment of work
accou comphensive an including all income
nting income. dprinci and expenses that
stand ple of usually bypass
ard. The diferenc the
-it between IFRS the income
rprese comprenhension leave statement because
nts cincome and other mre they have not
and comprehensive room
yet been realized.
captur income. for the
es the In financial intepre Comprehensive
eocmic accounting income is tation income is normally
s of a brken down in a and listed in a separate
trnsan multitud of ways may
citon ,and firmas have often statement than
better. som latitud on when require income, which does
-It s to recognize an length include changes in
comm drprot their earnings. y
owner equity.
on disclos
global -to compensate for ures Comprehensive
langua this, the Finantial onf income is calculated
ge for accounting finanti
by=net income + the
compn standars al
ay board(FASB) has statme sum of recognized
accoun firms collect and nts. revenues - the sum
ting report indromation - it is of recognized
affaird that helps to conisst
-SEC provide nen expenses, +other
has perspective for and comprehensive
expres investors and intuitu income.
sed a analysist. eve
Comprehensive
desire 2 such prinicp
to measumenret are les ar income:
swich comphensive income more It is a part of the
rom and other logicall owners equity section
GAAP comphensive y
to income. soudn of the balance
IFRS. and sheet(assets, liabilities
may owner equity notes:4 The finantial
posible I)Intn
sections). stamtment notes
better gibles
repres It represets the : invlving the eqeuity
ent the changes to owners section will detail the
ocnmic equity that occur II)Inve varior changes to
s of ntory
busine during an accunting costs: owners equity fro the
ss period thath com the period. In the notes , a
trnsac from= non owner most compny will typically
ctions. notabl
soruces, + the income explain the changes to
e
-IFRS fromo more traitional deiffer owners that resulted
does means sucha as net ence rom the ordinay coruse
nit beteee
operating income. of businees. It will also
consid n
ere There are 4 spruces of GAAP dtail the changes that
cimpe non-owner changes to and result romo non.owner
hensv owner eqeuity. They IFRS soruces.
e invlves
incom are: their
The sum of thes two
e to 1)adjustments to invent amounts is
be a markeatble securities ary. comprehnsive income
major Tratme The accountinf
the compnay holds for
ellem nts. treatment of
nt of sale IFRS
comphensive income is
perfor 2)foreign cucrrency rules
established in the
manc trnasction ban
e and the statment of fianncial
there adjustments, use of accounting standars
ore 3)adjustment to a last in,N130,according to this
dens reequired minmum first any income is
inlcud outLI comphensive if it
pension liability
e it.. FO(UE changes the equity of a
-this 4)value changes in PS) but business Enterprise
leaves future contract thar are allows wthou involving an
somo hedged pistions. the owner investment or
room FIFO creating a dsitribution
for Income from these first into an owner
mixim non-owner soruces and
-ex:any held investment
g results in an incresae first
classified as avaliable
owner out(PE
in teh value of the for sale wihc s is
and PS)
nowne compnay nomal line And nonderivative asset
r of business , the WACM not intended to be held
actviit until maturity and is
FASB considers it
y III)Wri not a loan or recivable,
within inappropiate to te can crate recognizable
the include this tupe of downs comprehensive income.
inanci income in the Any change in the value
al of the avaliable for sale
stamt
tradiction income
asset can be included.
ments stamtment
-foreigns currency
trnasactosn can crate to owners.
gains ir losses if the bal
ce of a compnay
currency holdings
fluctuates which they
often do.. this is special
fro large compnies with
delaings in many
different currencies.
Pension plans can slso
crate comphensive
income if the value of
the epnsion plan
increase.
Comprehensive
ncome (or earnings) is of net income, yet are
a specific term used in
companies' financial
reporting from the
company-whole point of
view. Because that use
excludes the effects of
changing ownership
interest, an economic
measure of
comprehensive income
is necessary for financial
analysis from the
shareholders' point of
view (All changes in
Equity except those
resulting from investment
by or distribution to
owners.)
Comprehensive income
is defined by
the Financial Accounting
Standards Board, or
FASB,[1] as the change a business. It is
in equity [net assets] of a
business enterprise
during a period from
transactions and other
events and
circumstances from non-
owner sources. It
includes all changes in
equity during a period
except those resulting
from investments by
owners and distributions
Comprehensive income
is the sum of net
income and other items
that must bypass
the income
statement because they
have not been realized,
including items like an
unrealized holding
gain or loss
from available for
sale securities and
foreign currency translati
on gains or losses.
These items are not part
important enough to be
included in
comprehensive income,
giving the user a bigger,
more comprehensive
picture of the
organization as a whole.
Items included in
comprehensive income,
but not net income are
reported under
the accumulated other
comprehensive
income section
of shareholder's equity.
Comprehensive income
attempts to measure the
sum total of all operating
and financial events that
have changed the value
of an owner's interest in
measured on a per-share
basis to capture the
effects of dilution and
options. It cancels out
the effects of equity
transactions for which
the owner would be
indifferent; dividend
payments, share buy-
backs and share issues
at market value.
It is calculated by
reconciling the book
value per-share from the special item as other
start of the period to the comprehensive
end of the period. This is income. It is commonly
conceptually the same referred to as FAS130.
as measuring a child's
growth by finding the Comprehensive
difference between his income is the total non-
height on each owner change in equity
birthday. All other line for a reporting period.
items are calculated, and
the equation solved for This change
comprehensive earnings encompasses all
changes in equity other
than transactions from
Shareholders' Equity, owners and
beg. of period (per distributions to
share) owners. Most of these
changes appear in the
- Dividends paid (per
income statement.
share)
+ Shares A few special types of
issued (premium gains and losses are not
over book value shown in the income
statement but as special
per share)
items in shareholder
- Share buy- equity section of the
backs (premium balance sheet.
over book value Since these
per share) comprehensive income
+ items are not closed to
Comprehensive retained earnings each
period they accumulate
Income (per share)
as shareholder equity
items and thus are
------------------ entitled Accumulated
------------------ Other Comprehensive
Income and is
------
sometimes referred to as
= "AOCI".
Shareholders'
Equity, end of Accumulated other
period (per share) comprehensive
income is a subsection
in equity where "other
comprehensive income"
is accumulated (summed
It is a reporting or "aggregated").
comphensive income.
This statement required The balance of AOCI is
all income presented in the Equity
statement items to be section of the Balance
reported either as a Sheet as is the Retained
regular item in the Earnings balance, which
income statement or a aggregates past and
current Earnings, and losses resulting
past and current from translating
Dividends. the financial
statements of
Other foreign
subsidiaries
comprehensive
(from foreign
income[edit] currency to the
presentation
Other comprehensive currency) [IAS
income is the difference 21/ "FAS 52" -
between net income as "Foreign
in the Income Currency
Statement (Profit or Loss Translation"],
Account)
and comprehensive 4 Actuarial gains
income, and represents and losses on
the certain gains and defined benefit
losses of plans recognized
the enterprise not (Minimum pensi
recognized in the P&L on liability
Account. It is commonly adjustments)
referred to as "OCI". [IAS 19/ "FAS
158" -
In practice, it comprises "Employers'
the following items: Accounting For
Defined Benefit
1 Unrealized gains Pension And
and losses Other
on available for Postretirement
sale securities [I Plans"]
AS 39/ "FAS
115" - 5 Changes in
"Accounting for the revaluation s
Certain urplus [IAS 16
Investments in and IAS 38]
Debt and Equity
Securities"] While the AOCI balance
is presented in Equity
2 Gains and section of the balance
losses sheet, the annual
on derivatives he accounting entries, as
ld as cash flow flows, are presented
hedges (only for sometimes in
effective a Statement of
portions) [IAS Comprehensive Income.
39/ "FAS 133" -
"Accounting for This statement expands
Derivative the traditional Income
Instruments and Statement beyond
Hedging Earnings to include OCI
Activities"] in order to present
Comprehensive Income.
3 Gains and

Under the revised IAS 1,
all non-owner changes in
equity (comprehensive
income) must be
presented either in one
Statement of
comprehensive income
or in two statements (a
separate income
statement and a
statement of
comprehensive income)
In the third quarter of
2008 the United States
Securities and Exchange
Commission received
several proposals to
allow the recognition in
AOCI of certain fair value
changes on financial
instruments. This
proposal was initially well
received by
representatives of the
banking community who
felt that Earnings
recognition of these fair
value changes during the
concurrent "credit
meltdown of 2008" would
be inappropriate. The
effect of this proposal, on
balance, would be to
remove sizeable losses
from Earnings and thus
Retained Earnings of
banks, and assist them
in preserving their
regulatory capital. The
regulatory capital of
banks in the US and
generally worldwide
includes contributed
equity capital and
retained earnings but
excludes AOCI, even
though it is reported as a
component of the Equity
section of the Balance
Sheet.
Other
Comprehensive
Income
Aaccount like
revenues, epenser
gains an dlooses that
haven no yet
relaized(not sold)
Ej: a prtofoilio of
bondsa hath has not
been sold. Gains and
losses from changng
value of the bonds
cannot be realized
until they are sold. So
the intemrim adjsutment
are recognized in other
comprehnesive income.
Other comprehensive
income is a catch-all
for all of the items
that cannot be
included in typical
profit and loss
calculations.
Examples of the types
of changes captured
by other
comprehensive income
include:
Gains and
losses
from derivativ
e instruments
Debt
security unreal
ized gains and
losses
Pension or
other
retirement
plan gains and
 clearer view.
losses

Foreign the differences

currency between Difference
between Net
transaction adj Income,
ustments Comprehensive
Income and Other
Comprehensive
Available-for-
Income.
sale securities
unrealized Net income =
Companys
gains and
earnings after
losses taxation whereby
earnings before
These items occur taxation is
difference between
rather infrequently total revenues and
for smaller total expenses
businesses, so other during period
(fiscal year)
comprehensive
Accounting
income is most
statements set is
important for valuing concerned by basic
larger corporations. accounting reports
such as balance
Watching the
sheet and profit and
unrealized loss or income
performance of a statement.
firm's investment Net income of the
portfolio can reveal year is part of P/L
statement but
the possibility of finally also appears
major losses down in BS in equity
position (equity
the road. You can see
position is part of
how overseas BS not PL).
operations and Other
currency hedging comprehensive
affects corporate income is
GAAP (both
performance. USGAAP and IFRS)
Comprehensive equity extension
income and other for changes on
equity which
comprehensive bypass(obvia)PL
income help bring and thus such
transactions are
complicated financial
not concerned in
reporting into a net income of the
year. Eg. actuarial
gains and losses, basic financial
revaluation surplus statements.
account, net
exchange
differences from The statement explains
investments to the changes in a
foreign subsidiary, company's Share
etc. Capital, accumulated
reserves and retained
Total
earnings over the
comprehensive
reporting period. It break
income or just
down changes in the
comprehensive
owners' interest in the
income=sum of net organization, and in the
income of the year application of retained
(through P/L)+ profit or surplus from
other one accounting period to
comprehensive the next. Line items
income. typically include profits or
The intention of losses from
standard bodies operations, dividends pai
while implementing d, issue or redemption of
other (total) shares, revaluation
comprehensive reserve and any other
income to set of items charged or
mandatory report credited to accumulated
statements was other comprehensive
higher income. In also includes
transparency and the Non-Controlling
reducing misreporti Interest attribuable to
ng issues. other individuals and
organisations.

Statement The statement is

expected under
of changes the generally accepted
in equity accounting
principles and explain
A Statement of the owners' equity shown
changes in equity and on the balance sheet,
similarly the statement where:
of changes in owner's
equity for a sole owners' equity = assets
trader, statement of liabilities
changes in partners'
equity for
a partnership, statement Requirements of
of changes in the U.S.
Shareholders' GAAP[edit]
equity for
In the United States this
a Company or statemen
is called a statement of
t of changes in
retained earnings and it
Taxpayers'
is required under the
equity[1] for Government
U.S. Generally Accepted
financial statements is
Accounting
one of the four
Principles (U.S. GAAP) Net Income
whenever comparative
balance sheets and This equation is
income statements are necessary to use to find
presented. It may appear the Profit Before Tax to
in the balance sheet, in a use in the Cash Flow
combined income Statement under
statement and changes Operating Activities when
in retained earnings using the indirect
statement, or as a method. This is used
separate Schedule whenever a
comprehensive income
statement is not given
Therefore, the statement but only the balance
of retained earnings uses sheet is given
information from
the income Requirements of
statement and provides
IFRS[edit]
information to
the balance sheet.
IAS 1 requires a
Retained earnings are business entity to
part of the balance present a separate
sheet (another basic statement of changes in
financial statement) equity (SOCE) as one of
under "stockholders the components of
equity (shareholders' financial statements.
equity)" and is mostly
affected by net income The statement shall
earned during a period of show: (IAS1.106)
time by the company
less any dividends paid 1 total
to the company's owners comprehensive
/ stockholders. The income for the
retained earnings period, showing
account on the balance separately
sheet is said to represent amounts
an "accumulation of attributable to
earnings" since net owners of
profits and losses are the parent and
added/subtracted from to non-
the account from period controlling
to period. interests

Retained Earnings are 2 the effects of

part of the "Statement of retrospective
Changes in Equity". The application,
general equation can be when applicable,
expressed as following: for each
component
Ending Retained
Earnings 3 reconciliations
= Beginning Reta between the
ined Earnings carrying
Dividends Paid + amounts at
the beginning an
 d the end of the equity should show all
period for each changes in equity
component including:
of equity,
separately total comprehensive
disclosing: income

profit or loss owners' investments

each item dividends

of other
comprehensi owners' withdrawals
ve income
of capital

transactions
treasury share
with owners,
transactions
showing
They can omit the
separately
statement of changes in
contributions
equity if the entity has no
by and
owner investments or
distributions
withdrawals other than
to owners an
dividends, and elects to
d changes in
present a combined
ownership
statement of
interests in
comprehensive income
subsidiaries
and retained earnings.
that do not
result in a
loss of -inventry costs: GAAP is rules
control based.
-GAAPS rules allow for
LIFO(UEPS), FIFO(PEPS) and
However, the amount of
the Weighted average cost
dividends recognised as
method(WACM)
distributions, and the
GAAP doesno allow fro
related amount per
inventary reversals, while
share, may be presented
IFRS permits tthem under
in the notes instead of
centain conditions.
presenting in the
-GAAP requires financial
statement of changes in
statments to include a
equity.
statment of comphensive
income.
However, the amount of
dividends recognised as
The diferenc between
distributions, and the
comprenhension cincome
related amount per
and other comprehensive
share, may be presented
income.
in the notes instead of
In financial accounting
presenting in the
income is brken down in a
statement of changes in
multitud of ways ,and firmas
equity. (IAS1.107)
have som latitud on when to
recognize an drprot their
For small and medium earnings.
enterprises (SMEs), the
statement of changes in
-to compensate for this, the
Finantial accounting
standars board(FASB) has
firms collect and report
indromation that helps to
provide perspective for
investors and analysist.
2 such measumenret
comphensive income and
other comphensive income.
Comprehensive Income
more traitional means sucha as
net operating income.
There are 4 spruces of non-
owner changes to owner
eqeuity. They are:
1)adjustments to markeatble
securities the compnay holds for
sale

Comprehensive income is used 2)foreign cucrrency trnasction

to measure the change in an adjustments,

owner's interest in a 3)adjustment to a reequired

minmum pension liability
business. This is done by
4)value changes in future
charting the change in a
contract thar are hedged
company's net assets from
pistions.
nonowner sources, including
Income from these non-owner
all income and expenses that
soruces results in an incresae
usually bypass the income
in teh value of the compnay
statement because they have
nomal line of business
not yet been realized.
FASB considers it inappropiate
Comprehensive income is
to include this tupe of income
normally listed in a separate
in the tradiction income
statement than income, which
stamtment
does include changes in
The finantial stamtment notes
owner equity. Comprehensive
invlving the eqeuity section will
income is calculated by=
detail the varior changes to
income + the sum of
owners equity fro the period.
recognized revenues - the
In the notes , a compny will
sum of recognized expenses
typically explain the changes to
+other comprehensive
owners that resulted rom the
income.
ordinay coruse of businees. It
Comprehensive income:
will also dtail the changes that
It is a part of the owners equity
result romo non.owner soruces.
section of the balance
The sum of thes two amounts is
sheet(assets, liabilities owner
comprehnsive income
equity notes:4 sections).
The accountinf treatment of
It represets the changes to
comphensive income is
owners equity that occur established in the statment of
during an accunting period fianncial accounting standars
thath com from= non owner N130,according to this any
income is comphensive if it
soruces, + the income fromo
changes the equity of a business
Enterprise wthou involving an
owner investment or creating a
dsitribution to an owner
-ex:any held investment classified
as avaliable for sale wihc s is
nonderivative asset not intended
to be held until maturity and is
not a loan or recivable, c
crate recognizable
comprehensive income. Any
change in the value of the
avaliable for sale asset can be
included.
-foreigns currency trnasactosn can
crate gains ir losses if the bal ce
of a compnay currency holdings
fluctuates which they often do..
this is special fro large compnies
with delaings in many different
currencies. Pension plans can slso
crate comphensive income if the
value of the epnsion plan increase.
Comprehensive
ncome (or earnings) is a specific
term used in companies' financial
reporting from the company-whole
point of view. Because that use
excludes the effects of changing
ownership interest, an economic
measure of comprehensive income
is necessary for financial analysis
from the shareholders' point of view
(All changes in Equity except those
resulting from investment by or
distribution to owners.)
Comprehensive income is defined
by the Financial Accounting
Standards Board, or FASB,
the change in equity [net assets] of
a business enterprise during a
period from transactions and other
events and circumstances from
non-owner sources. It includes all
changes in equity during a period
except those resulting from
investments by owners and
distributions to owners.
Comprehensive income is the sum
of net income and other items that
must bypass the income
statement because they have not
been realized, including items like
an unrealized holding gain
from available for
sale securities and
foreign currency translation gains
or losses. These items are not part
of net income, yet are important
enough to be included in
comprehensive income, giving the
user a bigger, more comprehensive
picture of the organization as a
whole.
Items included in comprehensive
income, but not net income
reported under the accumulated
other comprehensive
income section of shareholder's
equity.
Comprehensive income attempts to
measure the sum total of all
operating and financial events that
have changed the value of an
owner's interest in a business. It is
measured on a per-share basis to
capture the effects of dilution and
options. It cancels out the effects of
equity transactions for which the
owner would be indifferent;
dividend payments, share buy-
backs and share issues at market
value.
It is calculated by reconciling the
book value per-share from the start
of the period to the end of the
period. This is conceptually the
same as measuring a child's growth
by finding the difference between
his height on each birthday.
other line items are calculated, and
the equation solved for
comprehensive earnings
Shareholders' Equity, beg. of period
(per share)
- Dividends paid (per share)
+ Shares issued
(premium over book value
per share)
- Share buy-backs
(premium over book value
per share)
+ Comprehensive Income
(per share)
--------------------------
----------------
= Shareholders'
Equity, end of period (per
share)
It is a reporting comphensive
income. This statement required
all income statement items to be
reported either as a regular item
in the income statement or
special item as other
comprehensive income.
commonly referred to as FAS130.
Comprehensive income is the total
non-owner change in equity for a
reporting period.
This change encompasses all
changes in equity other than
transactions from owners and
distributions to owners. Most of
these changes appear in the
income statement.
A few special types of gains and
losses are not shown in the income
statement but as special items in
shareholder equity section of the
balance sheet.
Since these comprehensive income
items are not closed to retained
earnings each period they
accumulate as shareholder equity
items and thus are entitled
Accumulated Other
Comprehensive Income and is
sometimes referred to as "AOCI".
Accumulated other
comprehensive income
subsection in equity where "other
comprehensive income" is
accumulated (summed or
"aggregated").
The balance of AOCI is presented
in the Equity section of the Balance
Sheet as is the Retained Earnings
balance, which aggregates past
and current Earnings, and past and
current Dividends.
Other comprehensive
income[edit]
Other comprehensive income
difference between net income
in the Income Statement (Profit or
Loss Account) and comprehensive
income, and represents the certain
gains and losses of
the enterprise not recognized in the
P&L Account. It is commonly
referred to as "OCI".
In practice, it comprises the
following items:
6 Unrealized gains and
losses on available for
sale securities [IAS
39/ "FAS 115" -
"Accounting for Certain
Investments in Debt and
Equity Securities"
7 Gains and losses
on derivatives held as
flow hedges (only for
effective portions) [IAS
39/ "FAS 133" -
"Accounting for Derivative
Instruments and Hedging
Activities"]
8 Gains and losses resulting
from translating the
financial statements of
foreign subsidiaries (from
foreign currency to the
presentation currency) [IAS
21/ "FAS 52" - "Foreign
Currency Translation"
9 Actuarial gains and losses
on defined benefit plans
recognized
(Minimum pension
 adjustments) [IAS 19/
158" - "Employers'
Accounting For Defined
Benefit Pension And Other
Postretirement Plans"
10 Changes in
the revaluation surplus
[IAS 16 and IAS 38]
While the AOCI balance is
presented in Equity section of
the balance sheet, the annual
accounting entries, as flows, are
presented sometimes in
a Statement of Comprehensive
Income.
This statement expands the
traditional Income
Statement beyond Earnings to
include OCI in order to present
Comprehensive Income.
Under the revised IAS 1, all non-
owner changes in equity
(comprehensive income) must be
presented either in one Statement
of comprehensive income or in two
statements (a separate income
statement and a statement of
comprehensive income)
In the third quarter of 2008 the
United States Securities and
Exchange Commission received
several proposals to allow the
recognition in AOCI of certain fair
value changes on financial
instruments. This proposal was
initially well received by
representatives of the banking
community who felt that Earnings
recognition of these fair value
changes during the concurrent
"credit meltdown of 2008" would be
inappropriate. The effect of this
proposal, on balance, would be to
remove sizeable losses from
Earnings and thus Retained
Earnings of banks, and assist them
in preserving their regulatory
capital. The regulatory capital of
banks in the US and generally
worldwide includes contributed
equity capital and retained earnings
but excludes AOCI, even though it
is reported as a component of the
Equity section of the Balance
Sheet.
Other Comprehensive Income
Aaccount like revenues,
epenser gains an dlooses that
haven no yet relaized(not
sold)
Ej: a prtofoilio of bondsa hath has
not been sold. Gains and losses
from changng value of the bonds
cannot be realized until they are
sold. So the intemrim adjsutment
are recognized in other
comprehnesive income.
Other comprehensive income
is a catch-all for all of the
items that cannot be included
in typical profit and loss
calculations. Examples of the
types of changes captured by
other comprehensive income
include:
Gains and losses
from derivative
instruments
Debt
security unrealized
gains and losses
Pension or other
retirement plan gains
and losses
Foreign currency
transaction adjustment
s
Available-for-sale

securities unrealized
gains and losses
These items occur rather
infrequently for smaller
businesses, so other
comprehensive income is most
important for valuing larger
corporations. Watching the
unrealized performance of a
firm's investment portfolio
reveal the possibility of major
losses down the road. You can
see how overseas operations
and currency hedging affects
corporate performance.
Comprehensive income and
other comprehensive income
help bring complicated
financial reporting into a
clearer view.
the differences
between Difference
between Net Income,
Comprehensive Income and
Other Comprehensive
Income.
Net income = Companys
earnings after taxation
whereby earnings before
taxation is difference
between total revenues
total expenses during
period (fiscal year)
Accounting statements set
is concerned by basic
accounting reports such
balance sheet and profit and
loss or income statement.
Net income of the year is part
of P/L statement but finally
also appears in BS in equity
position (equity position is
part of BS not PL).
Other comprehensive
income is GAAP (both
USGAAP and IFRS) equity
extension for changes on
equity which
bypass(obvia)PL and thus
such transactions are not
concerned in net income of
the year. Eg. actuarial gains
and losses, revaluation
surplus account, net
exchange differences from
investments to foreign
subsidiary, etc.
Total comprehensive
income or just
comprehensive
income=sum of net income
of the year (through P/L)+
other comprehensive
income.
The intention of standard
bodies while implementing
other (total)
comprehensive income
set of mandatory report
statements was higher
transparency and
reducing misreporting
issues.
Statement of
changes in equity
A Statement of changes in
equity and similarly the statement
of changes in owner's equity
a sole trader, statement of
changes in partners' equity
a partnership, statement of
changes in Shareholders'
equity for
a Company or statement of
changes in Taxpayers'
equity[1] for Government financial
statements is one of the four
basic financial statements
The statement explains the
changes in a company's Share
Capital, accumulated
reserves and retained
earnings over the reporting period.
It break down changes in the
owners' interest in the organization,
and in the application of retained
profit or surplus from
one accounting period to the next.
Line items typically include profits
or losses from
operations, dividends paid, issue or
redemption of shares, revaluation
reserve and any other items
charged or credited to accumulated
other comprehensive income
also includes the Non-Controlling
Interest attribuable to other
individuals and organisations.
The statement is expected under
the generally accepted accounting
principles and explain the
equity shown on the balance sheet
where:
owners' equity = assets liabilities
Requirements of the
U.S. GAAP[edit]
In the United States this is called
a statement of retained
earnings and it is required under
the U.S. Generally Accepted
Accounting Principles (U.S. GAAP)
whenever comparative balance
sheets and income statements are
presented. It may appear in
the balance sheet, in a
combined income statement
changes in retained earnings
statement, or as a separate
Schedule
Therefore, the statement of
retained earnings uses information
from the income statement
provides information to the
sheet.
Retained earnings are part of
the balance sheet (another basic
financial statement) under
"stockholders equity (shareholders'
equity)" and is mostly affected by
net income earned during a period
of time by the company less any
dividends paid to the company's
owners / stockholders. The retained
earnings account on the balance
sheet is said to represent an
"accumulation of earnings" since
net profits and losses are
added/subtracted from the account
from period to period.
Retained Earnings are part of the
"Statement of Changes in Equity".
The general equation can be
expressed as following:
Ending Retained Earnings
= Beginning Retained
Earnings Dividends Paid
+ Net Income
This equation is necessary to use
to find the Profit Before Tax to use
in the Cash Flow Statement under
Operating Activities when using the
indirect method. This is used
whenever a comprehensive income
statement is not given but only the
balance sheet is given
Requirements of
IFRS[edit]
IAS 1 requires a business entity to
present a separate statement of
changes in equity (SOCE) as one
of the components of financial
statements.
The statement shall show:
(IAS1.106)
4 total comprehensive
income for the period,
showing separately
amounts attributable to
owners of the parent
to non-controlling interests
5 the effects of retrospective
application, when
applicable, for each
component
6 reconciliations between
the carrying amounts at
 the beginning and
the end of the period for
each component of
separately disclosing:
profit or loss
each item of other
comprehensive income
transactions with
owners, showing
separately contributions
by and distributions
to owners and changes
in ownership interests
in subsidiaries that
not result in a loss of
control
However, the amount of dividends
recognised as distributions, and the
related amount per share,
presented in the notes instead of
presenting in the statement of
changes in equity.
However, the amount of dividends
recognised as distributions, and the
related amount per share,
presented in the notes instead of
presenting in the statement of
changes in equity. (IAS1.107)
For small and medium
enterprises (SMEs), the statement
of changes in equity should show
all changes in equity including:
total comprehensive income
owners' investments
dividends
owners' withdrawals of capital
treasury share transactions
They can omit the statement of
changes in equity if the entity has
no owner investments or
withdrawals other than dividends,
and elects to present a combined
statement of comprehensive
income and retained earnings.
Income
statement
An income statement or
and loss account [1] (also referred
to as a profit and loss
statement (P&L), statement of
profit or loss, revenue
statement, statement of financial
performance, earnings
statement, operating statement
or statement of operations
is one of the financial
statements of a company and
shows the
companys revenues and
during a particular period.
It indicates how the revenues
(money received from the sale of
products and services before
expenses are taken out, also
known as the top line) are
transformed into the net
income (the result after all
revenues and expenses have been
accounted for, also known as net
profit or the bottom line). It
displays the revenues recognized
for a specific period, and
the cost and expenses charged
against these revenues,
including write-offs (e.g., depreciati
on and amortization of
various assets) and taxes
purpose of the income statement is
to
show managers and investors
her the company made or lost
money during the period being
reported.
One important thing to remember
about an income statement is that it
represents a period of time like
the cash flow statement. This
contrasts with the balance sheet
which represents a single moment
in time.
The income statement can be
prepared in one of two methods
[3]
The Single Step income
statement takes the simpler
approach, totaling revenues and
subtracting expenses to
bottom line. The more complex
Multi-Step income statement
takes several steps to find the
bottom line, starting with the
profit. It then calculates
expenses and, when deducted
from the gross profit, yields
income from operations. Adding to
income from operations is the
difference of other revenues and
other expenses. When combined
with income from operations,
this yields income before taxes
The final step is to deduct taxes,
which finally produces the net
income for the period measured
Usefulness and
limitations of income
statement[edit]
Income statements should help
investors and creditors
determine the past financial
performance of the enterpris
predict future performance, and
assess the capability of
generating future cash flows
through report of the income and
expenses.
However, information of an income
statement has several limitations:
Items that might be relevant
but cannot be reliably
measured are not reported
(e.g., brand recognition and
loyalty).
Some numbers depend on
accounting methods used
(e.g., using FIFO or LIFO
accounting to
measure inventory level).
Some numbers depend on
judgments and estimates
(e.g., depreciation expense
depends on estimated useful
life and salvage value).
Guidelines for statements of
comprehensive income and
income statements of business
entities are formulated by
the International Accounting
(IASB)Standards Board
numerous country-specific
organizations, for example
the FASB in the U.S..
Names and usage of different
accounts in the income statement
depend on the type of
organization, industry practices
and the requirements of different
jurisdictions.
If applicable to the business,
summary values for the following
items should be included in the
income statement:[4]
Operating section[edit
Revenue - Cash inflows or
other enhancements of
assets (including accounts
receivable) of an entity during
a period from delivering or
producing goods, rendering
services, or other activities that
constitute the entity's ongoing
major operations. It is
presented as sales - sales
discounts, returns, and
allowances. Every time a
business sells a product or
performs a service, it obtains
revenue. This often is referred
to as gross revenue or sales
revenue.[5]
Expenses - Cash outflows or
other using-up of assets or
incurrence of liabilities
(including accounts payable
during a period from delivering
or producing goods, rendering
services, or carrying out other
activities that constitute the
entity's ongoing major
operations.
Cost of Goods
Sold (COGS) / Cost of
Sales - represents the
direct costs attributable
to goods produced and
sold by a business
(manufacturing or
merchandizing). It
includes material
costs, direct labour
and overhead costs
in absorption costing
excludes operating costs
(period costs) such as
selling, administrative,
advertising or R&D,
Selling, General and
Administrative expenses
(SG&A or SGA) -
of the combined payroll
costs. SGA is usually
understood as a major
portion of non-
production related costs,
in contrast to production
costs such as direct
labour.
Selling expenses
represent expenses
needed to sell
products
(e.g., salaries of sales
people, commissions
and travel expenses
advertising, freight,
shipping, depreciation
of sales store buildings
and equipment
General and
Administrative (G&A)
expenses - represent
expenses to manage
the business
(salaries of officers /
executives, legal and
professional fees,
utilities, insurance,
depreciation of office
building and
equipment, office
rents, office supplies
etc.).
Depreciation / Amortizati
on - the charge with
respect to fixed
assets / intangible
assets that have
capitalised on the
sheet for a specific
(accounting) period. It is
a systematic and rational
allocation of cost ra
than the recognition of
market value decrement.
Research & Development
(R&D) expenses
represent expenses
included in research and
development.
Expenses recognised in the
income statement should be
analysed either by nature
materials, transport costs, staffing
costs, depreciation, employee
benefit etc.) or by function
sales, selling, administrative
(IAS 1.99) If an entity categorises
by function, then additional
information on the nature of
expenses, at least,
depreciation, amortisation and
employee benefits expense
must be disclosed. (IAS 1.104)
The major exclusive of costs of
goods sold, are classified as
operating expenses. These
represent the resources
expended, except for inventory
purchases, in generating the
revenue for the period. Expenses
often are divided into two broad
sub classicifications selling
expenses and administrative
expenses.[5]
Non-operating
section[edit]
Other revenues or gains
revenues and gains from
other than primary business
activities (e.g., rent, income
from patents, goodwill). It also
includes unusual gains that are
either unusual or infrequent,
but not both (e.g., gain from
sale of securities or gain from
disposal of fixed assets
Other expenses or losses
expenses or losses not
related to primary business
operations, (e.g., foreign
exchange loss).
Finance costs - costs of
borrowing from various
creditors (e.g., interest
expenses, bank charges
Income tax expense
the amount of tax payable to
tax authorities in the current
reporting period (current tax
liabilities/ tax payable) and the
amount of deferred
tax liabilities (or assets).
Irregular items[edit
They are reported separately
because this way users can
better predict future cash flows -
irregular items most likely will
not recur. These are reported
of taxes.
Discontinued operations
the most common type of
irregular items. Shifting
business location(s), stopping
production temporarily, or
changes due to
technological improvement
do not qualify as discontinued
operations. Discontinued
operations must be shown
separately.
Cumulative effect of changes in
accounting policies
(principles) is the difference
between the book value of the
affected assets (or liabilities
under the old policy (principle)
and what the book value would
have been if the new principle
had been applied in the prior
periods. For example, valuation
of inventories using LIFO
of weighted average method
changes should be
applied retrospectively and shown
as adjustments to
the beginning balance of
affected components in
All comparative financial
statements should be restated.
(IAS 8)
However, changes in
estimates (e.g., estimated useful
life of a fixed asset) only
requires prospective changes.
(IAS 8)
No items may be presented in the
income statement
as extraordinary items under
IFRS regulations, but are
permissible under US GAAP
(IAS 1.87)
Extraordinary items are both
unusual (abnormal) and
infrequent, for example,
unexpected natural disaster,
expropriation, prohibitions under
new regulations.
Additional items may be needed to
fairly present the entity's results of
operations. (IAS 1.85)
Disclosures[edit]
Certain items must be disclosed
separately in the notes (or
the statement of comprehensive
income), if material, including:
[4]
(IAS 1.98)
Write-downs of inventories
net realisable value or
of property, plant and
equipment to recoverable
amount, as well
as reversals of such write-
downs
Restructurings of the
activities of an entity
and reversals of any
provisions for the costs of
restructuring
Disposals of items of
property, plant and
equipment
Disposals of investments
Discontinued operations
Litigation settlements
Other reversals of provisions
Earnings per share
Because of its
importance, earnings per
share (EPS) are required to be
disclosed on the face of the
income statement. A company
which reports any of the irregular
items must also report EPS for
these items either in the
statement or in the notes.
There are two forms of EPS
reported:
Basic: in this case weighted
average of shares
outstanding includes only
actual stocks outstanding.
Diluted: in this case
average of shares
outstanding is calculated as
if all stock options, warrants,
convertible bonds, and other
securities that could be
transformed into
shares are transformed
increases the number of
shares and so EPS
decreases. Diluted EPS is
considered to be a more
reliable way to measure EPS.
Bottom line[edit]
Bottom line is the net
income that is calculated after
subtracting the expenses from
revenue. Since this forms the last
line of the income statement, it is
informally called bottom line
is important to investors as it
represents the profit for the year
attributable to the shareholders
After revision to IAS 1 in 2003, the
Standard is now using profit or
loss for the year rather than
profit or loss or net income
the descriptive term for the
bottom line of the income
statement.
Requirements of
IFRS[edit]
On 6 September 2007,
the International Accounting
Standards Board issued a
revised IAS 1: Presentation of
Financial Statements, which is
effective for annual periods
beginning on or after 1 January
2009.
A business entity adopting IFRS
must include:
a statement of
comprehensive income
two separate statements
comprising:
1.an income statement displaying
components of profit or loss
2-a statement of comprehensive
income that begins with profit or
loss (bottom line of the income
statement) and displays the items
of other comprehensive
income for the reporting period.
(IAS1.81)
All non-owner changes in equity
(i.e., comprehensive income
shall be presented in either
statement of comprehensive
income (or in a separate income
statement and a statement
comprehensive income).
Components of comprehensive
income may not be presented in
the statement of changes in
equity.
Comprehensive income for a period
includes profit or loss (net
income) for that period and
comprehensive
income recognised in that period.
All items of income and expense
recognised in a period must be
included in profit or loss unless
a Standard or an Interpretation
requires otherwise. (IAS 1.88)
Some IFRSs require or permit that
some components to be
excluded from profit or loss and
instead to be included in other
comprehensive income. (IAS
1.89)
Items and disclosures
The statement of comprehensive
income should include:[4]
1.Revenue
2.Finance costs (including
expenses)
2.Share of the profit or loss
of associates and joint
ventures accounted for using
the equity method
3.Tax expense
4.A single amount comprising the
total of (1) the post-tax profit or
loss of discontinued
operations and (2) the post-
tax gain or loss recognised on the
disposal of the assets or disposal
group(s) constituting
the discontinued operation
5.Profit or loss
6.Each component of other
comprehensive income classified
by nature
7.Share of the other
comprehensive income of
associates and joint ventures
accounted for using the equity
method
Total comprehensive income
The following items must also be
disclosed in the statement of
comprehensive income as
allocations for the period: (IAS
1.83)
-Profit or loss for the period
attributable to non-controlling
interests and owners of the
-Total comprehensive income
attributable to non-controlling
interests and owners of the parent
-No items may be presented in
the statement of comprehensive
income (or in the income
statement, if separately
presented) or in the notes
as extraordinary items.
professionals still use the
term P&L, which stands for profit
and loss statement, but this term
is seldom found in print these
day.

In addition, the terms "profits

The income statement is
three financial statements
stock investors need to
become familiar with (the other
two are balance
sheet and cash flow
statement). Understanding an
income statement is essential
for investors in order to
analyze the profitability and
future growth of a company,
which should play a huge role in
deciding whether or not to
invest in it.
"earnings" and "income
mean the same thing and are
used interchangeably.
Two basic formats for the
income statement are used in
financial reporting presentations
the multi-step and the single-
step. These are illustrated below
in two simple examples.

In the context of corporate

financial reporting, the
income statement
summarizes a
company's revenues (sales) n the multi-step income
and expenses quarterly and statement, four measures of
annually for its fiscal year profitability (*) are revealed at
four critical junctions in a
company's operationsgross,
operating, pretax and after tax.
Income statements come with
various monikers. The most
In the single-step
commonly used are "statement
presentation, the gross and
of income," "statement of
operating income figures are
earnings," "statement of
not stated; nevertheless, they
operations" and "statement of
can be calculated from the data
operating results." Many
provided.
the single-step method, sales
minus materials and production
equal gross income. And, by
subtracting marketing and
administrative and R&D
expenses from gross income,
we get the operating income
figure. If you are a DIY investor,
One last general observation.
Investors must remind
themselves that the income
statement recognizes
revenues when they are
realizedso when goods are
shipped, services rendered and
expenses incurred. With
accounting, the flow
of accounting events through the
income statement doesn't
necessarily coincide with the
actual receipt
and disbursement of cash. The
income statement measures
profitability, not cash flow
Income Statement
Accounts (Multi-Step
Format)
Net Sales (a.k.a. sales or
revenue): These terms
refer to the value of a
company's sales of
goods and services to its
customers. Even though
a company's bottom
line (its net income) gets
most of the attention from
investors, the top line
where the revenue or
income process begins.
Also, in the long run,
profit margins on a
company's existing
products tend to
eventually reach a
maximum that is difficult
on which to improve.
Thus, companies
typically can grow no
faster than their
revenues.
Cost of Sales (a.k.a.
cost of goods/products
sold (COGS), and cost of
services): For a
manufacturer, cost of
sales is the expense
incurred for labor,
materials, and
manufacturing overhead
used in the production of
goods. While it may be
stated
separately, depreciation
expense belongs in the
cost of sales. For
wholesalers and retailers,
the cost of sales is
essentially the purchase
cost of merchandise
used for resale. For
service-related
businesses, cost of sales
represents the cost of
services rendered or cost
of revenues. (To learn
more about sales,
 read Measuring
Company
Efficiency, Inventory
Valuation For Investors:
FIFO And
LIFO and Great
Expectations:
Forecasting Sales
Growth.)
Gross Profit (a.k.a.
gross income or
margin): A
company's gross
profit does more than
simply represent the
difference between net
sales and the cost of
sales. Gross profit
provides the resources
to cover all of the
company's other
expenses. Obviously,
the greater and mo
stable a company's
gross margin, the greater
potential there is for
positive bottom line (net
income) results.
Selling, General and
Administrative
Expenses: Often
referred to as SG&A, this
account comprises a
company's operational
expenses. Financial
analysts generally
assume that
management exercises a
great deal of control over
this expense category.
The trend of SG&A
expenses, as a
percentage of sales, is
watched closely to detect
signs, both positive and
negative, of managerial
efficiency.
Operating Income
Deducting SG&A from a
company's gross profit
produces operating
income. This figure
represents a
company's earnings
from its normal
operations before any
so-called non-operating
income and/or costs
such as interest
expense, taxes
and special items
Income at the operating
level, which is viewed
as more reliable, is
often used by financial
analysts rather than net
income as a measure
profitability.
Interest Expense
item reflects the costs of
a company's borrowings.
Sometimes companies
record a net figure here
for interest expense
interest income from
invested funds.
Pretax Income: Another
carefully watched
indicator of
profitability, earnings
garnered before
 the income tax
is an important bullet in
the income statement
Numerous and diverse
techniques are available
to companies to avoid
and/or minimize taxes
that affect their
reported income.
Because these actions
are not part of a
company's business
operations, analysts may
choose to use pretax
income as a more
accurate measure
corporate profitability.
Income Taxes: As
stated, the income tax
amount has not
actually been paidit
is an estimate, or an
account that has been
created to cover what a
company expects to pay.
Special Items or
Extraordinary
Expenses: A variety of
events can occasion
charges against income.
They are commonly
identified as restructuring
charges, unusual or
nonrecurring items
and discontinued
operations.
These write-offs
supposed to be one-
time events. Investors
need to take these
special items into
account when making
inter-annual profit
comparisons because
they can distort
evaluations.
Net Income (a.k.a.
profit or net earnings):
This is the bottom line,
which is the most
commonly used indicator
of a company's
profitability. Of course, if
expenses exceed
income, this account
caption will read as a
loss. After the payment
of preferred dividends, if
any, net income becomes
part of a
company's equity
n as retained earnings
Supplemental data is
also presented for net
income on the basis
of shares
outstanding (basic) and
the potential conversion
of stock
options, warrants
(diluted). (To read more,
see Evaluating Retained
Earnings: What Gets
Kept
Counts and Everything
You Need To Know
About Earnings.)
Comprehensive
Income: The concept
of comprehensive

income, which is
relatively new (1998),
takes into
consideration the effect
of such items as
foreign currency
translations adjustment
s, minimum pension
liability adjustments
and unrealized
gains/losses on certain
investments in debt
equity. The investment
community continues to
focus on the net income
figure. The
aforementioned
adjustment items all
relate to volatile market
and/or economic events
that are out of the control
of a company's
management. Their
impact is real when they
occur, but they tend to
even out over an
extended period of time.
The International Financial Reporting
Standards (IFRS) - the accounting standard used
in more than 110 countries - has some key
differences from the U.S. Generally Accepted
Accounting Principles (GAAP). At the
conceptually level, IFRS is considered more of a
"principles based" accounting standard in
contrast to U.S. GAAP which is considered
more "rules based." By being more
"principles based", IFRS, arguably, represents
and captures the economics of a transaction
better than U.S. GAAP. Some of differences
between the two accounting frameworks are
highlighted below:
Intangibles
The treatment of acquired intangible assets helps
illustrate why IFRS is considered more "principles
based." Acquired intangible assets under U.S.
GAAP are recognized at fair value, while under
IFRS, it is only recognized if the asset will have a
future economic benefit and has measured
reliability. Intangible assets are things like R&D
and advertising costs.
Inventory Costs
Under IFRS, the last-in, first-out (LIFO) method
for accounting for inventory costs is not allowed.
Under U.S. GAAP, either LIFO or first-in, first-
out (FIFO) inventory estimates can be used. The
move to a single method of inventory costing
could lead to enhanced comparability between
countries, and remove the need for analysts to
adjust LIFO inventories in their comparison
analysis.
Write Downs
Under IFRS, if inventory is written down, the write
down can be reversed in future periods if specific
criteria are met. Under U.S. GAAP, once
inventory has been written down, any reversal is
prohibited. (To learn more, check
out International Reporting Standards Gain
Global Recognition)
Free Cash Flow To
Equity - FCFE
Free cash flow to equity (FCFE) is a measure of
how much cash can be paid to the
equity shareholders of a company after all
expenses, reinvestment and debt are paid.
FCFE is a measure of equity capital usage. It
is calculated as
FCFE = Net Income - Net Capital Expenditure
% Net Working Capital + New
Debt - Debt Repayment.
FCFE is often used by analysts in an attempt to
determine the value of a company. This method
of valuation gained popularity as an alternative to
the dividend discount model, especially if a
company does not pay a dividend. Although free
cash flow to equity may calculate the amount
available to shareholders, it does not necessarily
equate to the amount paid out
shareholders.
Specifically, free cash flow to equity is composed
of net income, capital expenditures, working
capital and debt. Net income is located on the
company income statement. Capital expenditures
can be found within the cash flows from investing
section on the cash flow statement. Working
capital is also found on the cash flow
statement; however, it is in the cash flows
Net borrowings can also be found on the cash
flow statement in the cash flows from
financing section. It is important to remember
that interest expense is already included in
net income so you do not need to add back
interest expense.
How to Interpret
Analysts also use FCFE to determine if dividend
payments and stock repurchases are paid for
with free cash flow to equity or some other form
of financing. Investors want to see a dividend
payment and share repurchase that is fully paid
by FCFE. If FCFE is more than the dividend
payment and the cost to buy back shares, the
to company is funding with either debt or existing
capital. Existing capital includes retained
earnings made in previous periods. This is not
what investors want to see in a current or
prospective investment, even if interest rates are
low. Some analysts argue that borrowing to pay
for share repurchases when shares are trading at
a discount and rates are historically low is a good
investment. However, this is only the case if the
company's share price goes up in the future.

What does free

from operations section

in general, working capital represents the

cash flow to
difference between the companys most current
assets and liabilities. These are short-
term capital requirements related to

equity (FCFE)
immediate operations

really tell an
analyst?
Investors are keen to find the right set of metrics
to evaluate the performance and likely growth of
a company. Free cash flow to equity (FCFE) is
one of the many ways of assessing company
value. It is often used as an alternative to the
dividend discount model, as that model has
While any such calculation is purely an indicator
rather than a surefire way of working out the next
big investment, knowing how to calculate FCFE
can help avoid companies that do not have
sufficient resources left to grow into the future.

Free Cash Flow

proven to be difficult to apply in practice.

A useful FCFE depends on the initial free cash

flow figures being accurate and transparent.
Although free cash flow (FCF) indicates very
clearly how well a company can service debts,
For The Firm
invest in growth and weather minor economic
fluctuations, the way that it is calculated is
subject to manipulation. Because FCF is an
FCFF
indicator of how money is being spent at the
present time rather than capital investment, What is 'Free Cash Flow For
companies seeking investment may underreport The Firm - FCFF'
capital expenditure and R&D costs, neither of
Free cash flow for the firm (FCFF) is a measure
which form part of FCF calculations. The
of financial performance that expresses the net
methods by which receivables are recorded can
amount of cash that is generated for a firm after
also be manipulated to boost apparent FCF.
expenses, taxes and changes in net working
capital and investments are deducted. FCFF is
These tricks can make it difficult to get an
essentially a measurement of a company's
accurate read on a company's FCF without
profitability after all expenses and reinvestments.
performing extensive analysis. This can affect
It's one of the many benchmarks used to
what FCFE calculations can tell an analyst. Once
compare and analyze financial health.
a level of confidence in the FCF figures is
reached, the FCFE helps to quantify the likely
returns for investors in that business. BREAKING DOWN 'Free Cash
Flow For The Firm - FCFF'
The calculation is expressed as Net Income - Net
FCFF represents the cash available to investors
Capital Expenditure - Change in Net Working
after a company has paid all of its costs of doing
Capital + New Debt - Debt Repayment. This is
business, invests in current assets (such as
then a relatively accurate reflection of the money
inventory) and invests in long-term assets (such
available to pay dividends to investors once
as equipment). FCFF includes
reinvestment in the business and development
both bondholders and stockholders when
costs are taken into account, and hence a
considering the money left over for investors.
moderately reliable company valuation for
prospective investors.
The FCFF calculation is a good representation of
a company's operations and its performance.
FCFF takes into account all cash inflows in the
form of revenues, all cash outflows in the form of
ordinary expenses and all reinvested cash
needed to keep the business growing. The
money left over after conducting all of these
operations represents a company's FCFF.
Calculating FCFF
The calculation for FCFF can take many forms,
and it's important to understand each version.
The most common equation is shown as:
FCFF = net income + non-cash charges +
interest x (1 - tax rate) - long-term investments -
investments in working capital
Other equations include:
FCFF = Cash Flow from Operations + Interest
Expense x ( 1 - Tax Rate ) - Capex
FCFF = earnings before interest and taxes x (1 -
tax rate) + depreciation - long-term investments -
investments in working capital
FCFF = earnings before interest, tax,
depreciation and amortization x (1 - tax rate) +
depreciation x tax rate - long-term investments -
investments in working capital
Benefits of Using FCFF
Free cash flow is arguably the most important
financial indicator of the value of a company's
stock. The value, and therefore the price, of a
stock is considered to be the summation of the
company's expected future cash flows. However,
stocks are not always accurately priced.
Understanding a company's FCFF allows
investors to test whether a stock is fairly valued.
FCFF also represents a company's ability to
pay out dividends, conduct share repurchases or
pay back debt holders. Any investor who is
looking to invest in a company's corporate
bond or public equity should check its FCFF.
A positive FCFF value would indicate that the firm
has cash left after expenses. A negative value
indicates that the firm has not generated enough
revenue to cover its costs and investment
activities. In that instance, an investor should dig
deeper to assess why this is happening. It can be
a conscious decision, as in high-growth tech
companies that take consistent outside
investments, or it could be a signal of financial
issues.
Free Cash Flow (FCF)
Free cash flow (FCF) is the amount of cash that
a company has left over after it has paid all of
its expenses, including net capital
expenditures. Net capital expenditures are
what a company needs to spend annually to
acquire or upgrade physical assets such as
buildings and machinery to keep operating.
FCF=CASflow from operating activities-net caital
expenditures(total apital expenditure)-after tax
procedes from sale of assets.
The FCF measure gives investors an idea of a
company's ability to pay down debt, increase
savings and increase shareholder value, and
FCF is used for valuation purposes.
Free Cash Flow to the Firm (FCFF)
Free cash flow to the firm is the cash available to
all investors, both equity and debt holders. It can
be calculated using Net Income or Cash Flow
from Operations (CFO)
The calculation of FCFF using CFO is similar to
the calculation of FCF. Because FCFF is the
cash flow allocated to all investors including debt WCInv = Working Capital Investments
holders, the interest expense which is cash
available to debt holders must be added back.
ree Cash Flow to Equity (FCFE), the cash
The amount of interest expense that is available
available to stockholders can be derived from
is the after-tax portion, which is shown as the
FCFF. FCFE equals FCFF minus the after-tax
interest expense multiplied by 1-tax rate [Int x (1-
interest plus any cash from taking on debt (Net
tax rate)]. .
Borrowing). The formula equals:
his makes the calculation of FCFF using CFO
equal to:
FCFE=FCFF-(inte*(1-tax rate))+net bprrowing

FCFF = CFO + [Int x (1-tax rate)] FCInv

Where:
CFO = Cash Flow from Operations
Int = Interest Expense
FCInv = Fixed Capital Investment (total capital
expenditures)
This formula is different for firm's that follow
IFRS. Firm's that follow IFRS would not add back
interest since it is recorded as part of financing
activities. However, since IFRS allows
dividends paid to be part of CFO, the
dividends paid would have to be added back.
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The calculation using Net Income is similar to the

Operating Profit
one using CFO except that it includes the items
that differentiate Net Income from CFO. To arrive
at the right FCFF, working capital investments

After Tax
must be subtracted and non-cash charges must
be added back to produce the following formula:

NOPAT
FCFF= NI+NCC+(inters*(1-tax rate))- FCinv-
WCinv

Where:
NI = Net Income Net operating profit after tax (NOPAT) is a
NCC = Non-cash Charges (depreciation and company's potential cash earnings if
amortization) its capitalization were unleveraged that is, if it
Int = Interest Expense had no debt. NOPAT is frequently used
FCInv = Fixed Capital Investment (total capital in economic value added (EVA) calculations. It is
expenditures) calculated as: NOPAT = Operating Income x (1 -
Tax Rate). NOPAT is a more accurate look at
operating efficiency for leveraged companies,
and it does not include the tax savings many
companies get because of existing debt.
BREAKING DOWN 'Net
Operating Profit After Tax -
NOPAT'
Analysts look at many different measures of
performance when assessing a company as an
investment. The most commonly used measures
of performance are sales and net income growth.
Sales provide a top-line measure of performance,
but they do not speak to operating efficiency. Net
income includes operating expenses, but also
includes tax savings from debt. Net operating
profit after tax is a hybrid calculation that allows
analysts to compare company performance
without the influence of leverage. In this way, it is
a more accurate measure of pure operating
efficiency.
Net Operating Profit After Tax
Example
Net operating profit after tax is calculated as
operating income multiplied by 1, minus the tax
rate. Operating income is also referred to
as earnings before interest and taxes, or EBIT.
For example, if EBIT is $10,000 and the tax rate
is 30%, the calculation is $10,000 multiplied by 1
minus .3, or .7, which equals $7,000. This is an
approximation of after-tax cash flows without the
tax advantage of debt. Note that if a company
does not have debt, net operating profit after tax
is the same as net income after tax. When
calculating net operating profit after tax, analysts
like to compare against similar companies in the
same industry, because some industries have
higher or lower costs than others.
Interpretation and Uses
In addition to providing analysts with a measure
of core operating efficiency without the influence
of debt, mergers and acquisitions analysts use
net operating profit after tax. They use this to
calculate free cash flow to firm (FCFF) , which
equals net operating profit after tax, minus
changes in working capital. They also use it in
the calculation of economic free cash flow to firm
(FCFF), which equals net operating profit after
tax minus capital. Both are primarily used by
analysts looking for acquisition targets, since
the acquirer's financing will replace the current
financing arrangement. Another way to calculate
net operating profit after tax is net income plus
net after-tax interest expense, or net income plus
net interest expense, multiplied by 1, minus the
tax rate.
What is the difference
between earnings and profit?
Earnings, specifically retained earnings, and
profit are often used as synonyms in corporate
finance, although they are different terms and
have different meanings. These differences
largely center around accounting treatment. A
company's earnings are equal to revenue
less costs of production over a given period of
time. Profit is equal to total revenue less all
expenses. In the right context, these could be
equal to each other, although that is rare. Big
gaps between earnings and profits might be a
sign the company spends too much time and
money on unproductive activity.
Earnings Vs. Profit: An Example
Consider an example where a toy manufacturer
sells $10,000 worth of toys in one week. It did not
make any money from other sources over the
same week, so its total revenue is $10,000.
If it cost $7,000 to manufacture those toys, the
earnings for the company are $3,000 for the
week, or $10,000 - $7,000. This does not take
into account other fixed costs, however. The
company may have paid interest on some debt,
had to pay an accountant or fix a toilet at its
facility. Suppose the company incurred $1,800
worth of these overhead expenses during the
week. Now, its weekly profit is only $1,200 even
though earnings show $3,000.
This tells the company it needs to focus on
reducing miscellaneous costs. It is manufacturing
and selling toys at a 30% margin, but it has to
immediately sink a full 60% of its earnings into
other expenses.
Consider the ramifications of a company, or
investor, that ignores the difference between
earnings and profit. If the toys had only sold for a
15% margin instead of 30%, those miscellaneous
expenses would have resulted in a net loss for
the week but earnings still showed a $1,500 gain;
this is a very different picture.
Net Income, Net Profit, Net
Earnings
Definition:
Net income is the bottom line of the income
statement. It is what is left over from revenues
after all costs and expenses are subtracted.
Revenue cost of goods sold (for
manufacturing businesses, or cost of services
for service businesses), operating expenses,
taxes, interest, one-time charges, non-cash
expenses such as depreciation and
amortization, and any other costs not included
in operating profit leaves the net profit.
Net profit, net income, and net earnings all
mean the same thing.
Sign up for our online financial statement
training and get the income statement
training you need.
Example:
Here is a sample income statement to show
how net profit might be reflected on the
income statement of a small, hypothetical
company. Amounts shown in thousands.

Book Excerpt:
(Excerpts from Financial Intelligence,
Chapter 9 The Many Forms of Profit)
When someone asks, Whats the bottom
line? he or she is almost always referring to
net profit. Some of the key numbers used to
measure a company, such as earnings per
share and price/earnings ratio, are based on
net profit. Yes, it is strange that they dont just
call it profit per share and price/profit ratio.
But they dont.
(Excerpts from Financial Intelligence, Part
Two Toolbox)
Nonprofit organizations use the same financial
statements as for-profit companies, including
the income statement. They also have a
bottom line indicating the difference between
revenue and expenses, just like for-profit
companies. Sometimes the bottom line has a
different label, but it is still a profit or a loss.
And the fact is, a nonprofit organization needs
to earn a profit. How can it survive over the
long haul if it doesnt bring in more than it
spends? It has to earn a surplus to invest in its
future.
Free Cash Flow to Firm [FCFF]:
This is the net amount of cash left with a company
after all expenses (including sales, R&D, cost of goods
sold), taxes and re-investments in the business.
FCFF = Operating cash flow - Expenses - Taxes -
investments
Free Cash Flow to Equity [FCFE]:
This is the net amount of cash left for a company's
equity shareholders after all expenses, taxes,
investments and debt payments.
FCFE = FCFF - debt repayment
How to Calculate FCFF
and FCFE
To value a company, one of the most popular
methods is to use the discounted cash flow
method. Traditionally, the dividends paid by the
company are used as a proxy for the cash flows of
the business. However, the dividends do not truly
reflect the amount of cash flow the business can
generate for its shareholders.
Many analysts, instead of dividends, use alternative
measures of cash flow such as FCFF and FCFE.
Free Cash Flow to Firm (FCFF)
FCFF is the cash flow generated by the firm before
debt payment but after reinvestment needs and
taxes. FCFF helps in estimating the value of the
entire firm, by discounting the projected FCFF by
the weighted average cost of capital (WACC).
FCFF is the cash flow available to the suppliers of
capital after all operating expenses (including
taxes) are paid and working and fixed capital
investments are made. It is calculated by making
the following adjustments to EBIT.
FCFF = EBIT Taxes + Depreciation (non-cash
costs) Capital spending Increase in net working
capital Change in other assets + Terminal value
Free Cash Flow to Equity (FCFE)
FCFE is the cash flow after taxes, reinvestment
needs, and debt cash flows. Using FCFE, one can
directly calculate the value of equity by discounting
the projected FCFE by the cost of equity. It is the
cash flow available after all operating expenses,
interest, and principle repayments have been made
and necessary investments in working capital and
fixed capital have been made. It can be calculated
as follows:
FCFE = EBIT interest taxes + depreciation (non-
cash costs) capital expenditures increase in net
working capital principal debt repayments + new
debt issues + terminal value
Note that if we already have FCFF, we can use the
value of FCFF to calculate FCFE as follows:
FCFE = FCFF Interest expense * (1 tax) +
Increase in debt
Valuation Using FCFE and FCFF
Using the Gordon Growth Mode, the value of the
firm and equity can be calculated as follows:
VFirm = FCFF/(WACC g)
VEquity = VFirm Value of debt
Alternatively, value of equity can directly be
calculated as follows:
VEquity = FCFE/(Cost of Equity g)
This is the value of just the equity claim of the
business. Note that while using FCFF, the growth
needs to be considered in operating income and
FCFF. However, when using FCFE, growth in equity
income and FCFE is considered. Also note that the
discount rate is WACC when using FCFF and it is
just cost of equity when using FCFE.
Working Capital
Working capital is a measure of both a
company's efficiency and its short-
term financial health. Working capital is
calculated as:
Working Capital = Current Assets - Current
Liabilities
The working capital ratio (Current
Assets/Current Liabilities) indicates whether a
company has enough short term assets to cover
its short term debt. Anything below 1
indicates negative W/C (working capital).
While anything over 2 means that the
company is not investing excess assets. Most
believe that a ratio between 1.2 and 2.0 is
sufficient. Also known as "net working capital".
If a company's current assets do not exceed
its current liabilities, then it may run into
trouble paying back creditors in the short
term. The worst-case scenario is bankruptcy. A
declining working capital ratio over a longer time
period could also be a red
flag that warrants further analysis. For example, it
could be that the company's sales volumes are
decreasing and, as a result, its
accounts receivables number continues to get
smaller and smaller.Working capital also gives
investors an idea of the company's
underlying operational efficiency. Money that is
tied up in inventory or money that customers still
owe to the company cannot be used to pay off
any of the company's obligations. So, if a
company is not operating in the most efficient
manner (slow collection), it will show up as an
increase in the working capital. This can be seen
by comparing the working capital from one period
to another; slow collection may signal an
underlying problem in the company's operations.
Things to Remember
If the ratio is less than one then they have
negative working capital.
 A high working capital ratio isn't always a such as the annual report and also by investment
good thing, it could indicate that they have research services. Whatever its size, the amount
too much inventory or they are not of working capital sheds very little light on the
investing their excess cash quality of a company's liquidity position.

The Working
Another piece of conventional wisdom that needs
correcting is the use of the current ratio and, its
close relative, the acid test or quick ratio.

Capital Position
For investors, the strength of a
company's balance sheet can be evaluated by
examining three broad categories of
investment quality: working
capital adequacy, asset
performance and capitalization structure. In
this article, we'll start with a comprehensive
look at how best to evaluate the investment
quality of a company's working capital position. In
simple terms, this entails measuring
the liquidity and managerial efficiency related to a
company's current position. The analytical tool
employed to accomplish this task will be a
company's cash conversion cycle.
Contrary to popular perception, these analytical
tools don't convey the evaluative information
about a company's liquidity that an investor
needs to know. The ubiquitous current ratio, as
an indicator of liquidity, is seriously flawed
because it's conceptually based on a company's
liquidation of all its current assets to meet all of
its current liabilities. In reality, this is not likely to
occur. Investors have to look at a company as
a going concern. It's the time it takes to convert a
company's working capital assets into cash to
pay its current obligations that is the key to its
liquidity. In a word, the current ratio is misleading.
A simplistic, but accurate, comparison of two
companies' current positions will illustrate the
weakness in relying on the current ratio and a
working capital number as liquidity indicators:

Don't Be Misled by Faulty Analysis

Liquidity Company Company
To start this discussion, let's first correct some
Measures ABC XYZ
commonly held, but erroneous, views on a
company's current position, which simply Current Assets $600 $300
consists of the relationship between its current
assets and its current liabilities. Working capital is Current Liabilities $300 $300
the difference between these two broad
categories of financial figures and is expressed Working Capital $300 $0
as an absolute dollar amount.
Current Ratio 2:1 1:1
Despite conventional wisdom, as a stand-alone
At first glance, company ABC looks like an easy
number, a company's current position has little or
winner in a liquidity contest. It has an ample
no relevance to an assessment of its liquidity.
margin of current assets over current liabilities, a
Nevertheless, this number is prominently
seemingly good current ratio and a working
reported in corporate financial communications
capital of $300. Company XYZ has no current
asset/liability margin of safety, a weak current
ratio and no working capital.
However, what if both companies' current
liabilities have an average payment period of 30
days? Company ABC needs six months (180
days) to collect its account receivables, and
its inventory turns over just once a year (365
days). Company XYZ's customers pay in cash,
and its inventory turns over 24 times a year
(every 15 days). In this contrived example,
company ABC is very illiquid and would not be
able to operate under the conditions described.
Its bills are coming due faster than its generation
of cash. You can't pay bills with working capital;
you pay bills with cash! Company XYZ's
seemingly tight current position is much more
liquid because of its quicker cash conversion.
Measuring a Company's Liquidity the Right
Way
The cash conversion cycle (also referred to as
CCC or the operating cycle) is the analytical tool
of choice for determining the investment quality of
two critical assets - inventory and accounts
receivable. The CCC tells us the time (number of
days) it takes to convert these two important
assets into cash. A fast turnover rate of these
assets is what creates real liquidity and is a
positive indication of the quality and the efficient
management of inventory and receivables. By
tracking the historical record (five to 10 years) of
a company's CCC and comparing it to competitor
companies in the same industry (CCCs will vary
according to the type of product and customer
base), we are provided with an insightful indicator
of a balance sheet's investment quality.
Briefly stated, the cash conversion cycle is
comprised of three standards: the so-
called activity ratios relating to the turnover of
inventory, trade receivables and trade payables.
These components of the CCC can be expressed
as a number of times per year or as a number of
days. Using the latter indicator provides a more
literal and coherent time measurement that is
easily understood. The cash conversion cycle
formula looks like this:
Days Inventory Outstanding (DIO) + Days
Sales Outstanding (DSO) Days Payable
Outstanding (DPO) = CCC
Here's how the components are calculated:
Dividing average inventories by cost of sales
per day (cost of sales/365) = days inventory
outstanding (DIO).
Dividing average accounts receivables by net
sales per day (net sales/365) = days sales
outstanding (DSO).
Dividing average accounts payables by cost
of sales per day (cost of sales/365) = days
payables outstanding (DPO).
Liquidity Is King
One collateral observation is worth mentioning
here. Investors should be alert to spotting liquidity
enhancers in a company's financial information.
For example, for a company that has non-
current investment securities, there is typically
a secondary market for the relatively quick
conversion of all or a high portion of these items
to cash. Also, unused committed lines of credit -
usually mentioned in a note to the financials on
debt or in the management discussion and
analysis section of a company's annual report -
can provide quick access to cash.
SEE: Understanding Financial Liquidity
The Bottom Line
The old adage that "cash is king" is as important
for investors evaluating a company's investment
qualities as it is for the managers running the
business. A liquidity squeeze is worse than a
profit squeeze. A key management function is to
make sure that a company's receivables and
inventory positions are managed efficiently. This
means ensuring an adequate level of product
availability and providing appropriate payment
terms, while at the same time making sure that
working capital assets don't tie up undue
amounts of cash. This is a balancing act for
managers, but an important one. It is important
because with high liquidity, a company can take
advantage of price discounts on cash purchases,
reduce short-term borrowings, benefit from a top
commercial credit rating and take advantage of
market opportunities.
The cash conversion cycle and its component
parts are useful indicators of a company's true
liquidity. In addition, the performance of DIO and
DSO is a good indicator of management's ability
to handle the important inventory and receivable
assets.
Working Capital
Works
Cash is the lifeline of a company. If this lifeline
deteriorates, so does the company's ability to
fund operations, reinvest and meet capital
requirements and payments. Understanding a
company's cash flow health is essential to
making investment decisions. A good way to
judge a company's cash flow prospects is to look
at its working capital management (WCM).
What Is Working Capital?
Working capital refers to the cash a business
requires for day-to-day operations, or, more
specifically, for financing the conversion of raw
materials into finished goods, which the company
sells for payment. Among the most important
items of working capital are levels of
inventory, accounts receivable and accounts
payable. Analysts look at these items for signs of
a company's efficiency and financial strength.
(Read more, in Free Cash Flow: Free, But Not
Always Easy.)
Take a simplistic case: a spaghetti sauce
company uses $100 to build up its inventory of
tomatoes, onions, garlic, spices etc. A week later,
the company assembles the ingredients into
sauce and ships it out. A week after that, the
checks arrive from customers. That $100, which
has been tied up for two weeks, is the company's
working capital. The quicker the company sells
the spaghetti sauce, the sooner the company can
go out and buy new ingredients, which will be
made into more sauce sold at a profit. If the
ingredients sit in inventory for a month, company
cash is tied-up and can't be used to grow the
spaghetti business. Even worse, the company
can be left strapped for cash when it needs to
pay its bills and make investments. Working
capital also gets trapped when customers do not
pay their invoices on time or suppliers get paid
too quickly or not fast enough.
The better a company manages its working
capital, the less the company needs to borrow.
Even companies with cash surpluses need to
manage working capital to ensure that those
surpluses are invested in ways that will generate
suitable returns for investors. (Get some more
background information, in The Working Capital
Position.)
Not All Companies are the Same
Some companies are inherently better placed
than others. Insurance companies, for instance,
receive premium payments up front before having
to make any payments; however, insurance
companies do have unpredictable cash outflow
as claims come in.
Normally, a big retailer like Wal-
Mart (NYSE:WMT) has little to worry about when
it comes to accounts receivable: customers pay
for goods on the spot. Inventories represent the
biggest problem for retailers; as such, they must
perform rigorous inventory forecasting or they
risk being out of business in a short time.
Timing and lumpiness of payments can pose
serious troubles. Manufacturing companies, for
example, incur substantial upfront costs for
materials and labor before receiving payment.
Much of the time they eat more cash than they
generate. (Find out how to do an analysis,
in Evaluating A Company's Capital Structure.)
Evaluating Companies
Investors should favor companies that place
emphasis on supply-chain management to
ensure that trade terms are optimized. Days-
sales outstanding, or DSO for short, is a good
indication of working capital management
practices. DSO provides a rough guide to the
number of days that a company takes to collect
payment after making a sale. Here is the simple
formula:
Receivables/ Annual Sales/365 Days
Rising DSO is a sign of trouble because it shows
that a company is taking longer to collect its
payments. It suggests that the company is not
going to have enough cash to fund short-term
obligations because the cash cycle is
lengthening. A spike in DSO is even more
worrisome, especially for companies that are
already low on cash.
The inventory turnover ratio offers another good
instrument for assessing the effectiveness of
WCM. The inventory ratio shows how fast/often
companies are able to get their goods completely
off the shelves. The inventory ratio looks like this:
Cost of Goods Sold (COGS)/Inventory
Broadly speaking, a high inventory turnover
ratio is good for business. Products that sit on the
shelf are not making money. Granted, an
increase in the ratio can be a positive sign,
indicating that management, expecting sales to
increase, is building up inventory ahead of time.
For investors, a company's inventory turnover
ratio is best seen in light of its competitors. In a
given sector where, for instance, it is normal for a
company to completely sell out and restock six
times a year, a company that achieves a turnover
ratio of four is an underperformer.
Computer giant and stock
market champion, Dell (Nasdaq:DELL),
recognized early that a good way to
bolster shareholder value was to notch up
working capital management. The company's
world-class supply-chain management system
ensures that DSO stays low. Improvements in
inventory turnover increase cash flow, all but
eliminating liquidity risk, leaving Dell with more
cash on the balance sheet to distribute to
shareholders or fund growth plans. (Read more,
in Don't Get Burned By The Burn Rate.)
Dell's exceptional WCM certainly exceeds those
of the top executives who do not worry enough
about the nitty-gritty of working capital
management. Some CEOs frequently see
borrowing and raising equity as the only way to
boost cash flow. Other times, when faced with a
cash crunch, instead of setting straight inventory
turnover levels and reducing DSO, these
management teams pursue rampant cost
cutting and restructuring that may later aggravate
problems.
Conclusion
Cash is king - especially at a time when
fundraising is harder than ever. Letting it slip
away is an oversight that investors should not
forgive. Analyzing a company's working capital
can provide excellent insight into how well a
company handles its cash, and whether it is likely
to have any on hand to fund growth and
contribute to shareholder value. (Read more, in Z
Marks The End.)
Evaluating a
Company's Capital
Structure
or stock investors that favor companies with good
fundamentals, a "strong" balance sheet is an
important consideration for investing in a
company's stock. The strength of a company's
balance sheet can be evaluated by three broad
categories of investment-quality
measurements: working capital adequacy; asset
performance; and capital structure. In this article,
we'll look at evaluating balance sheet strength
based on the composition of a company's capital
structure.
A company's capitalization (not to be confused
with market capitalization) describes the
composition of a company's permanent or long-
term capital, which consists of a combination of
debt and equity. A healthy proportion of equity
capital, as opposed to debt capital, in a
company's capital structure is an indication of
financial fitness.
Clarifying Capital Structure
Related Terminology
The equity part of the debt-equity relationship is
the easiest to define. In a company's capital
structure, equity consists of a company's
common and preferred stock plus retained
earnings, which are summed up in the
shareholders' equity account on a balance sheet.
This invested capital and debt, generally of the
long-term variety, comprises a company's
capitalization, i.e. a permanent type of funding to
support a company's growth and related assets.
A discussion of debt is less straightforward.
Investment literature often equates a company's
debt with its liabilities. Investors should
understand that there is a difference between
operational and debt liabilities it is the latter that
forms the debt component of a company's
capitalization but that's not the end of the debt
story.
Among financial analysts and investment
research services, there is no universal
agreement as to what constitutes a debt liability.
For many analysts, the debt component in a
company's capitalization is simply a balance
sheet's long-term debt. This definition is too
simplistic. Investors should stick to a stricter
interpretation of debt where the debt component
of a company's capitalization should consist of
the following: short-term borrowings (notes
payable); the current portion of long-term debt;
long-term debt; two-thirds (rule of thumb) of the
principal amount of operating leases; and
redeemable preferred stock. Using a
comprehensive total debt figure is a prudent
analytical tool for stock investors.
It's worth noting here that both international and
U.S. financial accounting standards boards are
proposing rule changes that would treat operating
leases and pension "projected-benefits" as
balance sheet liabilities. The new proposed rules
certainly alert investors to the true nature of
these off-balance sheet obligations that have all
the earmarks of debt.
Is There an Optimal Debt-Equity
Relationship?
In financial terms, debt is a good example of the
proverbial two-edged sword. Astute use
of leverage (debt) increases the amount of
financial resources available to a company for
growth and expansion. The assumption is that
management can earn more on borrowed funds
than it pays in interest expense and fees on these
funds. However, as successful as this formula
may seem, it does require that a company
maintain a solid record of complying with its
various borrowing commitments.
A company considered too highly-leveraged (too
much debt versus equity) may find its freedom of
action restricted by its creditors and/or may have
its profitability hurt as a result of paying
high interest costs. Of course, the worst-case
scenario would be having trouble meeting
operating and debt liabilities during periods of
adverse economic conditions. Lastly, a company
in a highly-competitive business, if hobbled by
high debt, may find its competitors taking
advantage of its problems to grab more market
share.
Unfortunately, there is no magic proportion of
debt that a company can take on. The debt-
equity relationship varies according to industries
involved, a company's line of business and its
stage of development. However, because
investors are better off putting their money into
companies with strong balance sheets, common
sense tells us that these companies should have,
generally speaking, lower debt and higher equity
levels.
Capital Ratios and Indicators
In general, analysts use three ratios to assess
the financial strength of a company's
capitalization structure. The first two, the so-
called debt and debt/equity ratios, are popular
measurements; however, it's the capitalization
ratio that delivers the key insights to evaluating a
company's capital position.
The debt ratio compares total liabilities to total
assets. Obviously, more of the former means less
equity and, therefore, indicates a more leveraged
position. The problem with this measurement is
that it is too broad in scope, which, as a
consequence, gives equal weight to operational
and debt liabilities. The same criticism can be
applied to the debt/equity ratio, which compares
total liabilities to total shareholders' equity.
Current and non-current operational liabilities,
particularly the latter, represent obligations that
will be with the company forever. Also, unlike
debt, there are no fixed payments of principal or
interest attached to operational liabilities.
The capitalization ratio (total debt/total
capitalization) compares the debt component of a
company's capital structure (the sum of
obligations categorized as debt + total
shareholders' equity) to the equity component.
Expressed as a percentage, a low number is
indicative of a healthy equity cushion, which is
always more desirable than a high percentage of
debt.
Additional Evaluative Debt-
Equity Considerations
Companies in an aggressive acquisition mode
can rack up a large amount of
purchased goodwill in their balance sheets.
Investors need to be alert to the impact
of intangibles on the equity component of a
company's capitalization. A material amount of
intangible assets need to be considered carefully
for its potential negative effect as a deduction (or
impairment) of equity, which, as a consequence,
will adversely affect the capitalization ratio.
Funded debt is the technical term applied to the
portion of a company's long-term debt that is
made up of bonds and other similar long-term,
fixed-maturity types of borrowings. No matter how
problematic a company's financial condition may
be, the holders of these obligations cannot
demand payment as long as the company pays
the interest on its funded debt. In contrast, bank
debt is usually subject to acceleration clauses
and/or covenants that allow the lender to call its
loan. From the investor's perspective, the greater
the percentage of funded debt to total debt
disclosed in the debt note in the notes to financial
statements, the better. Funded debt gives a
company more wiggle room.
Lastly, credit ratings are formal risk evaluations
by credit-rating agencies Moody's, Standard &
Poor's, Duff & Phelps and Fitch of a
company's ability to repay principal and interest
on debt obligations, principally bonds
and commercial paper. Here again, this
information should appear in the footnotes.
Obviously, investors should be glad to see high-
quality rankings on the debt of companies they
are considering as investment opportunities
and be wary of the reverse.
Introduction To
Dividends
When a company earns profits from
operations, management can do one of two
things with those profits. It can choose to
retain them - essentially reinvesting them into
the company with the hope of creating more
profits and thus further stock appreciation.
The alternative is to distribute a portion of the
profits to shareholders in the form of
dividends. Management can also opt to
repurchase some of its own shares - a move
that would also benefit shareholders.
A company must keep growing at an above-
average pace to justify reinvesting in itself
rather than paying a dividend. Generally
speaking, when a company's growth slows, its
stock won't climb as much, and dividends will
be necessary to keep shareholders around.
This growth slowdown happens to virtually all
companies after they attain a large market
capitalization. A company will simply reach a
size at which it no longer has the potential to
grow at annual rates of 30-40% like a small
cap, regardless of how much money is
plowed back into it. At a certain point, the law
of large numbers makes a mega-
cap company and growth rates that
outperform the market an impossible
combination. In this section, we'll take a
deeper look at the different types of dividends
and the mechanics of dividend payments;
how companies establish dividend policy and
the different types of dividend policies; the
reasons why companies and investors might
prefer higher, lower or no dividend payments;
and share repurchases, stock splits and stock
dividends as an alternative to cash dividends.
Cash
Dividends And
Dividend
Payment
A cash dividend is money paid to
stockholders, normally out of the corporation's
current earnings or accumulated profits. Not
all companies pay a dividend. Usually, the
board of directors determines if a dividend is
desirable for their particular company based
upon various financial and economic factors.
Dividends are commonly paid in the form of
cash distributions to the shareholders on a
monthly, quarterly or yearly basis. All
dividends are taxable as income to the
recipients.
Dividends are normally paid on a per-share
basis. If you own 100 shares of the ABC
Corporation, the 100 shares is your basis for
dividend distribution. Assume for the moment
that ABC Corporation was purchased at
$100/share, which implies a $10,000 total
investment. Profits at the ABC Corporation
were unusually high so the board of directors
agrees to pay its shareholder $10 per share
annually in the form of a cash dividend. So,
as an owner of ABC Corporation for a year,
your continued investment in ABC Corp
should give us $1,000 in dividend dollars. The
annual yield is the total dividend amount
($1,000) divided by the cost of the stock
($10,000) which gives us in percentage
terms, 10%. If the 100 shares of ABC
Corporation were purchased at $200 per
share, the yield would drop to 5%, since 100
shares now cost $20,000, or your original
$10,000 only gets you 50 shares instead of
100. If the price of the stock moves higher,
then dividend yield drops and vice versa. The
Mechanics of Dividends
Do dividend-paying stocks make a good
overall investment? Dividends are derived
from a company's profits, so it is fair to
assume that dividends are generally a sign of
financial health. From an investment strategy
perspective, buying established companies
with a history of good dividends adds stability
to a portfolio. Your $10,000 investment in
ABC Corporation, if held for one year, will be
worth $11,000, assuming the stock price after
one year is unchanged. Moreover, if ABC
Corporation is trading at $90 share a year
after you purchased for $100 a share, your
total investment after receiving dividends still
breaks even ($9,000 stock value + $1,000 in
dividends).
Herein lies the appeal to buying stocks with
dividends: they help cushion declines in
actual stock prices, and they also present an
opportunity for stock price
appreciation coupled with the steady stream
of income that dividends provide.
This is why many investing legends such
as John Bogle, Warren Buffett and Benjamin
Graham all espouse the virtues of buying
stocks that pay a dividend as a critical part of
the investment return of an asset. (Discover
the issues that complicate these payouts for
investors Dividend Facts You May Not Know.)
Risks to Dividends
During the financial meltdown in 2008-2009,
all of the major banks either slashed or
eliminated their dividend payouts. These
companies were known for consistent, stable
dividend payouts each quarter for hundreds of
years, yet despite their storied history, the
dividends were cut.
The lesson is that dividends are not
guaranteed and are subject
to macroeconomic as well as company-
specific risks. Another potential downside to
investing in dividend-paying stocks is that
companies that pay dividends are not usually
high growth leaders. There are a few
exceptions, but high-growth companies
usually do not pay dividends to shareholders
even if they have significantly outperformed
over the vast majority of all stocks over the
last five years. Growth companies tend to
spend more dollars on research and
development, capital expansion, retaining
talented employees and/or mergers and
acquisitions, which leaves them with little to
no money to spend on dividends.
For these companies, all earnings are
considered retained earnings and are
reinvested back into the company instead of
rewarding loyal shareholders.
It is equally important to beware of companies
with extraordinarily high yields. As we have
learned, if a company's stock price continues
to decline, its yield goes up. Many rookie
investors get teased into purchasing a stock
just on the basis of a potential juicy dividend.
However, there is no specific rule of thumb in
relation to how much is too much in terms of a
dividend payout.
The average dividend yield on the S&P
500 companies that pay a dividend historically
fluctuates somewhere between 2-5%,
depending on market conditions. In general, it
pays to do your homework on stocks yielding
more than 8% to find out what is truly going
on with the company. Doing this due
diligence will help you decipher those
companies that are truly in financial shambles
from those that are temporarily out of favor
and therefore present a good investment. (To
read more on this subject, see Why
Dividends Matter, How Dividends Work For
Investors and 6 Common Misconceptions
About Dividends.)
How Companies Pay Dividends
Dividend payouts follow a set procedure. To
understand it, first we'll define the following
terms:
1. Declaration Date
The declaration date is the day the company's
board of directors announces approval of the
dividend payment.
2. Ex-Dividend Date
The ex-dividend date is the date on which
investors are cut off from receiving a dividend.
If, for example, an investor purchases a stock
on the ex-dividend date, that investor will not
receive the dividend. This date is two
business days before the holder-of-record
date. mails the dividend checks to the holders of
record.
The ex-dividend date is important because
from this date forward, new stockholders will

Dividend
not receive the dividend, and the stock price
reflects this fact. For example, on and after
the ex-dividend date, a stock usually trades at

Policy
a lower price as the stock price adjusts for the
dividend that the new holder will not receive.

3. Holder-of-Record Date
Dividend policy is the set of guidelines a
The holder-of-record (owner-of-record) date is
company uses to decide how much of its
the date on which the stockholders who are
earnings it will pay out to shareholders. Some
eligible to receive the dividend are
evidence suggests that investors are not
recognized.
concerned with a company's dividend policy
since they can sell a portion of their portfolio
(Understanding the dates of the dividend
of equities if they want cash. This evidence is
payout process can be tricky. We clear up the
called the "dividend irrelevance theory," and it
confusion in Declaration, Ex-Dividend and
essentially indicates that an issuance of
Record Date Defined.)
dividends should have little to no impact on
stock price. That being said, many companies
4. Payment Date
do pay dividends, so let's look at how they do
Last is the payment date, the date on which
it.
the actual dividend is paid out to the
stockholders of record.
There are three main approaches to
dividends: residual, stability or a hybrid of the
Example: Dividend Payment
two.
Suppose Newco would like to pay a dividend
to its shareholders. The company would
Residual Dividend Policy
proceed as follows:
Companies using the residual dividend policy
choose to rely on internally
1. On Jan. 28, the company declares it will
generated equity to finance any new projects.
pay its regular dividend of $0.30 per share to
As a result, dividend payments can come out
holders of record as of Feb. 27, with payment
of the residual or leftover equity only after all
on Mar. 17.
project capital requirements are met. These
2. The ex-dividend date is Feb. 23 (usually
companies usually attempt to maintain
four days before of the holder-of-record date).
balance in their debt/equity ratios before
As of Feb. 23, new buyers do not have a right
making any dividend distributions, deciding on
to the dividend.
dividends only if there is enough money left
3. At the close of business on Feb. 27, all
over after all operating and expansion
holders of Newco's stock are recorded, and
expenses are met.
those holders will receive the dividend.
4. On Mar. 17, the payment date, Newco
For example, let's suppose that a company
named CBC has recently earned $1,000 and
has a strict policy to maintain a debt/equity
ratio of 0.5 (one part debt to every two parts
of equity). Now, suppose this company has a
project with a capital requirement of $900. In
order to maintain the debt/equity ratio of 0.5,
CBC would have to pay for one-third of this
project by using debt ($300) and two-thirds
($600) by using equity. In other words, the
company would have to borrow $300 and use
$600 of its equity to maintain the 0.5 ratio,
leaving a residual amount of $400 ($1,000 -
$600) for dividends. On the other hand, if the
project had a capital requirement of $1,500,
the debt requirement would be $500 and the
equity requirement would be $1,000, leaving
zero ($1,000 - $1,000) for dividends. If any
project required an equity portion that was
greater than the company's available levels,
the company would issue new stock.
Typically, this method of dividend payment
creates volatility in the dividend payments that
some investors find undesirable.
The residual-dividend model is based on
three key pieces: an investment opportunity
schedule (IOS), a target capital structure and
a cost of external capital.
1. The first step in the residual dividend model
to set a target dividend payout ratio to
determine the optimal capital budget.
2. Then, management must determine the
equity amount needed to finance the optimal
capital budget. This should be done primarily
through retained earnings.
3. The dividends are then paid out with the
leftover, or residual, earnings. Given the use
of residual earnings, the model is known as
the "residual-dividend model."
A primary advantage of the dividend-residual
model is that with capital-projects budgeting,
the residual-dividend model is useful in
setting longer-term dividend policy. A
significant disadvantage is that dividends may
be unstable. Earnings from year to year can
vary depending on business situations. As
such, it is difficult to maintain stable earnings
and thus a stable dividend. While the
residual-dividend model is useful for longer-
term planning, many firms do not use the
model in calculating dividends each quarter.
Dividend Stability Policy
The fluctuation of dividends created by the
residual policy significantly contrasts with the
certainty of the dividend stability policy. With
the stability policy, quarterly dividends are set
at a fraction of yearly earnings. This policy
reduces uncertainty for investors and
provides them with income.
Suppose our imaginary company, CBC,
earned $1,000 for the year (with quarterly
earnings of $300, $200, $100 and $400). If
CBC decided on a stable policy of 10% of
yearly earnings ($1,000 x 10%), it would pay
$25 ($100/4) to shareholders every quarter.
Alternatively, if CBC decided on a cyclical
policy, the dividend payments would adjust
every quarter to be $30, $20, $10 and $40,
respectively. In either instance, companies
following this policy are always attempting to
share earnings with shareholders rather than
searching for projects in which to invest
excess cash.
Hybrid Dividend Policy
The final approach is a combination between
the residual and stable dividend policy. Using
this approach, companies tend to view the
debt/equity ratio as a long-term rather than a
short-term goal. In today's markets, this
approach is commonly used by companies
that pay dividends. As these companies will
generally experience business cycle
fluctuations, they will generally have one set
dividend, which is set as a relatively small
portion of yearly income and can be easily
maintained. On top of this set dividend, these
companies will offer another extra dividend
paid only when income exceeds general
levels.
Real-World
Factors
Affecting
Dividend
Payouts
Real-World Factors Affecting Low
Dividend Payouts
As we mentioned earlier, some financial
analysts feel that the consideration of
a dividend policy is irrelevant. They contend
that investors have the ability to create
"homemade" dividends by adjusting their
personal portfolios to reflect their own
preferences. For example, investors looking
for a steady stream of income are more likely
to invest in bonds (in which interest payments
don't change) than in a dividend-paying stock
(in which value can fluctuate). Because their
interest payments won't change, those who
own bonds don't care about a particular
company's dividend policy. The second
argument claims that little to no dividend
payout is more favorable for investors.
Supporters of this policy point out that
taxation on a dividend is higher than on
a capital gain. The argument against
dividends is based on the belief that a firm
that reinvests funds (rather than paying them
out as dividends) will increase the value of the
firm as a whole and consequently increase
the market value of the stock. When investors
sell, they profit from a lower-taxed capital
gain. According to the proponents of the no-
dividend policy, investors benefit more in the
long run from the company's undertaking
more projects, repurchasing its own shares,
acquiring new companies and profitable
assets, and reinvesting in financial assets.
(Keep reading about capital gains in Tax
Effects On Capital Gains.)
A third argument in favor of low dividends is
the high cost to a firm of issuing new stock. In
other words, to avoid the need to raise money
through the issuance of new stock, which is
expensive, firms should retain most or all of
their earnings and pay little to no dividends to
investors.
Real-World Factors Affecting High
Dividend Payouts
In opposition to these three arguments is the
idea that a high dividend payout is important
for investors because dividends provide
certainty about the company's financial well-
being; dividends are also attractive for
investors looking to secure current income.
In addition, there are many examples of how
the decrease and increase of a dividend
distribution can affect the price of a security.
 Companies that have a long-standing history
of stable dividend payouts would be
negatively affected by lowering or omitting
dividend distributions; on the other hand,
these companies would be positively affected
by increasing dividend payouts or making
additional payouts of the same dividends.
Furthermore, companies without a dividend
history are generally viewed favorably when
they declare new dividends. (For more,
see Dividends Still Look Good After All These
Years.
Stock repurchase
Stock repurchase may be viewed as an
alternative to paying dividends in that it is another
method of returning cash to investors. A stock
repurchase occurs when a company asks
stockholders to tender their shares for
repurchase by the company. There are several
reasons why a stock repurchase can increase
value for stockholders. First, a repurchase can be
used to restructure the company's capital
structure without increasing the company's debt
load. Additionally, rather than a company
changing its dividend policy, it can offer value to
its stockholders through stock repurchases,
keeping in mind that capital gains taxes are lower
than taxes on dividends.
Advantages of a Stock Repurchase
Many companies initiate a share repurchase at a
price level that management deems a good entry
point. This point tends to be when the stock is
estimated to be undervalued. If a company
knows its business and relative stock price well,
would it purchase its stock price at a high level?
The answer is no, leading investors to believe
that management perceives its stock price to be
at a low level.
Unlike a cash dividend, a stock repurchase gives
the decision to the investor. A stockholder can
choose to tender his shares for repurchase,
accept the payment and pay the taxes. With a
cash dividend, a stockholder has no choice but to
accept the dividend and pay the taxes.
At times, there may be a block of shares from
one or more large shareholders that could come
into the market, but the timing may be unknown.
This problem may actually keep potential
stockholders away since they may be worried
about a flood of shares coming onto the market
and lessening the stock's value. A stock
repurchase can be quite useful in this situation.
Disadvantage of a Stock Repurchase
From an investor's perspective, a cash dividend
is dependable; a stock repurchase, however, is
not. For some investors, the dependability of the
dividend may be more important. As such,
investors may invest more heavily in a stock with
a dependable dividend than in a stock with less
dependable repurchases.
In addition, a company may find itself in a
position where it ends up paying too much for the
stock it repurchases. For example, say a
company repurchases its shares for $30 per
share on June 1. On June 10, a major hurricane
damages the company's primary operations. The
company's stock therefore drops down to $20.
Thus, the $10-per-share difference is a lost
opportunity to the company.
Overall, stockholders who offer their shares for
repurchase may be at a disadvantage if they are
not fully aware of all the details. As such, an
investor may file a lawsuit with the company,
which is seen as a risk.
Price Effect of a Stock Repurchase
A stock repurchase typically has the effect of
increasing the price of a stock.
Example: Newco has 20,000 shares outstanding
and a net income of $100,000. The current stock
price is $40. What effect does a 5% stock
repurchase have on the price per share of
Newco's stock?
Answer: To keep it simple, price-per-earnings
ratio (P/E) is the valuation metric used to value
Newco's price per share.
Newco's current EPS = $100,000/20,000 = $5
per share
P/E ratio = $40/$5 = 8x
With a 2% stock repurchase, the following
occurs:
Newco's shares outstanding are reduced to
19,000 shares (20,000 x (1-.05))
Newco's EPS = $100,000/19,000 = $5.26
Given that Newco's shares trade on eight times
earnings, Newco's new share price would be $42,
an increase from the $40 per share before the
repurchase. (Read more about stock
repurchases in Market News That Seems
Promising But Isn't and Top Perks Warren Buffett
Gets When Purchasing Equities.)
Stock Dividends
And Stock Splits
Like cash dividends, stock dividends and stock
splits also have effects on a company's stock
price. Stock Dividends
Stock dividends are similar to cash dividends;
however, instead of cash, a company pays out
stock. As a result, a company's shares
outstanding will increase, and the company's
stock price will decrease. For example, suppose
Newco decides to issue a 10% stock dividend.
Each current stockholder will thus have 10%
more shares after the dividend is issued.
Stock Splits
Stock splits occur when a company perceives
that its stock price may be too high. Stock splits
are usually done to increase the liquidity of the
stock (more shares outstanding) and to make it
more affordable for investors to buy regular lots
(a regular lot = 100 shares). Companies tend to
want to keep their stock price within an optimal
trading range.
Stock splits increase the number of shares
outstanding and reduce the par or stated value
per share of the company's stock. For example, a
two-for-one stock split means that the company
stockholders will receive two shares for every
share they currently own. The split will double the
number of shares outstanding and reduce by half
the par value per share. Existing shareholders
will see their shareholdings double in quantity,
but there will be no change in the proportional
ownership represented by the shares. For
example, a shareholder owning 2,000 shares out
of 100,000 before a stock split would own 4,000
shares out of 200,000 after a stock split.
Stock Split Example:
Suppose Newco's stock reaches $60 per share.
The company's management believes this is too
high and that some investors may not invest in
the company as a result of the initial price
required to buy the stock. As such, the company
decides to split the stock to make the entry point
of the shares more accessible.
For simplicity, suppose Newco initiates a 2-for-1
stock split. For each share they own, all holders
of Newco stock will receive two Newco shares
priced at $30 each, and the company's shares
outstanding will double. Keep in mind that the
company's overall equity value remains the
same. Say there are one million shares
outstanding and the company's initial equity value
is $60 million ($60 per share x 1 million shares
outstanding). The equity value after the split is
still $60 million ($30 per share x 2 million shares
outstanding).
While stock prices will most likely rise after a split
or dividend (remember price increases are
caused by positive signals a company generates
with respect to future earnings), if positive news
does not follow, the company's stock price will
generally fall back to its original level. Some
investors think that stock splits and stock
dividends are unnecessary and do little more
than create more stocks. (For further reading on
stock splits, see Berkshire's Stock Splits: Good
Buy or Goodbye? and Top Stock Target Price
Misfires.)
Dividend Policy
What is a 'Dividend Policy'
A dividend policy is the policy a company uses to
decide how much it will pay out to shareholders
in the form of dividends. Some research and
economic logic suggests that dividend policy may
be irrelevant (in theory), but many investors rely
on dividends as a vital source of income.
BREAKING DOWN 'Dividend
Policy'
Because dividends represent a form of income
for investors, a company's dividend policy is an
important consideration for some investors. As
such, it is an important consideration for
company leadership, especially because
company leaders are often the largest
shareholders and have the most to gain from a
generous dividend policy. Most companies view a
dividend policy as an integral part of the
corporate strategy. Management must decide on
the dividend amount, timing and various other
factors that influence dividend payments over
time. There are three types of dividend policies: a
stable dividend policy, a constant dividend policy
and a residual dividend policy.
Stable Dividend Policy
The stable dividend policy is the easiest and
most commonly used policy. The goal of the
policy is to aim for steady and predictable
dividend payouts every year, which is what most
investors are seeking. When earnings are up,
investors receive a dividend. When earnings are
down, investors receive a dividend. The goal is to
align the dividend policy with the long-term
growth of the company rather than with quarterly
earnings volatility. This approach allows the
shareholder to have more certainty around the
amount and timing of the dividend.
Constant Dividend Policy
The primary drawback of the stable dividend
policy is that, in booming years, investors may
not see a dividend increase. By contrast, under
the constant dividend policy, a percentage of the
company's earnings are paid every year. In this
way, investors experience the full volatility of
company earnings. If earnings are up, investors
get a larger dividend; if earnings are down,
investors may not receive a dividend. The
primary drawback to the method is the volatility of
earnings and dividends. It is difficult to plan when
dividend income is highly volatile.
Residual Dividend Policy
A residual dividend policy is also highly volatile,
but for some investors, it is the only acceptable
dividend policy that a company should have. In a
residual dividend policy the company pays out
what's left after it pays for capital expenditures
and working capital needs. This approach is
volatile, but it makes the most sense in terms of
business operations. Investors don't want to
invest in a company that justifies its increased
debt with the need to pay dividends.
Dividend
A dividend is a distribution of a portion of a
company's earnings, decided by the board of
directors, to a class of its shareholders.
Dividends can be issued as cash payments, as
shares of stock, or other property.
BREAKING DOWN 'Dividend'
The dividend rate may be quoted in terms of the
dollar amount each share receives (dividends per
share, or DPS), or It can also be quoted in terms
of a percent of the current market price, which is
referred to as the dividend yield.
A company's net profits can be allocated
to shareholders via a dividend, or kept within the
company as retained earnings. A company may
also choose to use net profits to repurchase their
own shares in the open markets in a share
buyback. Dividends and share buy-backs do not
change the fundamental value of a company's
shares. Dividend payments must be approved by
the shareholders and may be structured as a
one-time special dividend, or as an ongoing cash
flow to owners and investors.
Mutual fund and ETF shareholders are often
entitled to receive accrued dividends as
well. Mutual funds pay out interest and dividend
income received from their portfolio holdings as
dividends to fund shareholders. In addition,
realized capital gains from the portfolio's trading
activities are generally paid out (capital gains
distribution) as a year-end dividend.
The dividend discount model, or Gordon growth
model, relies on anticipated future dividend
streams to value shares.
Companies That Issue
Dividends
Start-ups and other high-growth companies such
as those in the technology or biotechnology
sectors rarely offer dividends because all of their
profits are reinvested to help sustain higher-than-
average growth and expansion. Larger,
established companies tend to issue regular
dividends as they seek to maximize shareholder
wealth in ways aside from supernormal growth.
Companies in the following sectors and industries
have among the highest historical dividend
yields: basic materials, oil and gas, banks and
financial, healthcare and
pharmaceuticals, utilities, and REITS.
Arguments for Issuing
Dividends
The bird-in-hand argument for dividend policy
claims that investors are less certain of receiving
future growth and capital gains from the
reinvested retained earnings than they are of
receiving current (and therefore certain) dividend
payments. The main argument is that investors
place a higher value on a dollar of current
dividends that they are certain to receive than on
a dollar of expected capital gains, even if they are
theoretically equivalent.
In many countries, the income from dividends is
treated at a more favorable tax rate than ordinary
income. Investors seeking tax-advantaged cash
flows may look to dividend-paying stocks in order
to take advantage of potentially favorable
taxation. The clientele effect suggests especially
those investors and owners in high marginal tax
brackets will choose dividend-paying stocks.
If a company has a long history of past dividend
payments, reducing or eliminating the dividend
amount may signal to investors that the company
could be in trouble. An unexpected increase in
the dividend rate might be a positive signal to the
market.
Dividend Payout Policies
A company that issues dividends may choose the
amount to pay out using a number of methods.
Stable dividend policy: Even if corporate
earnings are in flux, stable dividend
policy focuses on maintaining a steady
dividend payout.
Target payout ratio: A stable dividend
policy could target a long-run dividend-to-
earnings ratio. The goal is to pay a stated
percentage of earnings, but the share
payout is given in a nominal dollar amount
that adjusts to its target at the earnings
baseline changes.
Constant payout ratio: A company pays
out a specific percentage of its earnings
each year as dividends, and the amount
of those dividends therefore vary directly
with earnings.
Residual dividend model: Dividends are
based on earnings less funds the
firm retains to finance the equity portion of
its capital budget and any residual profits
are then paid out to shareholders.
Dividend Irrelevance
Economists Merton
Miller and Franco Modigliani argued that a
company's dividend policy is irrelevant, and it has
no effect on the price of a firm's stock or its cost
of capital. Assume, for example, that you are a
stockholder of a firm and you don't like
its dividend policy. If the firm's cash dividend is
too big, you can just take the excess
cash received and use it to buy more of the firm's
stock. If the cash dividend you received was too
small, you can just sell a little bit of your existing
stock in the firm to get the cash flow you want. In
either case, the combination of the value of your
investment in the firm and your cash in hand will
be exactly the same. When they conclude that
dividends are irrelevant, they mean that investors
don't care about the firm's dividend policy
since they can create their own synthetically.
It should be noted that the dividend irrelevance
theory holds only in a perfect world with no taxes,
no brokerage costs, and infinitely divisible
shares.
Forward
Dividend Yield
A forward dividend yield is an estimation of a
year's dividend expressed as a percentage of
current stock price. The year's projected dividend
is measured by taking a stock's most recent
actual dividend payment and annualizing it.
Forward dividend yield is calculated by dividing a
year's worth of future dividend payments by a
stock's current share price.
BREAKING DOWN 'Forward
Dividend Yield'
For example, if a company pays a Q1 dividend of
25 cents and you assume the company's
dividend will be consistent, then the firm will be
expected to pay $1.00 in dividends over the
course of the year. If the stock price is $10, the
forward dividend yield is 10%.
The opposite of a forward dividend yield is
a trailing dividend yield, which shows a
company's actual dividend payments relative to
its share price over the previous 12 months.
When future dividend payments are not
predictable, trailing dividend yield can be a better
measure of value. When future dividend
payments are predictable or have been
announced, forward dividend yield is a more
accurate tool.
Dividend Rate
The dividend rate is the total amount of the
expected dividend payments from an investment,
fund or portfolio expressed on an annualized
basis plus any additional non-recurring dividends
that may be received during that period.
Depending on the company's preferences and
strategy, the dividend rate can be fixed or
adjustable.
BREAKING DOWN 'Dividend
Rate'
The dividend rate of an investment, fund or
portfolio is calculated by multiplying the most
recent periodic dividend payments by the number
of periods in one year. For example, if a fund of
investments pays a dividend of 50 cents on a
quarterly basis and pays an extra dividend of 12
cents per share because of a non-recurring event
from which the company benefited, the dividend
rate is $2.12 ($0.50 x 4 + $0.12) per year.
Dividends are generally paid out by companies
that generate stronger cash flows. Companies
that are growing rapidly typically reinvest any
cash generated back into the business, and they
don't pay out any dividends to shareholders.
Cash-intensive businesses like consumer staples
and utilities don't usually need to spend a lot
investing in growing their companies, so they can
distribute a percentage of income to shareholders
as dividends.
Dividend Payout Ratio
Companies that pay dividends often prefer to
maintain or slowly grow their dividend rates as a
demonstration of stability and as a means of
rewarding shareholders. Companies that cut their
dividends may be entering a financially weaker
state that, in many cases, is accompanied by a
drop in the stock price.
The dividend payout ratio is one way to assess
the strength of a company's dividend. It's
calculated as the dividend rate dividend by
earnings per share (EPS) over a 12-month time
period. Lower payout ratios are preferable, since
it means less of a company's net income is going
towards dividend payments. These dividends are
generally considered to be more sustainable.
Conversely, companies with high payout ratios
may have more trouble maintaining dividend
payments.
Dividend Aristocrats
Income-seeking investors often look to
companies with long histories of steadily growing
dividend payments. A dividend aristocrat is a
company that has raised its dividend for at least
25 straight years.
Dividend aristocrats typically come from sectors
that experience steady demand in different
economic environments. Companies engaged in
utility services, consumer goods and food
production are the most likely to have the means
to grow dividend rates continuously. As of May
31, 2016, a total of 108 companies meet the
dividend aristocrat definition. American States
Water Company (NYSE: AWR) is the longest-
tenured dividend aristocrat, with 61 consecutive
years of increased dividends.
Accelerated
Dividend
Special dividends paid by a company ahead of
an imminent change in the treatment of
dividends, such as an adverse change in
dividend taxation. Accelerated dividends from
U.S. companies came to the forefront in the
fourth quarter of 2012. During that period.
numerous companies expedited dividend
payments ahead of the January 1, 2013
expiration of the preferential 15% tax on dividend
income instituted by former President Bush in
2003. The concern was that as a consequence of
the fiscal cliff, the dividend tax rate could more
than double for taxpayers in the highest income
bracket.
BREAKING DOWN 'Accelerated
Dividend'
U.S. companies scrambled to pay accelerated
dividends in the fourth quarter of 2012, with total
special dividend announcements exceeding $31
billion, an increase of more than four times the
dividend payout made in the year-earlier period.
In November 2012 alone, 228 companies
announced special dividends, a more than three-
fold increase from the 72 companies that did so a
year earlier.
Many companies went to great lengths to
minimize the potential tax bill to their
shareholders. Some tactics included
consolidating future dividend payments into one
payout, and taking on debt to pay accelerated
dividends.
For example, the Washington Post accelerated
payment of all its 2013 dividends into one single
dividend payout made in December 2012.
Seaboard Corp accelerated its $3 annual
dividend for the 2013-2016 period and made a
single consolidated dividend payment on
December 28, 2012. Oracle accelerated its
dividend payments for the first three quarters of
2013, consolidating its quarterly dividend of 6
cents per share into one payment of 18 cents
paid on December 21, 2012. Oracle CEO Larry
Ellison, who owned 1.1 billion Oracle shares at
the time, received close to $200 million from the
accelerated dividend payment, saving over $50
million in federal income taxes. Costco paid out a
special dividend of $7 per share for a total of $3
billion, and funded it by taking on $3.5 billion in
debt.
Fears that the tax rate on dividends could soar
from 15% to over 40% for high-income taxpayers
subsequently proved to be unfounded. Thanks to
the last-minute fiscal cliff deal signed in January
2013, the top marginal tax rate on dividend
income was set at 20% for taxpayers with
adjusted gross income of $200,000 or more (the
threshold is $250,000 if married and filing jointly).
Indicated Yield
The dividend yield that a share of stock would
return based on its current indicated dividend.
Indicated yield is calculated by dividing the most
recent dividend multiplied by the number of
dividend payments each year (the indicated
dividend) by the current share price, and is
usually quoted as a percentage:
Stock ABC's most recent quarterly dividend, for
example, might be $4. If the stock is currently
trading at $100, the indicated yield would be:
Indicated Yield of Stock ABC = $4 X 4 / $100 =
16%
A dividend is a distribution of a portion of a
company's earnings, usually quoted in terms of
the dollar amount each share receives (such as
25 cents per share). The indicated yield is often
used as a forecasting technique to estimate a
stock's annual dividend yield or the
yearly earnings investors can expect for a
particular stock. Many stock tables included in
financial newspapers, such as the Wall Street
Journal, include the indicated dividend of each
stock to alert investors to the annual cash returns
they might be able to expect. Because common
stock dividends can change, instead of remain
constant, (stockholders may receive larger
dividends if earnings rise or smaller dividends if
earnings drop, for example) the indicated yield is
an estimate only.
Interim Dividend
An interim dividend is a dividend payment made
before a company's AGM and final financial
statements. This declared dividend usually
accompanies the company's interim financial
statements. This is used more frequently in the
United Kingdom, where it is usual for dividend
payments to occur semi-annually. The interim
dividend is generally the smaller of the two
payments made to shareholders.
BREAKING DOWN 'Interim
Dividend'
There are two main ways that investors can
invest in a company, through bonds or stocks.
Bonds pay a set rate of interest, and investors
have seniority over shareholders in case of
bankruptcy, but they don't give investors the
ability to participate in share price appreciation.
Stocks don't pay interest, but some do pay
dividends. Dividends also allow shareholders to
benefit from earnings growth through both interim
and final dividends as well as share price
appreciation. An interim dividend is declared by
directors and subject to shareholder approval. By
contrast, a normal, or final dividend is voted on
and approved at the annual general meeting
(AGM) once earnings are known. Both interim
and regular, or final, dividends can be paid out in
cash and/or stock.
Final vs. Interim Dividends
Dividends are paid out per share owned. For
example, if you own 100 shares of company A,
and company A pays out $1 in dividends every
year, you will receive $100 in dividend income
every year. If company A doubles their dividend it
means they will pay out $2 per share and you will
get $200 annually. Final dividends are
announced and paid out on an annual basis
along with earnings. That is, final or regular
dividends are announced after earnings are
determined. Interim dividends, however, are paid
out of retained earnings, not current earnings.
Retained earnings can also be thought of as
undistributed profits. As such, these dividends
are generally paid on a quarterly or six-month
basis, prior to the end of the year. Interim
dividends are paid every six months in the UK,
and every three months in the United States.
Companies generally declare and distribute an
interim dividend during an exceptional earnings
season or when legislation makes it more
advantageous to do so.
A final or regular dividend can be a set amount
every quarter, six months, or a year. It can be a
percentage of net income or earnings. It can also
be paid out of the earnings leftover after the
company pays for capital expenditures and
working capital. The dividend policy or strategy
used is dependent on management's goals and
intentions for shareholders. Interim dividends can
follow the same strategy as final dividends, but
since interim dividends are paid out before the
end of the fiscal year the financial statements that
accompany interim dividends are unaudited.
Residual Dividend
A residual dividend is a dividend policy company
management uses to fund capital expenditures
with available earnings before paying dividends
to shareholders, and this policy creates
more volatility in the dollar amount of dividends
paid to investors each year. The first priority is to
use earnings to cash flow capital expenditures,
and dividends are paid with any remaining
earnings generated by the firm.
BREAKING DOWN 'Residual
Dividend'
A companys capital structure typically includes
both long-term debt and equity, and a capital
expenditure can be financed by taking out a loan
or by issuing more stock.

How Companies Use Earnings
When a business generates earnings, the firm
can either retain the earnings for use in the
company or pay the earnings as a dividend to
stockholders, and retained earnings are used to
fund current business operations or to buy
assets. Every company needs assets to operate,
and those assets may need to be upgraded over
time and eventually replaced. Business
managers must consider the assets needed to
operate the business and the need to reward
shareholders by paying a dividend.
Factoring in Residual Dividends
Assume that a clothing manufacturer maintains a
list of capital expenditures that are required in
future years and that the firm needs $100,000 in
the current month to upgrade machinery and buy
a new piece of equipment. The firm generates
$140,000 in earnings for the month and spends
$100,000 on capital expenditures. The remaining
income of $40,000 is paid as a residual dividend
to shareholders, which is $20,000 less than was
paid in each of the last three months.
Shareholders may be upset when management
chooses to lower the dividend payment, and
senior management needs to explain the
importance of capital spending to justify the lower
payment.
Examples of Return on Assets
While shareholders may accept managements
strategy of using earnings for capital
expenditures, the investment community
analyzes how well the firm uses asset spending
to generate more income. The return on asset
(ROA) formula is net income divided by total
assets, and ROA is a common tool used to
assess managements performance. If the
clothing manufacturer makes smart spending
decision with the $100,000, the company can
increase production or operate machinery at a
lower cost, and both of these factors can increase
profits. As net income increases, the ROA ratio
improves, and shareholders may be more willing
to accept the residual dividend policy moving
forward. However, if the firm generates lower
earnings and continues to fund capital
expenditures at the same rate, shareholder
dividends decline.
Accumulated
Dividend
A dividend on a share of cumulative preferred
stock that has not yet been paid to
the shareholder. Accumulated dividends are the
result of dividends that are carried forward from
previous periods and shareholders of cumulative
preferred stock receive dividends before any
other shareholders.
BREAKING DOWN
'Accumulated Dividend'
Preferred stock can either be "non-cumulative",
which is traditionally the case or "cumulative"
when it comes to dividends. Non-cumulative
shares are entitled to dividends only if dividends
are declared. Some investors may want a
guaranteed return on a preferred stock. A
cumulative preferred stock allows the investor to
earn dividends regardless of the
company's ability to pay them immediately or in
the future. In some instances, when some
companies are not in a financial position to pay
a dividend during a certain year, accumulated
dividends are created. These dividends must be
paid before any other dividends can be paid.
Constructive
Dividend
A concept in U.S. taxation in which
various distributions to shareholders are not
labeled as dividends but are still considered
dividends by the IRS and taxed as such.
Constructive dividends are most commonly found
in companies in which the employees are also
the shareholders. You can think of a
constructive dividend as an undeclared dividend
by the company that involves the use of
corporate assets.
BREAKING DOWN
'Constructive Dividend'
For example, in many small companies,
employees who are also shareholders may
borrow money from the company to buy personal
items. This loan may be classified by the IRS as
a constructive dividend and must be reported on
the tax return of the shareholder. In addition, the
company would not be able to take
a deduction for the constructive dividend.
Funadmaental analysis
It is a quatittavi and cualitative view. Introduce the
subject of intrisic value adn conclude with some
of the downfalls of using this tcnique.
It attemps to detemrine a security's value by
focusing on underlying factors that affect a
company's actual business and its future
prospects. On a broader scope, you can
perform fundamental analysis on industries or
the economy as a whole.
fundamelta viw-refers to the analysis of the
economic well-being of a financial entity as
opposed to only its price movements.
Fundamental analysis serves to answer
questions, such as:
Is the company's revenue growing?
Revenue
Is it actually making a profit? profit
Is it in a strong-enough position to beat
out its competitors in the future?
Beat competitors in the future
Is it able to repay its debts? liquidity
and solvence in debts.
Is management trying to "cook the
books"?managmente
: Is the company's stock a good investment?
Think of FA as a toolbox to help you answer
this question.
Note: The term fundamental analysis is used
most often in the context of stocks, but you can
perform fundamental analysis on any security,
from a bond to a derivative. As long as you
look at the economic fundamentals, you are
doing fundamental analysis.
Fundamentals: Quantitative and Qualitative
You could define fundamental analysis as
"researching the fundamentals", but that
doesn't tell you a whole lot unless you know
what fundamentals are. As we mentioned in the
introduction, the big problem with defining
fundamentals is that it can include anything
related to the economic well-being of a
company. Obvious items include things like
revenue and profit, but fundamentals also
include everything from a company's market
share to the quality of its management.
The various fundamental factors can be
grouped into two categories: quantitative and
qualitative. The financial meaning of these terms
isn't all that different from their regular definitions.
Here is how the MSN Encarta dictionary defines
the terms:
Quantitative capable of being
measured or expressed in numerical
terms characteristics of the
Qualitative related to or based on the
quality or character of something, often
as opposed to its size or quantity.
In our context, quantitative fundamentals are
numeric, measurable characteristics about a
business. Quntitative methods are more with
great precision.
Turning to qualitative fundamentals, these are
the less tangible factors surrounding a
business - things such as the quality of a
company's board members and key
executives, its brand-name
recognition, patents or proprietary
technology.
Quantitative Meets Qualitative
Neither qualitative nor quantitative analysis is
inherently better than the other. Instead, many
analysts consider qualitative factors in
conjunction with the hard, quantitative
factors. Take the Coca-Cola Company, for
example. When examining its stock, an analyst
might look at the stock's annual dividend
payout, earnings per share, P/E ratio and
many other quantitative factors. However, no
analysis of Coca-Cola would be complete
without taking into account its brand
recognition,but few companies on earth are
recognized by billions of people. It's tough to
put your finger on exactly what the Coke brand
is worth, but you can be sure that it's an
essential ingredient contributing to the
company's ongoing success.
The Concept of Intrinsic Value
Asumptions:
I). the price on the stock market does not fully
reflect a stock's "real" value. In financial
jargon, this true value is known as the intrinsic
value.
II)In the long run, the stock market will reflect
the fundamentals. There is no point in buying a
stock based on intrinsic value if the price
never reflected that value. Nobody knows how
long "the long run" really is. It could be days
or years.
By focusing on a particular business, an
investor can estimate the intrinsic value of a
firm and thus find opportunities where to buy
at a discount. If all goes well, the investment will
pay off over time as the market catches up to
the fundamentals.
The big unknowns are:
1)You don't know if your estimate of intrinsic
value is correct; and
2)You don't know how long it will take for the
intrinsic value to be reflected in the
marketplace.
Criticisms of Fundamental Analysis
The biggest criticisms from two groups:
proponents of technical analysis and believers of
the "efficient market hypothesis".
1)Technical analysis is the other major form of
security analysis.
Put simply, technical analysts base their
investments (or, more precisely, their trades)
solely on the price and volume movements of
securities. Using charts and a number of other
tools, they trade on momentum, not caring
about the fundamentals.
tenets of technical analysis is that the market
discounts everything. Accordingly, all news
about a company already is priced into a
stock, and therefore a stock's price
movements give more insight than the
underlying fundamental factors of the
business itself.
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analysis would be almost immediately
(reducidas)whittled away by the market's Unlocking the vault for shareholders
many participants, making it impossible for Most banks profit margins should rise with
interest rates, but some stocks will get a
anyone to meaningfully outperform the market
bigger jolt than others.
over the long term.

he companies with the most skin in the
game are banks, whose profit margins
generally improve as rates riseand whose
stocks have recently soared in anticipati
says. That may not boost revenue next year
at Pentair, which focuses on filtering and
pumping water for residential and
industrial customers. But Ahlsten expects
Pentair to grow earnings 15% in 2017,
thanks to aggressive cost cutting

NEW SPENDING BOOM

Exuberance again in the U.S.

These companies could benefit from confident
consumers and federal stimulus spending.

loser to home, a pickup in the U.S.

economy, combined with renewed calls for
greater infrastructure investment, bodes
well for companies like Pentair (PNR,
-0.74%), a w
We think theres going to be a long-term
supercycle of water investment that
supersedes any economic cycle, Ahlsten
7. IBM (IBM)

By Benjamin Lau, CFA

Cloud, A.I. and mobility will drive Big

Blue back to glory in 2017.

IBM (IBM) is a turnaround story. Big

Blue is transforming its business to
meet the needs of the new era of
cloud, mobility, security, and artificial
intelligence. IBMs transformation had
begun to show some improvements in
2015. It gained momentum in 2016. I
think it will continue to bear fruit over
the next few years and lead to higher
revenues and profitability

The company has spent a tremendous

amount of money to invest in these areas
more than $5 billion in acquisitions in
2016, alone. These initiatives saw
accelerating growth of 16% in Q3 2016 and
now accounts for more than 40% of overall
firm revenues. One of IBMs most popular
products now is its artificial intelligence
platform, Watson, the same system that
beat two human contestants on Jeopardy!
4. Independence Realty Trust
(IRT)
By Brett Ewing
The run-up in interest rates has
caused a short-term rout across real
estate investment trusts, REITs.
Apartment REITs have been especially
hit. Most are more than 20% below
their 52-week highs.
The catalyst for Independence Realty
Trust (IRT) in 2017 lies in its necessity
for an equity raise. For years now, IRT
has been held down by the fact that it
pays fees to an external advisor
based on a number of assets under
management inside of the REIT.
Investors always rightly worry about
conflicts of interest with a REIT that is
externally managed and whose
incentives lie in buying as much as
possible, not making as much as
possible for shareholders.
This fact has made it a tougher sell to
many institutions. Thus it has
languished towards the very bottom
of the category regarding earnings
multiples. IRT raised the equity to buy
out the external manager and create
an internal team that is aligned with
shareholder interests.
Funds from operations, or FFO, is the
preferred earnings metric for REITs
instead of earnings per share (EPS),
which is used to evaluate non-real
estate stocks. Out of all the
companies in the apartment REIT
industry, there isn't a single one that
trades at less than a 15x price/FFO
ratio that is internally managed. The
average across the industry is 20x
price/FFO for 2016. Independence
trades for around 10x price/FFO.
IRT's dividend also sets itself apart
from the rest. At its current yield of
over 8%, it is more than double the
next closest internally managed
apartment REIT. Even if it dropped its
dividend down to a more respectable
payout ratio that was in-line with the
others in its space, it would still be
more than 25% higher than its closest
comps. Its ability to raise rents in the
Class B apartment space seems
positive for years to come because of
the solid employment environment
and rising income for middle-class
workers.
The biggest risks for IRT come from
interest rates rising and specifically
LIBOR (London Interbank Offered
Rate), which is directly tied to much of
IRT's debt. As it rises, the spread
between the net income the
properties produce and the debt
service required drops. This is typical
of most in the REIT space. But we
believe LIBOR will start to flatten out
toward the end of the first quarter of
2017 after inflationary outlooks
soften.
The internalization of IRT has created
a tradeable catalyst as the company
expands in the lucrative Class B
apartment space for years to come.
When the stigma of misalignment of
interests wears off, and investors
realize the discount valuations that
IRT offers in the growth phase of their
life cycle, the stock should perform
very favorably with a high margin of
safety.
Brett Ewing is the chief market
strategist at First Franklin Financial
Services with $110 million under
management in Tallahassee, Fla.
5. Forterra (FRTA)
By Eric Marshall
This recent IPO is a water
infrastructure products producer that
should see nice secular demand over
the next few years. Forterra (FRTA),
with roughly $1 billion in annual
revenues, has built a platform to add
additional infrastructure products.
Currently, there are few players
consolidating this industry. Forterra
could announce one or two accretive
acquisitions in the first half of 2017,
causing current street earnings
estimates to be revised up.
At Hodges Funds, we are especially
attracted to businesses that have high
barriers to entry. We
believe Forterra meets this criterion
due to the regional nature of shipping
large-diameter concrete pipe within a
100- to 150-mile radius from where it
is manufactured. As a result, Forterra
has limited competition within local
markets as well as rational pricing
power for its products.
Demand for water and drainage
products will be supported by the
replacement of aging public works
infrastructure across the entire
country. Management sees organic
demand growing at 6%-7% for
drainage in 2017, plus additional
growth from the Fast Act Money
requiring matching state funds of
$0.20 for each federal $1.00.
One negative is that Forterra has $1.1
billion of debt, which represents 4X its
enterprise value to EBITDA (earnings
before interest, taxes, depreciation
and amortization). We believe it will
reduce debt through cash flow over
the next couple of years, which should
support a higher P/E (price to
earnings) multiple for the stock.
Forterra trades at an attractive
valuation at just above 8X EV
(enterprise value)/EBITDA compared
to most cement and aggregate
players that are over 10X. Assuming
that Forterra is successful in
completing a couple of acquisitions in
the year ahead, the stock could trade
at $30 based on the valuations of
similar infrastructure stocks.
Eric Marshall is a portfolio manager at
Hodges Funds with $2.5 billion in
Dallas, Texas.
6. Dycom Industries (DY)
By Stephen DeNichilo, CFA
Dycom Industries (DY) is one of the
nations largest specialty contractors
whose business is driven by the
capital expenditure plans of the cable
and telecommunications industries. In
a market trading near all-time highs,
investors are best served by stocks
like Dycom that exhibit superior
organic growth attributes at
reasonable valuations with stock
prices below past peaks.
Dycom is the direct beneficiary of
what we see as a very long-term
trend. The U.S. is in the early innings
of a massive fiber-optic build-out in
response to ever-increasing demand
for lightning-fast internet speeds and
the exponential growth of data
consumption. Ask yourself a question:
Would you change internet providers
if a competitor offered consistently
faster service at a lower price?
Cable and telecom companies believe Inc. with $364.3 billion under
the answer is yes and have management in New York City.
embarked on a veritable arms race of
fiber-optic deployments. For Dycom,
that has translated to a consistent
organic growth of approximately 25%
and a backlog of work that is up 30%
year-over-year. These dramatic fiber
expenditures have allowed Dycom to What not t buy
achieve earnings per share growth
from $1.16/share in the fiscal year
2014 to near $5.00/share in 2016 a
trajectory we expect will continue.
Trading at less than 15x its fiscal year
2017 EPS, Dycom represents a rare
combination of growth and value in
this market.

Dycoms largest customer, AT&T(T),

illustrates the highly competitive
nature of the industry. Currently
serving under 3 million homes, AT&T
is committed to aggressively building
out its high-speed fiber network to
more than 12.5 million homes by
2019. Meanwhile, Comcast(CMCSA),
Charter, Verizon(VZ) and Altrice have
all publicly voiced a commitment to
faster speeds and increased
expenditures.

The stock has come under pressure

recently given worries that Google
(GOOGL), struggling to build its own
fiber network, will slow Dycoms
growth. At only 2% of revenues,
Google is merely a footnote. But the
Google noise may be creating an
attractive entry point into this multi-
year growth story.

Stephen DeNichilo, CFA, is portfolio Acciones de america latina

manager of Federated Investors, Acciones de PEru
1- Depsitos a plazo
Es la alternativa ms familiar y conservadora para las
personas, se denomina as al dinero que es custodiado
por las entidades financieras por un plazo
mayor de treinta das, a cambio de una tasa de
inters (rentabilidad). Estos son ofrecidos por los
bancos, las cajas municipales, las cajas rurales y las
financieras. El monto mnimo para ahorrar es
desde S/.50.
Estas instituciones financieras estn reguladas y
supervisadas por la Superintendencia de Banca,
Seguros y AFP (SBS). Los depsitos estn protegidos
por el Fondo de Seguro de Depsitos hasta S/.97.644.
A continuacin, muestro las entidades con mayor tasa
de rendimiento efectivo anual para depsitos en soles
a la fecha, puede verse que destacan las cajas rurales y
municipales.
2- Fondos Mutuos
Un fondo mutuo es el patrimonio integrado por
aportes de personas naturales y jurdicas para
su inversin en valores de oferta pblica y
bienes que la ley permita, que administra una
entidad financiera por cuenta y riesgo de los
aportantes.
El buen devenir de las bolsas de valores de lima y de
las principales bolsas a nivel mundial durante el 2016
ha tenido un buen impacto en los rendimientos
de los fondos mutuos locales, sobre todo los de
renta variable (acciones). Aqu muestro los
fondos con mejores rendimientos durante el 201
e fondos mutuos en el mercado, desde los
conservadores hasta agresivos, lo ideal siempre es
invertir de acuerdo al perfil de riesgo del
inversionista.
3- Mercado de valores
La inversin en Bolsa de valores directamente
puede generar una mayor rentabilidad pero
tambin conlleva mayor riesgo, la compra
directa de acciones se realiza a travs de una sociedad
agente de bolsa.
La Bolsa de valores de Lima durante el 2016,
segn su ndice IGBVL rindi un 59%, siendo la
segunda bolsa de Amrica latina con mayor
rendimiento. Si nos ponemos un poco ms
internacionales, el ndice S&P500, el ndice
representativo de la bolsa americana ha
rendido 80% en los ltimos 5 aos.
Si invirtiera en Bolsa que acciones o en que
sectores debera fijarme para este 2017?
Esta es la pregunta del milln y requiere un anlisis
ms exhaustivo, por ello hoy mencionare solamente
un sector que veo que tiene un alto potencial de
crecimiento para los siguientes aos, el sector
de robtica y automatizacin.
Despus de la aparicin del Internet- hace poco
ms de 15 aos- los rpidos avances en
tecnologa, tales como la visin artificial,
sensores de movimiento y el reconocimiento de
imgenes y de voz, estn permitiendo a los
robots realizar trabajos cada vez ms
sofisticados y delicados en la industria. Esto ampla
su uso a una increble variedad de industrias y
aplicaciones, concretamente, en sectores
como la produccin, servicios y exploracin,
incluso en la industria automotriz donde est
creciendo mucho la participacin robtica.
Aqu muestro el grfico de un Fondo que invierte en
empresas del sector de robtica:
Fuente: www.morningstar.es
Este fondo llamado Robotics and Automation
ndex(solo tiene 3 aos desde su creacin), es
un ETF que cotiza en la Bolsa del Nasdaq y est
compuesto por empresas que fabrican fsicamente
robots y mquinas de automatizacin, hasta
compaas especializadas en los diferentes
tipos de software y tecnologa que permiten la
automatizacin
Qu es un ETF?
El ETF -Exchange Traded Fund por sus siglas en
ingls- o fondo negociable, es un producto financiero
que opera como un portafolio o fondo que cotiza
en una bolsa de valores y cuyo precio refleja
en todo momento el valor de los activos que
componen dicho fondo o portafolio de inversin. En
este sentido, un ETF puede estar formado por valores
de una regin, un pas, una industria o un
sector especfico.
Los ETFs han ganado mucha popularidad en los
ltimos aos, entre sus ventajas destacan 3
caractersticas:
1- Diversificacin.
Los ETFs permiten invertir en un fondo compuesto
por varios activos subyacentes, por ejemplo, el
ETF SPDR replica el comportamiento del
ndice accionario S&P500, o el ETF CRB que
est formado por materias primas y
commodities. Adems, existen fondos que agrupan
sectores industriales y que estn compuestos
exclusivamente por compaas del sector
petrolero, el de automviles o el sector tecnolgico,
por citar ejemplos.
2- Simplicidad.
Los ETFs cotizan en mercados centralizados,
conocidos como Bolsas de Valores, y su precio
flucta conforme a la variacin de los activos
subyacentes que componen el fondo cotizado. En
este sentido, comprar un ETF es tan sencillo
como comprar una simple accin, y el
inversionista puede realizar un seguimiento
diario de su fondo con suma facilidad, adems
de ello el ETF permite utilizar estrategias de
selling o venta corta, con lo cual incluso en
pocas de fuertes cadas en los mercados
puede generar rentabilidad.
3- Menores costos de transaccin.
Los ETFs son ms competitivos que un fondo mutuo
comn, dado que tienen menores costos de
transaccin al no tener cargos de
administracin ni condiciones especiales de
permanencia o costos por retiros anticipados
comunes en los fondos de inversin ordinarios.

ETF ROBO GLOBAL Robotics & Automation

Index

A medida que transcurren los aos el impacto en

nuestras vidas de la robtica y de la
automatizacin se hace cada vez ms evidente,
la robtica est dejando de ser un nicho de
mercado para ser una tecnologa fundamental
que se aplicar en todas las industrias y
mercados.

Hace poco el Director del Robotics Institute de

la Universidad de California, Henrick Christensen,
seal que el mercado de robtica podra crecer
hasta los US $1,2 billones para el 2025, desde
los $64 mil millones actuales, lo cual deja un
margen de crecimiento estratosfricamente grande,
y no es de extraar que se pueda dar este
Ante la fuerte proyeccin de crecimiento de este
crecimiento teniendo en cuenta todas las
sector usted puede invertir en empresas
reas donde la robtica tendr impacto, como
particulares de este sector, pero si lo que
salud, hogares, entretenimiento, logstica,
desea es realizar una inversin ms ponderada y
automotriz, energa, aeronutica y hasta
que requiera menos seguimiento puede
telepresencia.
invertir a travs de un ETF, un ETF que
invierte en este sector es el ROBO GLOBAL,
Qu factores estn influyendo en el crecimiento de
este ETF tiene poco ms de 3 aos desde su
este sector?
creacin e invierte en cerca de 80 empresas de
este sector.
Principalmente hay una convergencia entre la
cada de precios de produccin y las mejoras
A continuacin, muestro el comportamiento del ETF
en el rendimiento de la robtica; la creciente
en el ltimo ao:
demanda de aplicaciones de alta complejidad; el
rpido aumento de la automatizacin a nivel
global y una mayor necesidad de mejorar la
productividad en las industrias.

Segn el Robotics Institute de la Universidad de

California, el suministro anual de robots
industriales ha aumentado un 15% anual en
promedio entre 2009 y 2016, adems se
proyecta que siga creciendo a este ritmo hasta
el 2018, siendo Japn, China y Corea del sur,
los lderes en este creciente aumento de la
automatizacin.

Fuente: www.nasdaq.com
Para captar el valor econmico total de la industria
robtica y de la automatizacin, el ETF ROBO
GLOBAL ha identificado empresas a lo largo
de la cadena de valor de produccin. Esto
abarca, por ejemplo, desde las empresas que
fabrican fsicamente robots y mquinas de
automatizacin, hasta compaas
especializadas en software y tecnologas que
permiten la automatizacin.
Segn Boston Consulting Group, el rea de la
robtica que tiene mayor margen de
crecimiento para los siguientes aos es el de
los robots industriales, por ello si usted desea
realizar una inversin ms especializada
puede buscar empresas en ese nicho de mercado.
Recuerde que una inversin en este sector
debera tener un horizonte de tiempo mnimo
de 1 ao, incluso mientras el periodo de
maduracin sea mayor, mayor tambin sern
los retornos con el transcurrir del tiempo,
dado el alto potencial de crecimiento de este sector
a futuro.
En qu
invertir en el
2017?
Las polticas de Trump, el aumento de tasas de
referencia en EE.UU. y la desaceleracin china
sern algunos factores que marcarn la pauta en el
2017 y crearn oportunidades de inversin.
7 se perfila como un ao con bastantes
incertidumbres sobre los caminos que seguir la
economa, no solo en el mbito local sino tambin a
nivel internacional.
sidente de EE.UU., Donald Trump, tanto en
materia de regulacin bancaria y de boom de
infraestructura americana, marcarn la pauta de lo
que suceda en los mercados globales
na desea invertir, lo ms importante es
que tenga un portafolio diversificado,
recomienda Rebolledo.
Adems, debe considerar el horizonte Si el inversionista tiene
temporal que desea para su inversin y flexibilidad, Rebolledo aconseja
el nivel de riesgo que est dispuesto a tener inversiones de tres a cinco
correr, aade. aos. As,a esas inversiones se les da
espacio para que generen
os inversionistas de largo plazo pueden incursionar
rentabilidades adecuadas, resalta.
en bienes inmuebles.
m aconseja invertir en acciones internacionales, Si por contrario, la persona solo cuenta
principalmente en la bolsa estadounidense. con un periodo corto para invertir,
bablemente las polticas gubernamentales de recomienda inclinarse por depsitos en
Donald Trump estn orientadas a tratar de mejorar cajas municipales, cuyas tasas estn
el sector de infraestructura, a tratar de desregular el
sector bancario y el sector famacutico
atractivas y seguirn probablemente
esa tendencia.
Bolsa local
La plaza limea seguira un comportamiento con
una mejora moderada
inculados a la demanda interna y al sector
construccin sern los motores que impulsen al
mercado accionario, sobre todo en el segundo
semestre del ao, precisa.
iere tener ms cautela en los sectores vinculados a
los metales preciosos, teniendo en cuenta el
aumento de tasas de referencia en EE.UU. y la
consecuente apreciacin del dlar frente a l
Renta Fija
ejecutivo recomienda ser cautos en las inversiones
en instrumentos de renta fija, principalmente por
los aumentos paulatinos que pueden haber en la
tasas de referencia de la Fed.
ntara por recortar las duraciones de los portafolios
de bonos y aprovechar de manera tctica, los bonos
vinculadas a riesgo crediticio que puedan ayudar a
amortiguar el efecto de aumento en tasas de
referencia
Asimismo, el inversionista, de manera tctica,
podra optar por posicionarse en bonos de
pases emergentes cuyas polticas
monetarias puedan ser expansivas,
menciona.
Plazos

azos dependen de la habilidad de

tomar riesgo y de la liquidez de los
inversionistas.

Infraestructura lider
el mercado de
fusiones el 2016
Operaciones en este sector habran
movido ms de US$800 millones en el
mercado de fusiones y adquisiciones
peruano.
por ejemplo, tenemos el caso del gigante brasileo
Odebrecht, que se vio obligado a vender casi el 60%
de la operacin de la concesin vial Rutas de Lima.
Rutas de Lima; Gaseoducto Sur Peruano, todava no
pero se trata; Linea Amarilla, que se firm pero
todava no se cierra; H2Olmos.
os montos de transaccin promedio de las
operaciones en este sector habran superado la cifra
de ms de US$800 millones. "Hay algunas de
US$600, US$800, US$1.000",
Van a continuar algunas de estas transacciones
grandes de infraestructura que ya estamos
trabajando, pero creo que, adems, van a ver estas
nuevas (transacciones) que empiezan en retail,
energa, en minera, en agro
mrica Latina concentra el 2,3% de todas las
transacciones de fusiones y adquisiciones del mundo,
y en mensos de 3% en cuandto a vlaor de de
transascons.
Brasil lder en el mercado de fusiones y adquisiciones
durante el 2016. Durante el tercer trimestre este
pas concentr el 43% del total de los acuerdos
generados de fusiones y adquisiciones en Latinoamrica.
103 operaciones,inversin significan ms de US$14.000
millones. Mientras que peru en el trcecr trmete 18
operaciones en temrinos de inverison 65 MM doalres
Las operaciones en Per aumentaron 20% este ao
hasta 131 operaciones. El Per descendi al ltimo
lugar de las fusiones y adquisiciones (M&A, en
ingls), debido a menores valoraciones y pese al
incremento de estas operaciones el 2016. Se estn
ahciendo mas trnasacicone de empresa mediana
pero de menro vlaor
En el caso de la salud, los proyectos
gubernamentales de inversiones en Asociaciones
Pblico Privadas generan un ambiente favorable
de percepcin en los inversionistas, y adems sera
un factor dinmico en el mercado transaccional
para el prximo ao, concluy.
Del 2015:
La millonaria adquisicin de Corporacin Lindley,
comercializador de Inca Kola, por parte de Arca
Continental, se sell mediante un acuerdo, el 10 de
septiembre. La fusin y adquisicin estuvo valuada
en US$760 millones.
La firma brasilea, Votorantim, elev su
participacin en la minera peruana, Milpo, para lo
cual compr acciones por un valor de US$118,35
millones. Como agente de ventas participaron
Sociedad Agente de Bolsa, Grupo Coril Sociedad
Agente de Bolsa, entre otros.
de Enagas ingres al accionariado de Transportadora
de Gas del Per en una fusin y adquisicin de cerca
de US$97 millones. Uno de los agentes de venta fue
la Corporacion Financiera de Inversiones. (F
El Rancho lleg un acuerdo con la empresa
constructora Viva GyM, por US$49,8 millonesoto:
Andina)
La firma experta en soluciones para el mercado de
valores, Cavali S.A, se fusion con la Bolsa de
Valores de Lima (BVL) por US$38,07 millones
Aumentan las operaciones de M&A en el
pas por la mayor participacin de
extranjeros y de sectores
vinculados a la demanda interna
Las transacciones de extranjeros vienen
sosteniendo el crecimiento del mercado de
M&A peruano. A mayo se registran 58
operaciones, por US$1,595 millones, y los
extranjeros participaron en 35 de ellas (ver
grfico). El Per sigue siendo un receptor de
inversionistas, dice Daniel Hernndez,
analista de la consultora espaola TTR. Los
inversionistas de Chile, Estados Unidos y
Mxico sumaron nueve transacciones, agrega
Creemos que esta transaccin es la mejor opcin
para nuestros clientes de banca de personal y
comercial, accionistas y empleados, y nos
Scotiabank anunci el cierre de la operacin de posiciona para enfocarnos en nuestros clientes
compra de los negocios de banca personal y corporativos e institucionales, ofreciendo mejores
comercial de Citibank en el Per, tras haber obtenido servicios a travs de nuestra presencia global
el permiso de la Superintendencia de Banca, Seguros
y AFP (SBS) para la operacin, valorizada en US$295
millones