Analysis of Profit and Loss Account & Balance Sheet from Equity Research Point of View

Presentation by CA V Kandaswamy Partner J. Singh & Associates Chartered Accountants

Profit & Loss Account

Key Issues

Sales Other Income Operating Margin (%) PAT before Exceptional Items EPS and PE ratios

Profit & Loss Account

Sales Variance Analysis Volume Price Mix

Profit & Loss Account

Other Income

Find sustainable other income Identify non recurring items

Profit & Loss Account

Operating Margins (%)

Due to increase in sales Due to reduction in costs Rise in prices Enrichment of Product Mix

Profit & Loss Account

PAT before Exceptional Items

Forex Impact Exceptional Items Tax Incidence Growth

Profit & Loss Account

EPS and PE ratios EPS should be based on normalised income Profits grow but EPS fall EPS grow despite fall in profits Sustainable growth in EPS can help PE to grow Winning Combination is a growth in EPS and PE ratio

EPS 12.0 14.4 18.7 26.2 39.3 327.6

Multiplier E ffec t E P S G rowth (% ) P E P E G rowth (% ) 4.0 25% 20% 5.0 20% 30% 6.0 17% 40% 7.0 14% 50% 8.0 200.0 G rowth % for the period

Market P rice 48.00 72.00 112.32 183.46 314.50 655.20

EPS 12.0 14.4 18.7 26.2 39.3 327.6

Multiplier E ffec t PE G rowth (% ) Market P rice E P S G rowth (% ) PE 4.0 48.00 20% 20% 4.8 69.12 30% 30% 6.2 116.81 40% 40% 8.7 228.95 50% 50% 13.1 515.14 327.6 1073.22 G rowth % for the period

Balance Sheet

Debt Equity Ratio Book Value Stock Turnover ratio Debtors Turnover ratio Trends in stocks and debtors

Balance Sheet

Debt Equity Ratio: Equity Share holders funds Equity Share Capital Preference Share Capital Reserves and Surplus Capital Reserves Revenue Reserves Revaluation Reserves Negative Reserves Networth excluding revaluation reserves

Balance Sheet

Debt Equity Ratio: Debt Long Term Debt Rupee loans Foreign Currency loans Quasi equity Short Term Debt Cash credit/over draft Long term debt Repayment due in 12 months Others

Balance Sheet

Book Value

No. of equity shares outstanding Average, Weighted Average, or year end equity? Networth excluding revaluation reserves Exclude preference capital if it is included in Networth Potential dilution of equity

ESOPS Convertible portion of quasi equity/debt Convertible Warrants

Balance Sheet

Turnover Ratios

Stock Turnover Ratio Debtors Turnover Ratio Trends in Stocks and Debtors

**They can be land mine that can topple equity appreciation, if not understood/analysed properly

Ratios

Liquidity Ratios Leverage Ratios Coverage Ratios Activity Ratios Profitability Ratios

Liquidity Ratios are based on only balance Sheet items

Current Ratio = Current Assets / Current Liabilities Quick / Acid Test Ratio = (Current Assets - Inventories)/Current Liabilities Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

Interval Measure = 365* (Current Assets - Inventories) /(COGS + SGA excluding depn)
Net Working Capital Ratio = Net Working Capital / Net Assets

Leverage Ratios are based on only balance sheet items

Debt Ratio = Total Debt /(Total Debt + Net worth) Debt Equity Ratio = Total Debt / Net worth

Capital Employed to Net Worth Ratio = Capital Employed / Net Worth

Capital Employed to Net Worth = 1 + Debt Equity Ratio Capital Employed = Net Assets = Net Worth + Total Debts

Coverage ratios involve items in Profit and loss account as well as Balance Sheet Debt Service Coverage Ratio = (Net profit + interest + lease rent + non cash expenses) / Instalments due + Lease Rentals

**Instalments due include principal and interest due for the period

Interest Coverage = Earnings before interest tax, depreciation and amortisation / Interest

Activity Ratios involve items in profit and loss as well as Balance Sheet

Inventory Turnover Ratio = Cost of goods sold / Average Inventory (or) Sales / Inventory

Days of Inventory holdings = 365 * inventory / sales

Debtors turnover ratio = Credit sales / average debtors (or) Sales / Debtors Average collection period = 365* Debtors / Sales

Assets Turnover ratio involve items in profit and loss as well as Balance Sheet

Net Assets Turnover Ratio = Sales / Net Assets Total Assets Turnover Ratio = Sales / Total Assets Fixed Assets Turnover ratio = Sales / Net Fixed Assets Current Assets Turnover Ratio = Sales / Current Assets

Working Capital Turnover Ratio = Sales / Net Current Assets

***Sales will be the Numerator in all turnover ratios

Profitability ratio generally involve only Profit and Loss account items

Gross Profit Margin = (Sales - Cost of Goods Sold ) / Sales Net Profit Margin = Profit after Tax / Sales Operating expenses ratio = Operating expenses / Sales Operating expenses = cost of goods sold + SGA

Return ratios involve both Profit and Loss account and Balance Sheet items

Return on Investment = Earnings before interest and tax / Total Assets Return on Investment = Earnings before interest and tax / Total Assets Return on capital employed = Earnings before interest and tax / Net Assets or Capital employed Return on Equity = Profit after tax / Net worth

Ratios of interest to investors and capital markets

Earnings per share = (Profit after tax - preference dividend) / No. of Equity Shares o/s Price - Earnings Ratio = Market Value Per Share / Earnings Per Share (or) Market Capitalisation / Net profit after preference dividend Dividend Per Share = Dividend to equity holders / No. of equity shares outstanding Dividend Pay out ratio = Equity dividend / Profit after tax
Dividend Yield = Dividend Per share / Market Value per share

Net worth = Equity Capital + Total Reserves and Surplus Exclude revaluation reserves in reserves and surplus Also reduce miscellaneous expenses not written off, if any Debit balance of Profit and loss account if negative reserve Book Value = Net Worth / No. of Equity Shares Market value to Book Value = Market Value per share / Book Value per share

Return On Capital Employed Operating Margin % = 100*((PBIDT - Other Income)/ Net Sales) Profit Margin = EBIT / Net Sales

Asset Turnover = Net Sales / Net Assets

Return on Net Assets (or) Return on Capital Employed = Profit Margin * Asset Turnover

Return on Net Assets= EBIT / Net Assets

Return On Net Worth

Leverage can accrue from income side as well as balance sheet side

Income side leverage = PAT / EBIT

Balance Sheet side leverage = Net assets / Net Worth

Financial leverage (or) Return on Capital Employed = Income side leverage * Balance Sheet side leverage = (PAT / EBIT) * (Net Assets / Net Worth)

Return on Net Worth = ROCE * Financial Leverage = (EBIT / Net Assets) * (PAT / EBIT) * (Net Assets / Networth) = PAT / Net Worth

P&L, Balance sheet and Ratios in real time analytics

Conclusion

There is no fool proof method to find multi baggers Understand the business, and USP of the company Value accretion can be sustainable only if growth is predictable Even one or two quarters of sub optimal performance can erode value Other things being constant, market will reward consistent performers

Thank You