Capstone Project:

Analyzing a company

Objectives

Critically analyze a company and provide recommendations about the company.

Demonstrate your mastering of the key knowledge and skills learnt from your undergraduate study in such areas as accounting, finance, economics, and management.

2

A company is a set of contracts formed to produce goods and services. Contracting parties need information to analyze the company.

> Equity Investors• Investment analysis• Management performance evaluation

> Debt Investors• Probability of default• Determination of lending rates• Covenant violations

> Management• Strategic planning• Investment in operations• Evaluation of subordinates

> Employees• Security and remuneration

> Consultants• Provision advisory services

• Litigants• Disputes over value in the firm

• Suppliers• Stability of customer• Ability of company to pay

• Customers• Security of supply

• Governments• Policy making and regulation• Taxation• Government contracting

• Competitors • Production

• Auditors• Determination of audit fees• Evaluation of audit risk

Selection of Company

Choose a publicly listed company

A listing history of at least five years

Analyze the company from the perspective of an equity investor

TELL A STORY ABOUT THE COMPANY TO A POTENTIAL INVESTOR

4

Coverage of the Report

1. Evaluate the accounting and financial performance of the company.

2. Consider the risk factors facing the company.3. Conduct a critical analysis (e.g., SWOT analysis) of

the company.4. Assess the intrinsic value of equity through the

process of business valuation with sensitivity analysis.

5. Other issues that might be of interest to an investor

5

Evaluation of Accounting and Financial Performance

Evaluate accounting quality. E.g., examine whether the firm has any accounting/auditing issues.

Prepare comparative financial statements and discuss any interesting patterns in the numbers. E.g., has sales been growing or declining?

6

Evaluation of Accounting and Financial Performance

Compute financial ratios of the firm and its peers.

Approaches to conduct ratio analyses: Time-series analyses: the same firm over time (e.g.,

Hang Seng Bank from 2014 to 2016) Cross-sectional analyses: different firms at a single

point in time (e.g., Hang Seng Bank versus BOC Hong Kong versus Bank of East Asia)

Benchmark comparisons: using industry norms or pre-determined standards

7

Evaluation of Accounting and Financial Performance

Examples of financial ratios that can be used in your analyses: Profit margin Interest coverage Debt service cover Short-term liquidity Leverage Operating efficiency Return on capital (e.g., ROA and ROE) DuPont decomposition of ROE

8

DuPont decomposition (Story-telling)

ROE = Profit margin*Asset turnover*Financial leverage

ROE = Net profit / Equity Profit margin = Net profit / Sales Asset turnover = Sales / Average Total Assets Financial leverage = Average Total Assets / Average Equity

Source: https://en.wikipedia.org/wiki/DuPont_analysis

9

https://en.wikipedia.org/wiki/DuPont_analysis

Analysis of Economic Environment

Microeconomic environment

Factors affecting the demand for the company’s products/services

Factors affecting the production cost Prospect of the industry Level of competition in the industry and the application

of Porter’s five forces model Effects of government’s regulatory policy

10

Analysis of Economic Environment

Macroeconomic environment

Domestic macroeconomic factors: GDP, interest rate, inflation, etc.

Global macroeconomic factors: exchange rate, foreign countries’ economic performance, etc.

You can apply quantitative tools such as regressions in your analysis.

11

Risk Factors

Operational risk: e.g., rising material cost, over-capacity, etc.

Economic risk: e.g., declines in economic conditions, etc.

Financial risk: e.g., exchange rate risk, interest rate risk, etc.

Political and regulatory risk: e.g., change in government’s overall economic policy and/or regulatory policy on the industry.

12

SWOT Analysis

Strengths

Weaknesses

Opportunities

Threats

13

Business Valuation

Discounted cash flow (DCF) approach

Estimate free cash flow and discounts them to arrive at a present value

Three parameters: Asset life Cash flow per annum Discount rate

14

Discounted cash flow (DCF) approach

A discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity. DCF analysis uses future free cash flow projections and discounts them to arrive at a present value estimate, which is used to evaluate the potential for investment.

Source: http://www.investopedia.com/terms/d/dcf.asp

15

http://www.investopedia.com/terms/f/freecashflow.asphttp://www.investopedia.com/terms/p/presentvalue.asp

Business Valuation

Relative valuation approach.

Assume that other firms in the same industry are comparable to the subject firm and the prices of those comparable firms are fair and correct under the prevailing market condition.

Use of industry ratios to estimate firm value, e.g., price-to-earnings (P/E) ratio and price-to-book value (P/B) ratio

16

Relative valuation approach

Average Multiple for Comparables

Dell's Number

Dell's Valuation

Sales 0.53 $31,168 $16,519

Earnings 52.8 1,246 65,789

Book Value 1.8 4,694 8,449

Average of Valuations 30,252

Sales Earnings Book Value

Market Value

P/S P/E P/B

Hewlett Packard Co.

$45,226

$624

$13,953

$32,963

0.73

52.8

2.4

Gateway 2000 Inc.

6,080 (1,290) 1,565 1,944 0.32 - 1.2

Dell Computer Corp.

31,168 1,246 4,694 ? ? ? ?

Average Multiple for

Comparables

Dell's

Number

Dell's

Valuation

Sales

0.53

$31,168

$16,519

Earnings

52.8

1,246

65,789

Book Value

1.8

4,694

8,449

Average of Valuations

30,252

Sales

Earnings

Book

Value

Market

Value

P/S

P/E

P/B

Hewlett Packard Co.

$45,226

$624

$13,953

$32,963

0.73

52.8

2.4

Gateway 2000 Inc.

6,080

(1,290)

1,565

1,944

0.32

-

1.2

Dell Computer Corp.

31,168

1,246

4,694

?

?

?

?

Other issues that might be of interest to an investor

Accounting policy: e.g., inventory policy, etc. Financial policy: e.g., leverage, payout policy, etc. Production and marketing policy: e.g., consolidation

of production plant, expansion or contraction of product line, market diversification, etc.

Corporate governance Corporate social responsibility

18

Capstone Project:��Analyzing a companyObjectivesA company is a set of contracts formed to produce goods and services. Contracting parties need information to analyze the company.Selection of CompanyCoverage of the ReportEvaluation of Accounting and Financial PerformanceEvaluation of Accounting and Financial PerformanceEvaluation of Accounting and Financial PerformanceDuPont decomposition (Story-telling) Analysis of Economic EnvironmentAnalysis of Economic EnvironmentRisk FactorsSWOT AnalysisBusiness ValuationDiscounted cash flow (DCF) approachBusiness ValuationRelative valuation approachOther issues that might be of interest to an investor