Portfolio Management

LECTURE FOUR Fundamental Analysis Company Analysis

Prepared By:

Noorulhadi Qureshi
Lecturer Govt College of Management Sciences Peshawar
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Final Stage of fundamental Analysis Broad outline of the prospect of-Growth in the economy.

Internal information consists of data and events made public by companies concerning their operations. Its include annual report to Share holder, public and private stakeholders.

Company Analysis

External resources of information are those generated independently outside the company. These are prepared by investment services and the financial press.

Company Analysis deal with Return and risk of individual Share and security. Analyst tries to forecast the Future earning which has Direct effect on share price.
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Financial Statements
Two Basic financial statement are:
Balance Sheet (picture of Company asset and liabilities.) Profit and Loss Account. (It postulates the earning of company).

It helps to asses the profitability and financial health. Balance Sheet gives the list of assets and liabilities.
Fixed Assets are intended to be used up over a period of several years. Current assets are intended to be converted into cash with in one year. The outside liabilities are short and long term liabilities. Liability toward share holder show the share capital value.

Financial Statements
Income statement reveals the revenue earned and the cost incurred for a period in the company. Profit is Profit is Profit is \z

Financial Analysis
Assessment of the firms past, present and future financial conditions Done to find firms financial strengths and weaknesses Primary Tools:
Financial Statements Comparison of financial ratios to past, industry, sector and all firms
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Financial Statements
Balance Sheet Income Statement Cashflow Statement Statement of Retained Earnings

Sources of Data
Annual reports
Via mail, SEC or company websites

Published collections of data

e.g., Dun and Bradstreet or Robert Morris

Investment sites on the web

Examples
http://moneycentral.msn.com/investor http://www.marketguide.com
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Review: Major Balance Sheet Items

Assets Current assets:
Cash & securities Receivables Inventories

Liabilities and Equity Current liabilities:

Payables Short-term debt

Fixed assets:
Tangible assets Intangible assets

Long-term liabilities Shareholders' equity

Abbreviated Balance Sheet

Assets:
Current Assets: Non-Current Assets: Total Assets: + + +
+ + + +
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Liabilities:
Current Liabilities: LT Debt & Other LT Liab.: Equity: Total Liab. and Equity:

Review: Major Income Statement Items

Gross Profit = Sales - Costs of Goods Sold EBITDA = Gross Profit - Cash Operating Expenses EBIT = EBDIT - Depreciation - Amortization EBT = EBIT - Interest NI or EAT = EBT- Taxes Net Income is a primary determinant of the firms cashflows and, thus, the value of the firms shares
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Abbreviated Income Statement

Sales Costs of Goods Sold Gross Profit Cash operating expense EBITDA Depreciation & Amortization Other Income (Net) EBIT Interest EBT Income Taxes Special Income/Charges Net Income (EAT) + + + + + + +

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Objectives of Ratio Analysis

Standardize financial information for comparisons Evaluate current operations Compare performance with past performance Compare performance against other firms or industry standards Study the efficiency of operations Study the risk of operations

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Rationale Behind Ratio Analysis

A firm has resources It converts resources into profits through
production of goods and services sales of goods and services

Ratios
Measure relationships between resources and financial flows Show ways in which firms situation deviates from
Its own past Other firms The industry All firms13

Types of Ratios
Financial Ratios:
Liquidity Ratios
Assess ability to cover current obligations

Leverage Ratios
Assess ability to cover long term debt obligations

Operational Ratios:
Activity (Turnover) Ratios
Assess amount of activity relative to amount of resources used

Profitability Ratios

Valuation Ratios:

Assess profits relative to amount of resources used Assess market price relative to assets or earnings
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Liquidity Ratio
Current Ratio:
Current Ratio : Current Assets Current Liabilitie s

Quick (Acid Test) Ratio:

Current Assets - Inventorie s Acid Test Ratio : Current Liabilitie s

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Leverage Ratio
Debt Ratio:

Debt Ratio :

TotalLiabilitie s TotalAssets

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Profitability Ratio
Return on Assets (ROA):
Net Income ROA : Total Assets

Return on Equity (ROE):

Net Income ROE : Total Common Equity
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Profitability Ratio
Net Profit Margin:
EBIT Net Profit Margin : Sales

Retention Ratio
Retention Ratio ( ) : EPS - Div EPS
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Activity (Turnover) Ratio

Total Asset Turnover Ratio:
Sales Total Asset Turnover : Total Assets

Inventory Turnover Ratio:

Sales Inventory Turnover : Inventory
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The DuPont System

Method to breakdown ROE into:
ROA and Equity Multiplier

ROA is further broken down as:

Profit Margin and Asset Turnover

Helps to identify sources of strength and weakness in current performance Helps to focus attention on value drivers
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The DuPont System

ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

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The DuPont System

ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

ROE ROA Equity Multiplier Net Income Total Assets Total Assets Common Equity
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The DuPont System

ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

ROA Profit Margin Total Asset Turnover Net Income Sales Sales Total Assets
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The DuPont System

ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

ROE Profit Margin Total Asset Turnover Equity Multiplier Net Income Sales Total Assets Sales Total Assets Common Equity
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The DuPont System

ROE Net Income Sales Total Assets Sales Total Assets Common Equity Profit Margin Total Asset Turnover Equity Multiplier ROA Equity Multiplier

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Summary of Financial Ratios

Ratios help to:
Evaluate performance Structure analysis Show the connection between activities and performance

Benchmark with
Past for the company Industry

Ratios adjust for size differences

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Limitations of Ratio Analysis

A firms industry category is often difficult to identify Published industry averages are only guidelines Accounting practices differ across firms Sometimes difficult to interpret deviations in ratios Industry ratios may not be desirable targets Seasonality affects ratios
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Ratios and Forecasting

Common stock valuation based on
Expected cashflows to stockholders ROE and are major determinants of cashflows to stockholders

Ratios influence expectations by:

Showing where firm is now Providing context for current performance

Current information influences expectations by:

Showing developments that will alter future performance

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How Might Ratios Help Me on the IEM?

Analysis of AAPL, IBM and MSFT, and comparisons to the S&P500 companies can help to:
Assess the (absolute and relative) financial state of each company Show each companys strengths and weaknesses Predict sustainable growth rate

Combined with current information, this can help to:

Assess likely future performance Predict future valuation and earnings growth Predict returns
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