Lehrstuhl für Allgemeine Betriebswirtschaftslehre / Rechnungslegung
Financial Statement Analysis and Valuation
Prof. Dr. Bernd Hüfner
Summer semester 2014
Financial Statement Analysis and Valuation 1 Prof. Dr. Bernd Hüfner
Course Content (I)
Objective: How to use financial statements and accounting information to value a company‘s equity or share prices respectively?
The course aims to answer the question by dealing with the following three topics: I. Framework for Business Analysis und Valuation II. Business and Accounting Analysis Tools III. Prospective Analysis with Valuation
Financial Statement Analysis and Valuation 2
Course Content (II)
Chapters 1. Conceptual Basis 1.1 Introduction 1.2 Framework for Business Analysis und Valuation 2. Analysis Tools 2.1 Strategy Analysis 2.2 Accounting Analysis 2.3 Financial and Ratio Analysis 3. Prospective Analysis 3.1 Forecasting Methods 3.2 Valuation Methods
Prof. Dr. Bernd Hüfner
Financial Statement Analysis and Valuation 3 Prof. Dr. Bernd Hüfner
Course Organisation (I)
Lecturer:
Prof. Dr. Bernd Hüfner Phone: 03641 / 943150 Internet: www.wiwi.uni-jena.de/rele
Assistant:
Dipl.-Kfm. Axel Eismann Phone: 03641 / 943154 Mail: [email protected]
Financial Statement Analysis and Valuation 4 Prof. Dr. Bernd Hüfner
Course Organisation (II)
Wednesday, 12:00 – 14:00 Uhr, SR 3.07: lecture Thursday, 14:00 – 16:00 Uhr, SR 2.06: tutorial Test for Diploma-students • No test at the end of the lecture series/ no credit-point test! • Test as part of final diploma-exams
Test for Master-students • at the end of the lecture series Test for „AMUS“ • at the end of the lecture series Additional credits for successful working with case studies: up to 4 credits as bonus for the final test Test: tba.
Financial Statement Analysis and Valuation 5 Prof. Dr. Bernd Hüfner
Course Organisation (III)
Teaching components
1. Lecture
Regular interactive control of comprehension • Clarification of open questions and quotations
2. Tutorial
Interactive exercises which take individual initiative for granted Dealing with few exercises from Palepu et al. (2010): • Control of comprehension and discussions of open questions • Doing exercises • Working with case studies
3. Self-study of recommended and further literature
Financial Statement Analysis and Valuation 6 Prof. Dr. Bernd Hüfner
Literature
Key recommendations • Palepu / Healy / Peek, Business Analysis and Valuation - IFRS Edition, current
edition, London. • Penman, Financial Statement Analysis and Security Valuation, International
Edition, current edition, New York. • Easton, P. D. / McAnally, M. L. / Fairfield, P. / Zhang, X.-J. / Halsey, R. F., Financial
Statement Analysis & Valuation, Cambridge Business Publishers, current edition. Further reading • Baetge / Kirsch / Thiele, Bilanzanalyse, Current Edition, Düsseldorf. • Coenenberg, Jahresabschluss und Jahresabschlussanalyse,
Current Edition, Stuttgart. • Koller / Goedhart / Wessels, Valuation: Measuring and Managing the Value of
Companies, Current Edition, New York. • Cottle / Murray / Block, Graham and Dodd’s Security Analysis, Current Edition,
New York et al. • Ballwieser/Hachmeister, Unternehmensbewertung – Prozess, Methoden und
Probleme, aktuelle Auflage, Stuttgart. Additional literature will be presented within the particular chapter!
Financial Statement Analysis and Valuation 7
Metacoon
• Log on at: http://metacoon.uni-jena.de (without www)
• Your username and password is the same as for „Friedolin“ resp. „URZ“
• Access the room: „Analyse der Rechnungslegung und Bewertung“
• Password for the room: announced separately
• Password for the documents: announced separately
Prof. Dr. Bernd Hüfner
Financial Statement Analysis and Valuation 8 Prof. Dr. Bernd Hüfner
1 Contents
Introduction 1.1.1 Motivation
1.1.2 Fundamentals of Financial Accounting
1.1.3 Introduction to Company Examples
1.1.4 Approach of Fundamental Analysis Literature: Penman (2013), Financial Statement Analysis and Security Valuation, p. 3-16.
Financial Statement Analysis and Valuation 9
1.1.1 Analyst Recommendation: Hennes & Mauritz ”Sell“ (I)
Prof. Dr. Bernd Hüfner
“We disagree with the market and expect H&M's gross margin to contract over time, given growing low end price competition in combination with cost inflation and unfavourable currency trends. Our EPS estimates are now 2%, 7% and 8% below consensus for 2012/14E and we cut our target price to SEK200 (220), reiterating our 3/UP rating. Fundamental Valuation: Underperformed Current Share Price: SEK 210 6-month Price Target: SEK 200” Daniel Ovin equity analysts at Cheuvreux (Nov. 19 2012) https://www.cheuvreux.com/dl.aspx?filter=172395
What is the current share price of H&M?
Financial Statement Analysis and Valuation 10
1.1.1 Analyst Recommendation: Hennes & Mauritz ”Sell“ – Share price performance since recommendation
Prof. Dr. Bernd Hüfner
http://www.finanzen.net/chart/HennesMauritz_AB_%28HM,_H&M%29 (Zugriff: 25.02.2014)
Price Target: SEK 200
Financial Statement Analysis and Valuation 11
1.1.1 Analyst Recommendation: Hennes & Mauritz (current)
Prof. Dr. Bernd Hüfner
Current analyst recommendations and revisions on H&M (08.05.2013)
http://www.reuters.com/finance/stocks/analyst?symbol=HMb.ST (25.02.2014)
Financial Statement Analysis and Valuation 12 Prof. Dr. Bernd Hüfner
1.1.1 Motivational and Inspirational Quotes
“Millions of shares of business firms are traded every day on the world's stock markets. The investors who buy and sell these shares ask themselves: Am I trading at the right price? What are the shares really worth?“ Penman (2010), p. 3.
“How does one assess how much to pay for a stock and what is the role of accounting in that assessment?” Penman (1992), p. 465.
„Risk comes from not knowing what you’re doing.” Warren Buffet, American magnate, investor, and CEO of Berkshire Hathaway, in: Kaiser (2006), p. 144 „Risk comes from not understanding what you are reading in financial statements.” Kaiser (2006), p. 144
“How does one estimate the expected future payoffs to be valued?” Fama (1996), p. 247
"There is nothing so dangerous as the pursuit of a rational investment policy in an irrational world." John Maynard Keynes.
Financial Statement Analysis and Valuation 13 Prof. Dr. Bernd Hüfner
1.1.1 Target Setting: At the End of the Course you should know…
• the role of financial statements in determining firms’ values
• what determines a firm’s value • how to pull apart the financial statements to get
at the relevant information • the relevance of cash flow and accrual
accounting information • how to assess the quality of the accounting • how to identify and adjust accounting distortions • how ratio analysis aids in valuation • how to do business forecasting • how to use different valuation models • how to calculate P/E and price-to-book ratios
Financial Statement Analysis and Valuation 14 Prof. Dr. Bernd Hüfner
1.1.2 What is Financial Accounting?
In general: Conceptual design, environment and usage of corporate information systems
Provision of information-systems to external stakeholders • Financial statements • Other obligatory reports • Voluntary disclosure
Information-systems for internal users (e.g. management) • Capital budgeting • Cost and performance
accounting
Accounting
Financial Accounting Managerial Accounting
Financial Statement Analysis and Valuation 15 Prof. Dr. Bernd Hüfner
1.1.2 What is Financial Accounting?
Financial accounting measures, classifies, and summarizes in report form business activities and that information which relate to the enterprise as a whole for use, primary by external parties.
Elements of financial statements: • Balance sheet
• Income statement
• Statement of owner´s equity
• Cash flow statement
• Segment reporting
• Notes
Financial Statement Analysis and Valuation 16 Prof. Dr. Bernd Hüfner
1.1.2 Some Users of Firms’ Financial Information
• 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
• Intermediaries - Investment analysis - Enhance credibility of financial
information • Litigants
- Disputes over value in the firm • Customers
- Security of supply • Governments
- Policy making - Regulation - Taxation - Government contracting
• Competitors
Financial Statement Analysis and Valuation 17 Prof. Dr. Bernd Hüfner
1.1.2 Investors are supposed to be the primary users of financial statements on capital markets “The objective of general purpose financial reporting1 is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.” IFRS CF.OB7
Describe the decision-situations and the informational requirements to financial accounting of: • a fundamental free-float investor/shareholder • a debt capital provider (bank)!
Financial Statement Analysis and Valuation 18 Prof. Dr. Bernd Hüfner
1.1.2 Financial Accounting as Informational Institution
Basic problem • Separation between creator and recipient of accounting
(agency-related frictions) • Problem of managerial influence on accounting information
(earnings management) • Requirement of institutional and/or contractual solution
Complementary relation between accounting and other information systems • Existence of alternative (real-time) information sources • Relative competitive advantage of accounting in disciplining other
available information through reliability (information hygiene)
Financial Statement Analysis and Valuation 19 Prof. Dr. Bernd Hüfner
1.1.2 Institutional Frame of Accounting (I) C
orpo
rate
Gov
erna
nce
Business transactions
Transformation and aggregation based on accounting principles/rules
Management‘s (legal) discretion within the given accounting system
Financial Accounting Additional information (voluntary disclosure,
ad-hoc report, …)
Financial Statement Analysis and Valuation 20 Prof. Dr. Bernd Hüfner
1.1.2 Institutional Frame of Accounting (II) C
orpo
rate
Gov
erna
nce
Release
Financial Accounting Additional information (voluntary disclosure,
ad-hoc report, …) Auditing
Audit Committee
Monitoring by committees and panels (e.g. courts, stock exchange)
Decision of recipient
Judiciary
External sources of information
Financial Statement Analysis and Valuation 21 Prof. Dr. Bernd Hüfner
1.1.2 Dissatisfying Informational Situation
Despite financial accounting and voluntary disclosure, the informational requirements of recipients are usually not satisfied. The informational context is affected by: • Market frictions • Imperfect and incomplete markets • Uncertainty • Bounded rationality of creator and recipient of financial
accounting • Management’s opportunism • Transaction costs
Financial Statement Analysis and Valuation 22 Prof. Dr. Bernd Hüfner
1.1.2 Business Analysis to Improve Information
Implications • Limited ability to use and understand published information • Imperfect accounting rules and principles • Discretion and forecasting errors • Problem of (legal) earnings management and transaction
structuring
“(…) it is difficult for outside users of financial statements to separate the true information from distortion and noise” Palepu et al. (2013), p. 13
Comprehensive analysis in order to overcome the dissatisfying information situation and to get at manager’s inside information! Note: cost/benefit constraint
Financial Statement Analysis and Valuation 23
1.1.3 Introduction to company examples (I)
Prof. Dr. Bernd Hüfner
“The parent company H & M Hennes & Mauritz AB is a limited company domiciled in Stockholm, Sweden. The Group’s business consists mainly of sales of clothing, accessories, footwear, cosmetics and home textiles to consumers.” [GB (2012), S. 56.]
„Industria de Diseño Textil, S.A. domiciled in Spain. The principal activity of which consists of the distribution of fashion items, mainly clothing, footwear, accessories and household textile products. Inditex carries out its activity through various commercial formats such as Zara, Pull & Bear, Massimo Dutti, Bershka, Stradivarius,Oysho, Zara Home and Uterqüe.” [GB (2012), S. 137.]
Financial Statement Analysis and Valuation 24
1.1.3 Introduction to company examples (II)
Prof. Dr. Bernd Hüfner
Hennes & Mauritz H & M AB • Headquarter in Stockholm (Sweden), first Hennes store 1947 in Västerås • Retailer, sells trendy, affordable products and is able to respond quickly to
changing trends by maintaining short production and lead times • Main competitor: Inditex • Key figures 2011/2012: 120 799 million SEK turnover, 23,4 million SEK EBITDA,
72.276 employees, listed at Stockholm Stock Exchange
Industria de Diseño Textil, S.A. • Headquarter in Arteixo (Spain), founder Amancio Ortega Gaoana started clothing
manufacture, 1975 first Zara store • Textile, design, manufacturing, distribution, different brands for different target
groups • Competition: H & M, GAP, Benetton • Key figures 2011: 13.793 million € turnover, 3.257 million EBITDA, 109.512
employees, listed on stock exchanges of Madrid, Barcelona, Bilbao and Valenci
Financial Statement Analysis and Valuation 25
1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet – Assets (I)
Prof. Dr. Bernd Hüfner
production factors
Mitt
elve
rwen
dung
Financial Statement Analysis and Valuation 26
1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet – Assets (II)
Prof. Dr. Bernd Hüfner
Total resources/ investing
Mitt
elve
rwen
dung
Financial Statement Analysis and Valuation 27
1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet – Equity
Prof. Dr. Bernd Hüfner
Owner claim on resources M
ittel
herk
unft
Financial Statement Analysis and Valuation 28
1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet –Liabilities
Prof. Dr. Bernd Hüfner
Non-owner claims on resources
Total financing
Mitt
elhe
rkun
ft
Financial Statement Analysis and Valuation 29
1.1.3 Annual Report 2011/12 of H&M in Detail Income Statement
Prof. Dr. Bernd Hüfner
Goods and services provided to customer
Costs incurred to generate revenues
Bottom line Net income
Profit generated by operations (EBIT)
Financial Statement Analysis and Valuation 30
1.1.3 Annual Report 2011/12 of H&M in Detail Other Comprehensive Income
Prof. Dr. Bernd Hüfner
Bottom line Net income
Total non-owner change in equity
Gains and losses not recognized in the income statement
Financial Statement Analysis and Valuation 31
1.1.3 Annual Report 2011/12 of H&M in Detail Cash Flow Statement (I)
Prof. Dr. Bernd Hüfner
Cash flows from operating activities
Financial Statement Analysis and Valuation 32
1.1.3 Annual Report 2011/12 of H&M in Detail Cash Flow Statement (II)
Prof. Dr. Bernd Hüfner
Cash flows from investment activities
Total Cash
Cash flows from financing activities
Financial Statement Analysis and Valuation 33
1.1.3 Annual Report 2011/12 of H&M in Detail Statement of Changes in Equity
Prof. Dr. Bernd Hüfner
Sources of equity change
Accounts under equity
Financial Statement Analysis and Valuation 34
1.1.3 Articulation of Financial Statements (I)
Prof. Dr. Bernd Hüfner
Identify and explain the main financial statements and understand their links across time (articulation)! What relationships can be derived from the articulation of financial statements? How does information flow among financial statements?
Balance Sheet Beginning of period
Income Statement
OCI
Cash Flow Statement
Statement of Equity Changes
Balance Sheet End of period
Easton et al. (2010), S. 1-10
Financial Statement Analysis and Valuation 35
1.1.3 Articulation of Financial Statements (II)
Prof. Dr. Bernd Hüfner
Easton et al. (2010), S. 2-20f
Financial Statement Analysis and Valuation 36
1.1.4 Investment Styles and Fundamental Analysis
Prof. Dr. Bernd Hüfner
Investment style: Approach, mindset, or philosophy, under the influence of which investors frame their expectations
“Method of analyzing information, forecasting payoffs from that information, and arriving at a valuation based on those forecasts.” (Penman (2010), S. 84)
Relies on the “intrinsic value” of a stock and thus challenges stock market prices for a potential mispricing
Problem: laborious
Valuation on the basis of historical price movements and patterns Chart and statistical analysis
Fundamental Analysis Technical Analysis Others
• Passive • Intuitive
Financial Statement Analysis and Valuation 37 Prof. Dr. Bernd Hüfner
1.1.4 Market Efficiency and its Implications for Investment Styles “A market in which prices always ‘fully reflect’ available information is called ‘efficient’.” Fama (1970), “Efficient Capital Markets: A Review of Theory and Empirical Work”, JoF, pp. 383-417.
• Market efficiency is related to a specific quantity of information
• Fama (1970) distinguishes between three different stages of market efficiency
Weak form efficiency: Past price information
Semi-strong efficiency: Public, available information
Strong efficiency: All information (public and private)
Discuss the investment styles within the context of market efficiency!
Financial Statement Analysis and Valuation 38 Prof. Dr. Bernd Hüfner
1.1.4 The interrelated sequential Process of Fundamental Analysis (Penman 2010)
Industry Analysis
Business/ Strategy Analysis
Financial Statement Analysis
Fore- casting
Valuation + Decision
Valuation model
1.Know the firms products 2.Know the technology required to
bring the product to the market 3.Know the firm’s knowledge base 4.Know the competitiveness of the
industry 5.Know the political, legal, regu-
latory, and ethical environment
1.Reformulation/ adjustments to financial statements
2.Profitability and growth analysis
3.Assessment of accounting quality
1.Specify Payoffs
2.Forecast Payoffs
1.Reduction of forecasts to one number
2.Adjustment for time value of money and risk
Penman (2010), S. 85f.
Financial Statement Analysis and Valuation 39 Prof. Dr. Bernd Hüfner
1.1.4 Questions that Fundamental Investors Ask
Coca-Cola had a price-to-book ratio of 6.5 in 2005. Why is its market value so much more than its book value?
Yahoo! had a market capitalization of 44 billion in 2005. What future sales and profits would support this valuation?
Dell Computer traded at 87.9 times earnings in 2000. Historically, P/E ratios have averaged about 14. Is Dell’s P/E ratio too high? Would one expect its price to drop?
What growth in earnings is required to justify a P/E of 87.9?
Ford Motor Co. traded at a P/E of 5.0 in 2000. Is this too low?
Google went public in 2004 and received a very high valuation in its IPO. How would analysts translate its business plans and strategies into a valuation?
Financial Statement Analysis and Valuation 40 Prof. Dr. Bernd Hüfner
1.1.4 Tenets of Sound Fundamental Analysis
• One does not buy a stock, one buys a business • When buying a business, know the business • Value depends on the business model, the strategy • Good firms can be bad buys • Price is what you pay, value is what you get • Part of the risk in investing is the risk of paying too much for a stock • Beware of paying too much for growth • When calculating value to challenge price, beware of using price in the
calculation • Stick to your beliefs and be patient; prices gravitate to fundamentals,
but that can take some time
Penman (2010), S. 19.
Financial Statement Analysis and Valuation 41
1.1.4 Example: Discounted Cash Flow Valuation for H&M
Prof. Dr. Bernd Hüfner
SEK (million) 2008e 2009e 2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017e
Sales 89.314 101.461 115.158 129.553 145.747 163.966 184.462 207.519 233.459 262.642
EBITmargin 23,8% 24,0% 24,1% 24,1% 24,0% 24,0% 24,0% 24,0% 24,0% 24,0%
NOPAT 15.436 17.654 20.121 22.636 25.360 28.530 32.096 36.108 40.622 45.700
Free Cash Flow
12.977 14.156 17.328 19.282 20.939 23.556 29.268 30.159 33.929 38.171
Discount Rate 10,6 %
Total PV to 2017
141.109
PV of Terminal Value
176.600
NV of Net Interest-Bearing Debt
19.041
Total DCF to Equity
336.482
Number of Shares
828
Value per Share
406,6 SEK Quelle: Equity Research Jyske Bank, Consumer Discretionaries, 28 March 2008,
https://jyskebank.com/wps/wcm/connect/d0197e804d0c48ac984a9af6968f215c/268990_280308HM1q08analyse.pdf?MOD=AJPERES&CACHEID=d0197e804d0c48ac984a9af6968f215c
Financial Statement Analysis and Valuation 42 Prof. Dr. Bernd Hüfner
Check yourself
• Why do you see a need for financial accounting? • Explain how potential external users might use financial
statements in their decision making process! • What are the main financial statements and what
information is typically conveyed in each? • Decide the relative weights you would put on the different
statements while evaluating a company! • Which investment styles do you know? • How do financial statements support valuation? • What is market efficiency?