EssentialsBusiness cycle-Emergence of economic growth-Expansion phase (fast growth)-Maturity – Decline / recession-1. Emergence of economic growth-2. Expansion phase (fast growth)-3. Maturity-4. Decline / recession--• 3 types of financial information-1. Info about past performance i.e., EPS, cash flows from operations-2. Info about the present condition of a business i.e., Debt ratio, ROI, ROE-3. Info about the future performance of the business i.e., Expected EPS, Forward P/E ratioIncreasing ROE by:1.Product differentiation• Differentiation on quality i.e., BMW cars, iPhone2.Cost advantagea.• Differentiation on cost i.e., Costco, McDonald’s• Rapid growth-i.e. Fast-growth technology small stocks may experience cash flow problems financing all theirgrowth.•Uneconomical expansion-i.e., Opening retail stores in less than desirable locations with low profitability (or not at all).• Subjective factors-Some vital information is not in the annual report.-i.e., Amazon growth is due to intellectual properties such as 1-click patent in e-commerce and theuse of advertising in the ranking of its own productsearch engine• Income Statement:-Profitability over time• Balance Sheet:-Financial condition at a point in time• Statement of Cash Flows:-Tracks the cash implications of transactions
•Economic earnings-Sustainable cash flow that can be paid to stockholders without impairing productive capacity of thefirm•Accounting earnings-Affected by conventions regarding the valuation of assets-Manager responsibilities:-1. Investment decisions-2. Financing decisions-• Ratios show efficiency/profitability of these decisions:-ROA: EBIT /𝑇𝑜𝑡𝑎?Assets-ROC: EBIT /(Long − term Capital )-ROE: Net Income/Shareholders Equity′--ROE is a key determinant of earnings growth-• Past profitability does not guarantee future profitability-• Security values are based on future profits-• Expectations of future dividends determine today’s stock valueFinancial Leverage and ROELeverage allows ROE to differ from ROA• Leverage makes ROE more volatilet = tax rater = interest rateROE = Net profit/Equity =ROE = (1-T) * [ROA + (ROA -R) * DEBT/Equity ]-No debt or ROA = RROE = ROA (1-t)-IF: ROA > r, firm ears more than it pays out to creditors and ROE increases-IF: ROA < r, ROE will decline as a function of the debt toequity ratio-DEBIT is worse for bad years FOR ROE. It decreases it since ROE is net profit
Economic Value added (EVA)-EVA: is the difference between return on assets (ROC return on capital) and the opportunity cost ofcapital (K) multiplied by the capital invested by the firm-EVA is also called residual income-If ROC > K, value is added to the firmROA = EBIT/ SALEs * Sales / Assets = Margin * TurnoverMarging and turnover are unaffected by leerageROA reflects soundness of firms operations regardless of financingROE = Tax burden * ROA * compound leverage FactorTax burden is not affected by leverageCompound Leverage factor = interest burden * leverage
The Graham Technique• Rules for stock selection:-Purchase common stocks at less than their working-capital value –-Give no weight to plant or other fixed assets
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Term
Fall
Professor
blimma
Tags
Financial Ratio, Generally Accepted Accounting Principles
