financial analysis credit analysis equity analysis
Post on 22-Dec-2015
253 views
TRANSCRIPT
Financial Analysis
Credit Analysis Equity Analysis
Creditors What is the borrowing cause? What is the firm’s capital
structure? What will be the source of debt
repayment?
Credit Rating Business Risk
Industry characteristics Company position Management
Financial Risk Financial characteristics Financial Policy Profitability Capital Structure Cash Flow Protection Financial flexibility
Standard & Poor’s rating method
1. EBIT interest coverage2. EBITDA interest coverage3. Funds from operations/Total debt %4. Free operating cash flow/Total debt %5. Return on capital %6. Operating income/Sales7. Long-term debt/Capital8. Total debt/Capital
Standard and Poors Corporate Ratings
Financial distress
The deterioration in a company’s financial condition such that its ability to repay debt is impaired
Prediction of financial distressUnivariate models
Beaver (1966) relied on Cash flow to total debt Net income to total assets Total debt to total assets Working capital to total assets Current ratio No-credit (defensive) interval
Prediction of financial distressMultivariate models
Altman Z-score (Current assets – current liabilities)/total
assets (weight-1,2) Retained earnings/Total assets (weight-
1,4) EBIT/Total assets (weight-3,3) Preferred and common stock market
value/Book value of liabilities (weight-0,6) Sales/Total assets (weight-1,0)
Altman Z-score Z> 2,99 Not in financial distress Z< 1,81 In financial stress 2,99>Z>1,81 Uncertain
Altman Z score Anadolu Cam
Altman Z-score 2006 2005 2004Ratio 1 0,04 0,08 0,14 Ratio 2 0,11 0,12 0,10 Ratio 3 0,04 0,07 0,12 Ratio 4 1,60 2,27 2,97 Ratio 5 0,55 0,51 0,61 Altman Z-score 1,85 2,36 3,08
A. Cam
Additional considerations Mezzanine items
Could be debt or equity Off-balance-sheet liabilities
Operating leases Contingent liabilities Environmental liabilities
Equity Analysis Buy-side
Work for an institutional investors (mutual fund)
Make internal recommendations regarding the purchase of equity securities
Might review reports of sell-side analysts Sell-side
Work for brokerage firms Issue reports for retail and institutional
customers
Valuation Current value V0 is a function of
Present value of next year’s cash flow, CF1
Required rate of return, r Expected constant growth rate, g
10
CFV
r g
Equity Analysis
Provides information regarding1. The future cash flow generating
ability of the firm2. The growth (or lack thereof) of
those cash flows3. The risk of those cash flows, and4. The risk-free rate commanded by
the market
Top-Down Analysis Begin at highest (economy) level
Allocation between domestic and international equities
Market sectors Industries (within a sector) End with evaluation of specific
companies
Bottom-Up Analysis Begin with individual companies
Look for key strengths Screen large data bases for
attractive characteristics Compustat, Bloomberg, Baseline
Search for a combination of characteristics
Macroeconomic Analysis
Gross Domestic Product (GDP): total value of all final goods and services produced within a country. Nominal, measured in current dollars Real, adjusted for changing prices
Gross National Product (GNP): total value of all final goods and services produced by factors of production owned by citizens of a country regardless of production location
Growth rates of both can be used as an initial estimate of a firm’s growth rate
Business Cycle
Expansion Period of economic growth Increased need for PP&E, labor, inventory
Peak – high point following expansion Recession
Contraction following a peak Rising unemployment, decreased need for
factors of production Two quarters of falling real GDP
Business Cycle
Trough – low point following recession Depression
Prolonged and severe recession Some sectors and industries will perform
better in some stages of the cycle than in others.
Cyclical firms are sensitive to stages of the economic cycle.
Inflation Consumer Price Index (CPI) measures
inflation of a market basket of consumer goods
Producer Price Index (PPI) measures inflation at the wholesale level
Higher inflation, higher required risk-free rate of interest
Impacts all companies and all industries (to varying degrees)
Economic Indicators Leading indicators
Move in advance of the business cycle Unemployment claims, new orders
Lagging indicators Follow behind the business cycle Average duration of unemployment,
average prime rate Coincident indicators
Move with the business cycle Industrial production
Sector/Industry Analysis
Assess the ability of companies within the industry to generate cash flow
Assess the potential growth of that cash flow
Assess the risks related to receipt of those cash flows
Assess the industry’s ability to grow relative to the overall economy
Porter’s 5 Competitive Forces that determine industry profitability
1. Threat of New Entrants- Capital requirements, government policy, access to distribution
2. Bargaining Power of Suppliers - Supplier concentration, switching costs, differentiation of inputs
3. Bargaining Power of Buyers- Buyer concentration, price sensitivity, brand identity
4. Threat of Substitute Products or Services5. Rivalry Among Existing Firms
- Industry growth, barriers to exit, current industry concentration
Company Analysis
1. Understand the business2. Evaluate past performance3. Forecast performance4. Value the company5. Make an investment
recommendation
Understanding the Business
Gain an understanding of the products and services provided by the company and the market for those products and services
Talk to employees, suppliers, competitors Interview customers Utilize the company’s products or
services
Evaluating Past Performance
Understand reported financial information Common size and ratio analysis Consider efficiency, liquidity, solvency,
cash flow and relative valuation Understand US GAAP and IAS Financial reporting quality and
conservatism
Forecasting Performance Based on evaluation of past
performance, economic/industry conditions and expected changes
Pro-forma (projected) financial statements
Projection of future earnings Use earnings model or statistical
projection
Valuing the Company Determine the appropriate price
for making an equity investment Is the intrinsic value higher or
lower than the current market price?
Specific methods Discounted cash flow Market-multiple Residual income
Making an Investment Recommendation Current price of subject company’s
securities Results of valuation Risks of investment Investor’s risk tolerance, objectives and
time horizon Buy/Attractive Hold/Market Perform Sell/Market Under perform
Five Steps of a Financial Statement Analysis
Who are you and why are you interested in this company?
What questions would you like to have answered?
What info is vital to the decision at hand?
Establish objectives of the analysis
Step 1
Five Steps of a Financial Statement Analysis (cont.)
Study the industry in which the firm operates and relate industry climate to current and projected economic developments
Step 2Step 2
Five Steps of a Financial Statement Analysis (cont.)
How well does this firm appear to be run? Are they taking advantage of
opportunities? Are they innovative, forward-looking, etc?
Step 3
Develop knowledge of the firm and the quality of management
Five Steps of a Financial Statement Analysis (cont.)
Common-size financial statements Key financial ratios Trend analysis Structural analysis Comparison with industry competitors
Step 4
Evaluate financial statements–tools include:
Five Steps of a Financial Statement Analysis (cont.)
Short-term liquidity Operating efficiency Capital structure and long-term
solvency Profitability Market ratios Segmental analysis (when relevant) Quality of financial reporting
Step 4 Evaluate financial statements–areas include:
Five Steps of a Financial Statement Analysis (cont.)
Reach conclusions about the firm relevant to your established objectives
Step 5
Summarize findings based on analysis
What we have accomplished
Auditor’s Report
Statement of Cash Flows
MD&A
Statement of Shareholders’ EquityBalance Sheet
Note
s
Inco
me S
tate
ment
TurnedMaze
Financial StatementsAn OverviewMap