decoding financial statements by gary trennepohl
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Gary Trennepohl presents "Decoding Financial Statements" during the annual 2012 Reynolds Business Journalism Seminars, hosted by the Donald W. Reynolds National Center for Business Journalism. For more information about free training for business journalists, please visit businessjournalism.org.TRANSCRIPT
Decoding Financial Statements
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Jan. 4, 2012
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Donald W. Reynolds National Center
For Business Journalism
At Arizona State University
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Gary Trennepohl, Ph.D. ONEOK Chair and President’s Council Professor of Finance Oklahoma State University Trustee, Oklahoma Teachers Retirement System Member, OSU Foundation Investment Committee
Topics Wednesday:
8:30 am to 3:00 pm – Decoding Financial Statements and Company Analysis.
3:15 pm to 5:00 pm – Investing in a Time of Uncertainty
Thursday: 8:30 am to 11:15 am – Financial Markets in 2012:
Where are the Stories?
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I. Decoding Financial Statements
1. Financial Ratios – what they tell us
2. Profitability Model – how the firm generates profits
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Ratios to Measure Financial Health
Liquiditycurrent ratio =
quick ratio =
Current assets
Current liabilities
Current assets - inventory
Current liabilities
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Another View of Liquidity:Net Working Capital
Total Assets = Liab.+Net Worth
Current Assets
Fixed Assets
Current liabilities
Common equity
Long Term Debt +
Net Working Capital
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Ratios (con’t)
Profitability
net profit margin =
return on assets =
total asset turnover =
net profit after tax
sales
net profit after tax
total assets
sales
total assets
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Profitability Ratios (con’t)
Factors affecting profitability
inventory turnover =
accounts receivable
collection period =
cost of goods sold
inventory
accounts receivable
(sales/365 days)
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Ratios (con’t)
How is the firm financed?
debt ratio =
debt/equity ratio =
equity multiplier =
total debt
total assets
Total debt
total equity
total assets
common equity
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Ratios (con’t)
What return is generated for common stockholders?
return on equity =EACS
common equity
The Profitability Model
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Evaluating a Company Using The Profitability Model
The profitability model is useful because it separates return on equity (ROE) into three components - financial leverage (equity multiplier), operating efficiency (net profit margin) asset utilization (total asset turnover).
ROE is a function of all three factors
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The Profitability Model (con’t)
Return on equity =
NPM X total asset turnover X equity multiplier
ROE =
net profit
salesX sales
total assetsX
common equity
total assets
II. Investing in Time of Uncertainty; WSJ calls it “Macro” Investing
1. What is Risk and Uncertainty?
2. Historical Perspective on Return and Risk in the Market.
3. How Country Demographics will drive Investment and Returns in the Coming Decades
Macro Uncertainty Examples Natural Disasters:
Katrina, The Japanese earthquake
Political Turmoil The Arab Spring Terrorist Attacks European Debt Crisis
Economic Events The 2008 Recession Bankruptcy of Lehman Bros.
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Perspective over Past 60 Years U.S. stocks enjoyed a great boom in the 1980’s and
’90’s – returns averaged 18% yearly. 2000’s decade returns: S&P returned 1%, Bonds 6%
annually. A survey in 1951 about investing showed:
49% favored bonds, then real estate then bank deposits Only 6% favored stocks. 28% said they would not hold
stocks because of “lack of safety.”
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World Events Over thePast two Generations
A world war that cost 50 million lives Korean Conflict A cold war and Iron Curtain that threatened world
destruction. The Vietnam Conflict, the Oil Embargo in 1974,
severe inflation, wage and price controls, another oil shock, the dissolution of the Soviet Union.
Two wars in the Middle East, and 9/11/2001. The 2000’s that gave us a real estate bubble, toxic
mortgage securities, and near collapse of the world banking system.
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What this Means for Investors
Put your fears into perspective: Warren Buffett: “We have usually made our best
purchases when apprehensions about some macro event were at a peak.”
Is fear warping your perception of risk? Take selective risks:
If you endured the past decade, hang in there. Exposure to factors like illiquidity, credit concerns,
natural disasters and insurable events wil be better rewarded than in the past century.
Invest with a global perspective19
History of U.S. Stock and Bond Returns Provides a Perspective for the Future
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What about the Decade Of 2000 to 2010?
Many news sources have reported that the “’00s” were the lost decade for returns for stocks, but it depends on which numbers you choose. S&P 500 - .4% DJIA + 2.5% Small Cap + 6.2% World Index + 1.3% Brazil +21.0% U.S. T-Bonds+ 8.3%
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*Matt Moran, CBOE seminar, Oct. 29, 2010
You Can Keep Track of Current Market Volatility with the VIX The “VIX” is a measure of the market’s perception
about market uncertainty over the next 30 days. It’s derived from the Black-Scholes “option pricing
model” of which one input value is expected volatility (ie. future standard deviation) of the S&P 500.
You make the calculation by “solving the model backwards” – that is “given the observed price, what volatility is needed to produce that price by the model.”
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So, What Does All Of This Data Tell Us?
First, remember when people say “this time is different,” it is never different.
Markets over and under correct, but they ultimately revert to the mean of their long term values.
Periods of over performance will be followed by periods of underperformance, etc.
Diversification is a key strategy for investing.
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Did the Markets Really Change in 2008? Probably not, but two factors are changing
investing in profound ways: Technology that makes market information
instantly available Globalization of financial markets is linking
economies around world.
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What is Really Changing: Demographics of Major Countries
1. Countries with larger numbers of younger workers will enjoy higher growth rates than “older” countries.
2. Demand for housing, autos, and consumer goods is driven by the 25 to 45 year old age cohort.
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Italy
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Germany
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United States
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Brazil
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India
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China
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So, What Will the Next Decade Bring Us?
Here’s some data to help you decide
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“The Bond Buyer’s Dilemma” By Burton Malkiel in the WSJ, Dec 7, 2011
The yields on long term U.S. Treasuries will likely fall below inflation for the next several years - Long Term treasuries are likely to be sure losers
Investors should consider as alternatives: Bonds with moderate credit risk where the spreads over
treasuries are generous. Tax exempt municipal bonds are especially attractive Foreign bonds in fiscally secure countries, e.g. Australia
High quality U.S. stocks with generous dividend yields
Abbott Labs, ATT, Exxon, J&J, P&G.
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Story Ideas1. What do investors and investment
advisors say about market volatility?
2. Are investors/advisors investing in international markets? If so, where and why?
3. What will happen to bond prices and interest rates in 2012-2014?