Indd ros82361ch03indd 57 52708 101501 am confirming

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Unformatted text preview: 6. CHAPTER 3 Financial Statements Analysis and Long-Term Planning 57 ros82361_ch03.indd ros82361_ch03.indd 57 5/27/08 10:15:01 AM Confirming Pages THE REAL WORLD W H AT ’ S I N A R AT I O ? Abraham Briloff, a well-known financial commentator, famously remarked that “financial statements are like fine perfume; to be sniffed but not swallowed.” As you have probably figured out by now, his point is that information gleaned from financial statements—and ratios and growth rates computed from that information—should be taken with a grain of salt. For example, in early 2008, shares in 99 Cents Only Stores had a PE ratio of about 108 times earnings. Similarly, stock in First Solar, Inc., was hot. The PE was about 144. You would expect that these stocks would have high growth rates, and indeed analysts thought so: The estimated earnings growth rates for these companies were 109 percent and 81 percent, respectively. Delta Airlines illustrates another problem. If you calculated its ROE in 2006, you would get about 45.6 percent, which is quite good. What’s strange is the company reported a loss of about $6.2 billion dollars during 2006! What’s going on is that Delta had a book value of equity balance of negative $13.59 billion. In this situation, the more Delta loses, the higher the ROE becomes. Of course, Delta’s market-to-book and PE ratios are also both negative. How do you interpret a negative PE? We’re not really sure, either. Whenever a company has a negative book value of equity, it means that losses have been so large that book equity has been wiped out. In such cases, the ROE, PE ratio, and market-to-book ratio are often not reported because they are meaningless. Even if a company’s book equity is positive, you still have to be careful. For example, consider venerable consumer products company Clorox, which had a market-to-book ratio of about 53 in late 2007. Since the market-to-book ratio measures the value created by the company for shareholders, this would seem to be a good sign. But a closer look shows that Clorox’s book value of equity per share dropped from $7.23 in 2004 to $1.03 in 2006. This decline had to do with accounting for stock repurchases made by the company, not gains or losses, but it nonetheless dramatically increased the market-to-book ratio in that year and subsequent years as well. Financial ratios are important tools used in evaluating companies of all types, but you cannot simply take a number as given. Instead, before doing any analysis, the first step is to ask whether the number actually makes sense. TABLE 3.6 FINANCIAL STATEMENTS FOR DU PONT 12 months ending December 31, 2006 (All numbers are in $ millions) INCOME STATEMENT Sales CoGS Gross profit SG&A expense Depreciation EBIT Interest EBT Taxes Net income $28,356 19,038 $ 9,318 4,108 1,384 $ 3,826 482 $ 3,344 196 $ 3,148 Current assets Cash Accounts receivable Inventory Total Fixed assets BALANCE SHEET Current liabilities Accounts payable Notes payable Other Total Total long-term debt Total equity Total assets $31,777 Total liabilities and equity $ 1,893 5...
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This note was uploaded on 10/28/2009 for the course FINA 505 taught by Professor Deborahcernauskas during the Summer '09 term at Northern Illinois University.

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