443_5 - Applied Equity Analysis and Por3olio...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Applied Equity Analysis and Por3olio Management Red Flag Analysis •  It’s important to not only evaluate the business risks but also review the company’s financial statements for accounCng “red flags” •  If something looks too good to be true, it usually is, so investors should: –  –  –  –  –  Check the accounCng opinion and SEC cerCficaCon Read the notes to the financials before reading the financials Check the amount and sources of cash flow Examine assets and liabiliCes (especially deferred tax liabiliCes) Carefully evaluate any credit or equity reports Red Flag Analysis •  Before you examine the income statement, balance sheet and cash flow statement, and before you run raCo and trend analysis, it is criCcal to read and analyze the notes to the financials so that you can test for: –  –  –  –  correctness completeness consistency comparability Red Flag Analysis (cont) •  We will begin with a discussion about rules and stock price ramificaCons for a variety of data quality items you can observe before you crunch any numbers: –  –  –  –  –  –  –  –  –  Qualified v. clean accounCng opinions Significant accounCng pracCces and any changes in pracCces Events since end of accounCng period Non ­recurring income items and restated financial statements Account classificaCons and reporCng periods Segment reporCng Corporate acquisiCons and investments in securiCes FX translaCon Quality of Earnings Qualified v. Clean Opinions •  As a result of Sarbanes ­Oxley, the opinion now has two components –  effecCveness of internal controls –  fairness of amounts on financial statements •  Look for clean vs. qualified opinion •  What does the IBM opinion say? Significant AccounCng PracCces and Changes •  Any changes to accounCng policies will be defined in the Notes to Financials •  Look for adopCon of new policies and changes to exisCng policies as defined by GAAP •  Evaluate how this may (or may not) impact financial results and reporCng consistency •  Discuss accounCng changes for IBM Events Since End of AccounCng Period •  The company should disclose any major developments between the close of the accounCng period and the filing of the 10 ­K in the Note •  Also review press releases and any 8 ­K filings by the company •  Determine the impact this has on future results or operaCng condiCons for the company •  Discuss the events for IBM Nonrecurring Income Items •  Nonrecurring items are: –  unusual in nature –  of material amount –  infrequent in occurrence •  As an analyst, determine whether items like this are going to persist •  Understand any impact on security price •  Discuss the nonrecurring items for IBM Restated Financials •  Companies should restate financials for significant changes in accounCng policies or when they have disconCnued a busienss •  Understand impact to comparability (how far back did the company restate) •  Discuss any restatements by IBM Account ClassificaCons and ReporCng Periods •  Differences in account classificaCons also impact comparability •  Understand differences across firms for items such as depreciaCon, R&D •  Look for differences in reporCng periods •  When comparing firms, make appropriate adjustments to normalize classificaCons •  Discuss IBM’s classificaCons Segment ReporCng •  Segment informaCon (sales, op income, assets) may be reported by industry segment, geographic locaCon and/or type of customer •  Use this informaCon to analyze the company’s results in more depth •  Review IBM’s segment informaCon Corporate AcquisiCons •  All acquisiCons today are accounted for using the purchase method •  Companies may choose to finance an acquisiCon with cash or stock •  Understand how an acquisiCon will impact a companies results and reporCng •  Understand IBM’s acquisiCon history and how it reports it Investments in SecuriCes •  Understand the type of investments the company is making •  Look at how they are classifying their investments: –  Minority, passive investments –  Minority, acCve investments –  Majority, acCve investments •  Review IBM’s investments FX TranslaCon •  Review any foreign currency exposure of the company •  Understand the funcConal currency of its foreign operaCons –  Largely driven by the operaCng characterisCcs and operaCng currency •  FX gains and losses are recorded when realized •  Understand the impact to IBM Quality of Earnings •  The concept of quality of earnings refers to how well a company’s reported earnings reflects actual operaCons and cash flow •  In order to evaluate quality of earnings, it is criCcal to evaluate: –  Methods for recognizing income –  Asset valuaCons –  Liability conCnuum: recogniCon and valuaCons Income RecogniCon •  Revenue is typically recogniized when: –  –  –  –  When inventory is sold When services are completed and billed As Cme passes or as assets are used for permission to use assets At point of sale when selling an asset other than inventory •  Generally, revenue is recognized when invoiced •  Follows the matching principal –  Expenses and revenues are recognized in the same period •  Differences between accounCng recogniCon and tax recogniCon •  What are IBM’s income recogniCon policies? •  How should analysts treat different methods of income recogniCon? Asset ValuaCons •  Understand GAAP for valuing: –  Inventory –  Fixed assets –  Intangible assets (goodwill, R&D, other) •  Tax treatment for asset valuaCons •  Asset valuaCon consideraCons for analysts •  How does IBM value assets? Liability ConCnuum •  Basic principals of liability recogniCon •  Current vs. long ­term liabiliCes •  What are examples of: –  Fixed obligaCons –  EsCmated obligaCons –  Probable obligaCons –  ConCngent obligaCons Liability RecogniCon and ValuaCon •  Analysts must properly evaluate: –  Hybrid financing –  Leases –  Off ­balance sheet financing –  DerivaCves –  ReCrement benefits –  Reserve accounts –  Stock opCons Hybrid Financing •  Hybrid securiCes have characterisCcs of both debt and equity (i.e., converCble bonds) •  AccounCng for hybrid securiCes •  Tax treatment for hybrids •  ConsideraCons as an analyst •  Does IBM have any hybrid financing? Lease Financing •  OperaCng lease vs. capital leases •  Difference in tax treatment between operaCng and capital leases •  Analyst treatment of leases •  Does IBM have any leases? Off ­Balance Sheet Financing •  What is off ­balance sheet financing? •  Does IBM have any off ­balance sheet financing? •  How should analysts handle off ­balance sheet financing? DerivaCves •  AccounCng for derivaCve transacCons –  Recognized on balance sheet as either asset or liability, depending on contract –  Marked to market each period •  TaxaCon of derivaCve transacCons •  Analyst treatment of derivaCves •  Has IBM entered into any derivaCve transacCons? ReCrement Benefits •  •  •  •  GAAP requirements for reCrement benefits Tax treatment for reCrement benefit liabiliCes Analyst consideraCons for reCrement benefits What should we noCce about IBM’s obligaCons for reCrement benefits? Reserve Accounts •  Reserve accounts are permanent or temporary accounts used to “reserve” payments for a future period •  Tax treatment of reserves •  Analyst treatment of reserve accounts •  What reserve accounts does IBM have? Stock OpCons •  Firms are currently required to expense opCons using the fair value method (SFAS Statement No. 123) •  Most firms use an opCon pricing model, such as Black Scholes, to value their opCons •  Analysts should anCcipate opCon related expenses for impact to both earnings and shares outstanding •  How does IBM record stock opCons? Things to Remember •  Understanding the company is the first step in analyzing a stock •  Always check financials for correctness, completeness, consistency and comparability •  Notes to financial statements are oien more important than the financial statements themselves ...
View Full Document

This note was uploaded on 02/22/2011 for the course BMGT 443 taught by Professor Perfetti during the Spring '11 term at Maryland.

Ask a homework question - tutors are online