CHAPTER 12

FINANCIAL STATEMENT ANALYSIS:

APPLICATIONS
Presenters name
Presenters title
dd Month yyyy

EVALUATION OF A COMPANYS PAST

PERFORMANCE

1999
2000
2001
2002
2003
2004
2005
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2006
2007
2008
2009
2010
2011
2012
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EVALUATION OF A COMPANYS PAST

PERFORMANCE: APPLE
$ (millions)
$70,000
Sales
$60,000
Gr. Profit
$50,000
$40,000
$30,000
$20,000
$10,000
$0
2007

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2008

2009

2010

EVALUATION OF A COMPANYS PAST

PERFORMANCE: APPLE
Fiscal Year
($ millions)

2010

2009

Net sales

$65,225

$42,905 $37,491 $24,578

Gross margin

25,684

Net income (NI)

14,013
2010

Gross margin (% sales)

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39%

2008

2007

17,222

13,197

8,152

8,235

6,119

3,495

2009
40%

2008
35%

2007
33%

EVALUATION OF A COMPANYS PAST

PERFORMANCE: APPLE
Panel A: Data for Apple Inc.
($ millions)
Cash and marketable securities
Total current assets
Total assets
Total current liabilities

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Fiscal Year
2010

2009

2008

2007

$51,011

$33,992

$24,490

$15,386

41,678

31,555

30,006

21,956

75,183

47,501

36,171

24,878

20,722

11,506

11,361

9,280

EVALUATION OF A COMPANYS PAST

PERFORMANCE: APPLE
100%
90%
80%
70%

Peripherals and other hardware

Software, service and other sales

60%

Other music related

50%

iPad & related

40%

iPod
Total Mac

30%

iPhone & related

20%
10%
0%
2007

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2008

2009

2010

FORECASTING
Sales Forecast
Expenses
Gross Profit
Operating Profit
Assets
Liabilities

Cash Flow

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FORECASTING

Sales Forecast
Expenses
Gross Profit
Operating Profit
Assets
Liabilities

Cash Flow

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FORECASTING

Sales Forecast
Expenses
Gross Profit
Operating Profit
Assets
Liabilities

Cash Flow

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FORECASTING

Sales Forecast
Expenses
Gross Profit
Operating Profit
Assets
Liabilities

Cash Flow

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ITERATIONS IN FORECASTING

Sales Forecast

Forecast
Debt

Forecast
Interest
Expense

Forecast
Cash Flow

Forecast
Income and
Taxes

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Expenses
Gross Profit
Operating Profit
Assets
Liabilities

Cash Flow

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FORECASTING OPERATING PROFIT BASED ON

HISTORICAL MARGINS
Johnson & Johnson
(NYSE: JNJ)
U.S. health care conglomerate,
founded in 1887.
2009 sales of around $61.9
billion from its three main
businesses: pharmaceuticals,
medical devices and diagnostics,
and consumer products.
For the four years prior to 2009,
average operating profit margin
was approximately 25.0%.

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Baidu (NASDAQ: BIDU)

Chinese language internet
search engine, established in
2000 and went public on
NASDAQ in 2005.
Revenues for 2009 were 4.4
billion renminbi (RMB), an
increase of 40% from 2008 and
more than 14 times greater than
revenues in 2005.
For the four years prior to 2009,
average operating profit margin
was approximately 27.1%.

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FORECASTING OPERATING PROFIT BASED ON

HISTORICAL MARGINS
Johnson & Johnson
(NYSE: JNJ)
2009 sales were $61.9 billion.
For the four years prior to 2009,
average operating profit margin
was approximately 25.0%.
Actual operating profit for 2009
was $15.6 billion.
Actual operating profit margin for
2009 was 25.2%.

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Baidu (NASDAQ: BIDU)

2009 revenues were 4.4 billion
renminbi (RMB).
For the four years prior to 2009,
average operating profit margin
was approximately 27.1%.
Actual operating profit for 2009
was RMB1.6 billion.
Actual operating profit margin for
2009 was 36.4%.

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ASSESSING CREDIT QUALITY

Credit risk: Risk of loss caused by a debtors failure to
make a promised payment
Credit analysis: Evaluation of credit risk
- Risk in a particular transaction or for a particular security
- Obligors overall creditworthiness

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TECHNIQUES FOR ASSESSING CREDIT

QUALITY
Credit scoringstatistical techniques
Period-by-period cash flow projections
Analysis of business and financial risk factors

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ASSESSING CREDIT QUALITY: EXAMPLE

Bombardier
Inc.

BAE
Systems
plc

7.5%

10.1%

3.9

3.1

Retained cash flow to debt

6.1%

13.7%

Free cash flow to net debt

7.0%

7.7%

EBITDA/Average assets
Debt/EBITDA

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STOCK SCREENING

Universe of Stocks

Stocks Meeting
Criteria
Selection

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EXAMPLE OF STOCK SCREENS

Stocks Meeting Criterion

Criterion

Number

P/E <15

Percent of Total

1,471

28.36%

880

16.97%

NI/Sales > 0

2,907

56.04%

Dividend yield > 0.5%

1,571

30.29%

101

1.95%

Total debt/Assets 0.5

Meeting all four criteria simultaneously

Source for data:

http://google.com/finance/
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SCREENS AND BACK-TESTING

Valuation metrics + Accounting metrics
Evaluation of screen using back-testing
Caveats when back-testing:
- Survivorship bias
- Look-ahead bias
- Data-snooping bias

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TWO HYPOTHETICAL SCREENING STRATEGIES

Strategy A
Invest in stocks that are
components of a global
equity index, have an ROE
above the median ROE of all
stocks in the index, and
have a P/E less than the
median P/E.

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Strategy B
Invest in stocks that are
components of a broadbased U.S. equity index,
have a ratio of price to
operating cash flow in the
lowest quartile of companies
in the index, and have
shown increases in sales for
at least the past three years.

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TWO HYPOTHETICAL SCREENING STRATEGIES:

AVOID UNINTENTIONAL SELECTIONS
Strategy A

Strategy B

Invest in stocks that are

components of a global
equity index, have an ROE
above the median ROE of all
stocks in the index, and
have a P/E less than the
median P/E.

Invest in stocks that are

components of a broad-based
U.S. equity index, have a ratio
of price to operating cash flow
in the lowest quartile of
companies in the index, and
have shown increases in sales
for at least the past three years.

What if Net income was < 0

and Equity < 0?
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What if operating cash flow was

< 0?
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ANALYST ADJUSTMENTS
Importance (materiality). Is an adjustment to this item likely to affect the
conclusions? In other words, does it matter? In an industry where
companies require minimal inventory, does it matter that two
companies use different inventory accounting methods?
Body of standards. Is there a difference in the body of standards being
used (U.S. GAAP versus IFRS)? If so, in which areas is the difference
likely to affect a comparison?
Methods. Is there a difference in accounting methods used by the
companies being compared?
Estimates. Is there a difference in important estimates used by the
companies being compared?

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INVESTMENTS
Investments
- Unrealized gains and losses on the income statement
versus
- Unrealized gains and losses not on the income statement
but instead recognized in equity.
If two otherwise comparable companies have significant
differences, it may be useful to adjust.

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INVENTORY: EXAMPLE

Company A
(FIFO)

Current assets (includes inventory)

LIFO reserve
Current liabilities

Company B
(LIFO)

$300,000

$80,000

NA

$20,000

$150,000

$45,000

NA = not applicable

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INVENTORY: EXAMPLE
Company B
Company A
(FIFO)

Unadjusted
(LIFO basis)

Adjusted
(FIFO basis)

Current assets
(includes inventory)

$300,000

$80,000

$100,000

Current liabilities

$150,000

$45,000

$45,000

2.00

1.78

2.22

Current ratio

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GOODWILL AND
INTANGIBLE ASSETS
Market capitalization on January 2010 (market
price per share times the number of shares
outstanding)
Total shareholders equity as of most recent
quarter
Goodwill
Other intangible assets

SCHW

AMTD

$21,871

$11,525

$5,073

$3,551

$528

$2,472

$23

$1,225

The MV/BV for the companies is

SCHW
$21,871/$5,073 = 4.3
AMTD
$11,525/$3,551 = 3.2
Note: MV/BV equals the total market value of the stock (the market capitalization) divided
by total stockholders equity. It is also referred to as the price-to-book ratio because it can
also be calculated as price per share divided by stockholders equity per share.
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GOODWILL AND INTANGIBLE ASSETS

Total stockholders equity

Less goodwill
Book value, adjusted
Adjusted MV/BV

Total stockholders equity

Less goodwill
Less other intangible assets
Tangible book value
MV/tangible book value

($ millions)
SCHW
AMTD
$5,073
$3,551
$528
$2,472
$4,545
$1,079
4.8

10.7

($ millions)
SCHW
AMTD
$5,073
$3,551
$528
$2,472
$23
$1,225
$4,522
($146)
4.8

NM

NM = not meaningful
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OFF-BALANCE-SHEET FINANCING
Use disclosures to assess a companys financial position as if offbalance-sheet obligations (e.g., operating leases) were included in its
total liabilities.
Steps:
- Determine present value of future operating lease payments.
- Add present value of future operating lease payments to total debt
and to total assets.
- Adjust expenses to
- Include depreciation expense, interest expense.
- Exclude rent expense.
The adjustments for operating leases essentially treat the transaction
as if the asset subject to the operating lease had been purchased
rather than leased.
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SUMMARY
Financial statement analysis applications discussed in this
presentation include
Evaluating a companys past performance.
Projecting a companys future performance.
Assessing the credit quality of a potential debt investment.
Screening for potential equity investments.
Adjusting a companys financial statements to facilitate
cross-sectional comparison.

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