Professional Documents
Culture Documents
Fundamental Analysis
Fundamental Analysis
Fundamental Analysis
Slide: 1
Course Content
Why & how to apply Fundamental Analysis Industry Analysis Financial Statement Analysis Intrinsic Stock Valuation
Guideline Company Method
Fundamental Analysis
Slide: 2
Firm Value
BALANCE SHEET ASSETS DEBT EQUITY
Fundamental Analysis
Slide: 3
Fundamental Analysis
Slide: 4
Lend Money
Debt How risky? Debt coverage ratios, etc.
Fundamental Analysis
Slide: 5
Equity Investment
You are buying into the firm as is:
Existing management, strategy, capital structure
Fundamental Analysis
Slide: 6
Applications of FSA
Analyzing trends Evaluating company performance
How is it generating profits? How efficiently is it utilizing assets? How risky a firm is it?
Fundamental Analysis
Slide: 8
THREAT OF SUBSTITUTES
Threat of Entry
Importance of barriers to entry:
Economies of scale First mover cost advantages Capital required Government/legal barriers Control of distribution Product differentiation
Buyer Power
Price sensitivity x Bargaining power
Cost of purchase vs total costs Profitability of buyers Size & concentration of buyers relative to suppliers Buyers switching costs Buyers information Ability to integrate backwards
Threat of Substitutes
Willingness to substitute Price-performance of substitutes Example: frozen food industry
Prices limited by prices of canned & fresh foods
Fundamental Analysis
Slide: 12
Competitor Rivalry
Increase rivalry, lower profitability:
Low industry concentration Slow demand growth High fixed costs Homogeneous goods
Fundamental Analysis
Slide: 13
Objective:
Value 5.45% ownership interest
Industry Trends
Firm Rivalry - High
Mature industry Homogeneous goods
Prospects:
Lower sales growth Pressure on margins
Copyright 1996 - 2006 Investment Analytics
Strategy
Focus on efficiency Market share
Fundamental Analysis Slide: 15
Financial Statements
P&L Balance sheet Statement of Cashflows
Fundamental Analysis
Slide: 16
P&L Statement
ABC Grocery Co.
Revenues Cost of Goods Sold Gross Profit Operating Expenses: Selling, General & Admin. Depreciation Total Operating Exp. Operating Income Nonoperating Income & expenses EBIT Interest Expense NPBT Provision for Income Tax Net Income Dividends Retained Earnings
Copyright 1996 - 2006 Investment Analytics
1993 ($000)
1992 ($000)
1991 ($000)
1990 ($000)
1989 ($000)
1,628,251 1,526,509 1,440,023 1,348,304 1,183,979 1,209,590 1,130,856 1,066,439 1,012,982 885,340 418,661 395,653 373,584 335,322 298,639 348,313 25,345 373,658 45,003 18,438 63,441 10,587 52,854 18,499 34,355 6,954 27,401 323,556 25,771 349,327 46,326 18,762 65,088 10,121 54,967 19,238 35,729 6,349 29,380 306,721 24,562 331,283 42,301 13,910 56,211 8,842 47,369 16,579 30,790 5,303 25,487 278,591 23,006 301,597 33,725 14,220 47,945 8,763 39,182 13,714 25,468 4,591 20,877 246,426 21,185 267,611 31,028 10,971 41,999 8,186 33,813 11,834 21,979 4,022 17,957
Slide: 17
Fundamental Analysis
Balance Sheet
ABC Grocery Co. ASSETS Current Assets: Cash & Equivalents Investments Accounts Receivable Prepaid Expenses Inventory Total Current Assets Fixed Assets: Land Buildings Equipment & Fixtures Transportation Equipment Total Fixed Assets; Cost Accumulated Deprn. Total Fixed Assets; Net Leases, Deferred Taxes & Other Assets TOTAL ASSETS 1993 ($000) 21,609 1,850 12,679 580 121,259 157,977 17,114 130,628 196,485 11,401 355,628 (166,851) 188,777 86,071 432,825
L IA B IL IT IE S & E Q U IT Y L ia b ilitie s : C u rre n t L ia b ilitie s : O ve rd ra ft C a p ita l L e a se s T ra d e A cco u n ts P a ya b le A cco u n ts P a ya b le - A ffilia te s N o te s & M o rtg a g e s P a ya b le In co m e T a xe s P a ya b le A ccru e d E xp e n se s T o ta l C u rre n t L ia b ilitie s L o n g T e rm D e b t: N o te s & M o rtg a g e s P a ya b le C a p ita l L e a se s T o ta l L o n g T e rm D e b t O th e r D e b t T o ta l L ia b ilitie s E q u ity: C o m m o n S to ck P a id -in C a p ita l R e ta in e d E a rn in g s T re a su ry S to ck T o ta l S h a re h o ld e r's E q u ity T O T A L L IA B IL IT IE S & E Q U IT Y 0 4 ,2 9 3 6 2 ,9 5 3 2 ,9 4 6 1 ,2 9 8 2 ,7 8 0 4 4 ,5 7 2 1 1 8 ,8 4 2 3 2 ,4 2 3 5 8 ,5 7 0 9 0 ,9 9 3 4 ,7 0 8 2 1 4 ,5 4 3 2 ,4 5 7 263 2 2 1 ,0 7 5 (5 ,5 1 3 ) 2 1 8 ,2 8 2 4 3 2 ,8 2 5
Fundamental Analysis
Slide: 18
Performance Ratios
How efficiently a company is trading
Shareholder Returns
Benefits to be gained by investing in shares
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis Slide: 19
Trends
Most useful trends include
Revenues EBIT Pre-Tax / Net Income Invested Capital
Shareholders equity + LTD + STD
Compare annual % changes with RPI and industry averages Look at compound growth rate & Coefficient of Variation: CV = m 100
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis Slide: 20
Trends: Charts
Pre-Tax Profit Growth (% )
150.0% 100.0% 50.0% 0.0% 1993 -50.0% -100.0% RMA Average ABC
1992
1991
1990
1992
1991
1990
Fundamental Analysis
Slide: 21
Profitability
Copyright 1996 - 2006 Investment Analytics
Fundamental Analysis
ROA Calculation
SALES EBIT ASSETS 1993 1,628.3 63.4 432.8 1992 1,526.5 65.1 408.5
ROA
(EBIT/ASSETS) (65.1/408.5)
15.9%
NET MARGIN
(EBIT/SALES)
4.3%
(65.1/1526.5)
ASSET TURNOVER
(SALES/ASSETS)
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis
3.7
(1526.5/408.5)
Slide: 23
ROA Trend
RMA SALES EBIT ASSETS 1993 1,628.3 63.4 432.8 14.7% 1992 1,526.5 65.1 408.5
ROA
(EBIT/ASSETS)
15.9%
(65.1/408.5)
NET MARGIN
(EBIT/SALES)
3.9% 3.8
4.3%
(65.1/1526.5)
ASSET TURNOVER
(SALES/ASSETS)
Copyright 1996 - 2006 Investment Analytics
3.7
(1526.5/408.5)
Slide: 24
ROA Analysis
ROA is still above industry average
Higher margin Better efficiency
Fundamental Analysis
Slide: 25
ROA Breakdown
ROA Asset Turnover
Sales/Fixed Assets Stock Days Debtor Days Creditor Days
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis Slide: 26
Net Margin
Gross Margin Net Income/Sales
Fundamental Analysis
Slide: 27
Stock Turnover/Days
How many days sales are held in stock
Rise in stock days could indicate slowdown in sales Reducing stock days frees up working capital But increases risk of stockout
STOCK TURNOVER = STOCK DAYS = COST OF SALES INVENTORY INVENTORY COST OF SALES x 365
Debtor Turnover/Days
How many days taken to collect debts
Rise in debtor days could indicate credit problems Reducing debtor days frees up working capital Why is debtor days so low here?
DEBTOR TURNOVER = DEBTOR DAYS = SALES TRADE DEBTORS TRADE DEBTORS x 365 SALES
Creditor Turnover/Days
How many days credit allowed by suppliers
Working capital financing at the expense of suppliers Increasing creditor days adds to working capital Fall in creditor days means suppliers are speeding collection
CREDITOR TURNOVER = CREDITOR DAYS = COST OF SALES TRADE CREDITORS TRADE CREDITORS x 365 COST OF SALES
COST OF SALES TRADE CREDITORS (Accounts Payable) CREDITOR TURNOVER CREDITOR DAYS
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis
Net Margin
Mark-up of sales over operating costs
Decline may reflect fall in gross margin Or, rise in operating costs (SGA)
Gross Margin
Mark-up of sales over direct costs
Usually first component to reflect price pressures Fractions of % are significant because of knock-on effect
Net Income/Sales
How many cents of each $1 in sales are available for distribution to shareholders
As a shareholder want to see stability in this ratio Reflects changes in gross margin, net margin, tax and
financing costs
Financial Risk
Financial Leverage
Operating Leverage
Business risk is uncertainty of income due to:
Fluctuating sales Level of fixed costs
Fundamental Analysis
Slide: 37
Fundamental Analysis
Slide: 38
Financial Leverage
Reflects degree of fixed financial costs (interest)
Financial risk is additional to business risk High financing costs = high financial leverage Returns to equity holders more variable
FIN LEV = % Change Net Income % Change in EBIT ABCs FIN LEV ratio for 1993 was 1.5
A 1% change in operating income produces approximately a
1.5% change in income available to shareholders
Fundamental Analysis
Slide: 39
Leverage
The proportion of the company financed by debt
High leverage implies more volatile earnings, higher beta.
LEVERAGE = TOTAL DEBT TOTAL ASSETS Many different measures used: DEBT/EQUITY RATIO = D/E
Note: L = D/A = D/(D+E); D/E = L/(1-L)
TOTAL DEBT (Liabilities) TOTAL ASSETS LEVERAGE
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis
Interest Cover
How easily can the firm meet its interest obligations
Primarily of interest to long term debt-holders
INTEREST COVER =
Fundamental Analysis
Current Ratio
Can firm meet short term liabilities on time? Old rule of thumb (2:1) not really valid
Compare to industry norms Look for trends
Fundamental Analysis
Slide: 43
Fundamental Analysis
Slide: 44
Fundamental Analysis
Slide: 45
Return on Equity
Key measure of returns to shareholder ROE = NET INCOME SHAREHOLDERS EQUITY 1992 NET INCOME 35.7 SHAREHOLDERS EQUITY 190.9 ROE 18.7%
Fundamental Analysis
Slide: 46
Fundamental Analysis
Slide: 47
Payout Ratio
Proportion of profits paid out as dividends PAYOUT RATIO = DIVIDEND NET INCOME DIVIDENDS NET INCOME PAYOUT RATIO PLOUGHBACK RATIO = (1 - PAYOUT RATIO)
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis
Dividend Yield
Yield income to shareholders DIVIDEND YIELD = DIVIDEND PER SHARE SHARE PRICE 1992 DIVIDENDS PER SHARE $4.43 SHARE PRICE $225 DIVIDEND YIELD 1.97%
Fundamental Analysis
Slide: 50
Price-Book Value
Degree to which market value of equity exceeds book value P-B RATIO = SHARE PRICE PER SHARE BOOK VALUE 1992 SHARE PRICE $225 PER SHARE BOOK VALUE $133 P-B RATIO 1.69
Fundamental Analysis
Slide: 51
Fundamental Analysis
Slide: 52
ROE: Conclusions
ROE has declined significantly in 1993 due to:
Decline in profitability Fall in leverage Despite small improvement in ATO
Decline in Profitability:
Fall in gross margin Rise in operating costs (SG&A)
Leverage?
Fundamental Analysis
Slide: 53
ASSETS
Interest =I
DEBT
EQUITY
(EBITI)
Fundamental Analysis
Slide: 54
ASSETS
Interest =I
Rd = I D
Copyright 1996 - 2006 Investment Analytics
Equity
ROA
Assets
Rd
Debt
Leverage = D/E
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis Slide: 57
d = 0
e
Fundamental Analysis
* e
Slide: 58
Equity beta
a
d = 0
Fundamental Analysis
Slide: 59
Fundamental Analysis
Slide: 60
Fundamental Analysis
Slide: 61
Fundamental Analysis
Slide: 62
Fundamental Analysis
Slide: 63
Multiples
Equity Multiples: Equity Value as Multiple of:
Earnings (P/E ratio) Book value (P-B ratio) Sales
Fundamental Analysis
Slide: 64
Estimating Multiples
Regression estimate - best method
Measures reliability of multiple as a predictor of MVE Provides confidence range for MVE prediction Requires adequate number of guideline firms
Fundamental Analysis
Slide: 66
Regression Example
MVE = bPE x Net Income + e Regression will provide best estimate of bPE
Estimate ABCs MVE = bPE x Net Income R2 - goodness of fit: how much of variation is explained by independent variables
Fundamental Analysis
Slide: 67
Regression in MS-Excel
Fundamental Analysis
558.4
y = 16.25x R2 = 0.87
Slide: 69
Fundamental Analysis
Slide: 70
Coefficient of Determination
R2 = SSR/SST How much of total variation is explained by regression
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis Slide: 71
Residuals
You need to check residuals: Ei = (Yi - Yi*)
Residual = Actual MVE - Predicted MVE
Test for:
Non-Normality of residuals Bias: non-zero mean Heteroscedasticity (non-constant variance)
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis Slide: 72
Residual Plot
Residual
MVE
Fundamental Analysis
Slide: 73
Residual
MVE
Fundamental Analysis
Slide: 74
Residual
MVE
Fundamental Analysis
Slide: 75
Confidence Intervals
Sample MVE is an unbiased estimate of the true discount factor MVETRUE Confidence interval: 95% certain that:
MVELOWER < MVETRUE < MVEUPPER We can estimate this range from regression model, provided assumptions hold
Fundamental Analysis
Slide: 76
1 S* = S 1 + + n xi2 ( xi ) 2 / n
S = Standard error of the estimate (MSE)1/2
Copyright 1996 - 2006 Investment Analytics Fundamental Analysis Slide: 77
( x p x) 2
Fundamental Analysis
Slide: 78
Fundamental Analysis
Slide: 80
M V IC /E B IT V a lu a tio n
y = 11.8x R2 = 0.95
150.0
Slide: 81
MVIC Valuations
MVIC/ SALES Estimated MVIC Less: Debt Estimated MV Equity 798.3 96.6 701.7 MVIC/ EBIT 770.8 96.6 674.2
Fundamental Analysis
Slide: 82