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Financial Analysis
Source: Morningstar
Source: Morningstar
Example of extracting quick knowledge using horizontal analysis Balance Sheet Accounts
(such can be done with Income Statement and, less meaningfully, with Cash Flow Statement
100%
Accounts
Receivable
100%
PP&E
Goodwill
Long Term
Debt
Source: Morningstar
100%
100%
Example of extracting quick knowledge using horizontal analysis Balance Sheet Accounts
(such can be done with Income Statement and, less meaningfully, with Cash Flow Statement
100%
Accounts
Receivable
100%
PP&E
Goodwill
Long Term
Debt
Source: Morningstar
100%
100%
Financial Ratios
(How well does this company Perform? How much does it rely on Leverage? Is the company
sufficiently Liquid to avert a last minute emergency (like an earthquake .. Ej. Toyota)?
Invested Capital (IK) is the historical value (book value, not the market value) of capital that has been
Invested in company. With a little balance sheet rearrangement, we see that IK equals either Op. Cash +
A/R + Inv A/P STB + PPE + OLTA - OLTL or Equity + LTD Exc Cash. The latter (Equity+LTD-Exc Cash) is
quicker to calculate (when one needs to find IK) There is no need to tease out Equity You use the total.
Contrast that with the Liabilities side, where you only use LTD
1
Faster you convert your assets to
cash (or the longer the time
before you pay suppliers), the
better for your company b/c you
are using less resources to build
products. Youre more efficient
A/R T.O.
[A/R]/Sales
Inv T.O.
[Inv]/Sales
2
The higher the profitability
ratios, the higher the amount
your company retains for every
dollar of sales
NI Margin
NI/Sales
EBIT Margin
EBIT/Sales
Gross Margin
[Sales-COGS]/Sales
Liquidity Ratios
Leverage Ratios
EBITDAX =
EBITX
SALESX =
EV
EBITDA
EV
EBIT
EV
SALES
Current = CA / CL
Ratio
Quick = [CA-Inv] / CL
Ratio
Book Leverage =
DB
DB + EB
A/P T.O.
[A/P]/Sales
P-to-B X = EM = Ps
SE
SE/#sh
Interest =
Coverage
EBIT
Interest
DB = LTD
EB = SE
EM = # shares x Pstock or Market Cap
(1-T)
EBIT
S
Profit
Margin
ROIC
inorganico
EBIT
SALES
ROIC
orgnico
SALES
Q
Efficiency
(1 - GWDef )
Sales
IK-GW
PPEnet+OLTA+CA
IK-GW
OLTL + CL
Performance
Performance
(How Profitable and Efficient is a company?)
TBD
Profitability and Efficiency
If PPE goes
up, Dep too!
Profit
Margin
ROIC
inorganico
(1-T)
EBIT
EBIT
SALES
ROIC
orgnico
Goodwill
deflator
GWDef = GW
IK
SALES
Q
TBD Sales
Efficiency
IK-GW
(1 - GWDef )
PPEnet+OLTA+CA
IK-GW
OLTL + CL
Are we converting
CAs to cash
fast enough?
Leverage Liquidity
Liquidity
Leverage
LTD = Book Leverage = 1 - E
IK
LTD + TE
Dm = Capital structure
Dm + Em
EBIT
INT
Considers coverage on
Debt interest
EBIT
INT+Pr
CA
CL
CA-INV
CL
Leverage Liquidity
Liquidity
(Book)
Leverage
Leverage
Dm = Capital structure
Dm + Em
(Market)
Leverage
EBIT
INT
Considers coverage on
Debt interest
EBIT
INT+Pr
CA
CL
CA-INV
CL
All are
Financial Ratios
Linking
Performance
Profitability and Efficiency
and
Unifying concept:
g* = Sustainable
growth rate
Leverage
(Book)
All are
Financial Ratios
Linking
Performance
Profitability and Efficiency
and
Leverage
(Book)
Unifying concept:
g* = Sustainable
growth rate
(Lectures 5 and 6)
g*= Maximum growth that is possible without needing to issue new stock
g* =
PM x Eff x Fl x (1-d)
1 (PM x Eff x FL x (1-d))
,where d = 1
NI Div
EBIT x (1 T)
g* is higher if you increase your profit margin (PM) or efficiency (Eff) or if you lever your company more (FL)
EBIT
SALES
Sales
IK
IK
E
Value Multiples
(How valuable is this company?)
Considers sales,
margins & CAPex
EBITDAx =
EV
EBITDA
Considers margins
And sales
SALESx =
EV
SALES
Considers sales
Rationale of
Value multiples
EBITDAx
EBITx = EV
EBIT
Considers sales,
margins & CAPex
Pepsi
11.8x
EBITDAx =
EV
EBITDA
Considers margins
And sales
SALESx =
EV
SALES
Considers sales
Coke
14.5x
Rationale of
Value multiples
EBITDAx
EBITx = EV
EBIT
Considers sales,
margins & CAPex
Pepsi
Coke
11.8x
EBITDAx =
EV
EBITDA
Considers margins
And sales
SALESx =
EV
SALES
Considers sales
14.5x
Em + Dm
EBITDA
FCFo x (1+g)
(Rwacc g)
EBITDA
Rationale of
Value multiples
EBITDAx
EBITx = EV
EBIT
Considers sales,
margins & CAPex
Pepsi
Coke
11.8x
EBITDAx =
EV
EBITDA
Considers margins
And sales
SALESx =
EV
SALES
Considers sales
14.5x
Em + Dm
EBITDA
FCFo x (1+g)
(Rwacc g)
EBITDA
Fundamental
Analysis
Deuda Libro
Deuda
Largo Plazo
Equity Libro
Patrimonio
Patrimonio
Fundamental
Analysis
Deuda Libro
Deuda
Largo Plazo
Equity Libro
Patrimonio
Patrimonio
Fundamental
Analysis
Deuda Libro
Deuda
Largo Plazo
Deuda
Mercado
Equity Libro
Patrimonio
Patrimonio
Equity
Mercado
Fundamental
Analysis
Cuanto vale la Deuda y el
Patrimonio en el Mercado?
Deuda Libro
Deuda
Largo Plazo
Deuda
Mercado
Equity
Mercado
Equity Libro
Patrimonio
Patrimonio
Fundamental
Analysis
Deuda Libro
Deuda
Largo Plazo
Deuda
Mercado
Equity Libro
Patrimonio
Patrimonio
Equity
Mercado
Fundamental
Analysis
Deuda Libro
DB
Deuda
Largo Plazo
Equity Libro
EB
Patrimonio
Patrimonio
DM
Deuda
Mercado
compare
EM
Equity
Mercado
Fundamental
Analysis
Valor Economico de Instrumentos
Deuda Libro
DB
DM
Deuda
Largo Plazo
Deuda
Mercado
compare
Equity Libro
EB
EM
Patrimonio
Equity
Mercado
Patrimonio
FCF = Flujo de Caja Libre = EBIT x (1-T) + Depreciacion Inversiones Incrementos de Capital Trabajo
Rwacc
Fundamental
Analysis
Your
Opinion
Markets
Opinion
DM+EM
<
Fundamental
Analysis
= Buy stock
Value
Multiples
>
Fundamental
Analysis
= Sell stock
Value
Multiples
Fundamental
Analysis
Value
Multiples
Indifferent
Value
Multiples
Profitability
Efficiency
Leverage
(Book)
Liquidity
Leverage
(Market)
Fundamental
Analysis
Reliance on Debt to
support business
Performance
Economic
Value expected
of Company
Ability
to weather
bad surprises
Profitability
Efficiency
Leverage
(Book)
Liquidity
Value
Multiples
Leverage
(Market)
Fundamental
Analysis
Unifying concept:
g* = Sustainable
growth rate
(Lectures 5 and 6)
Value
Multiples
Financial Ratios
Reliance on Debt to
support business
Performance
Economic
Value expected
of Company
Ability
to weather
bad surprises
Profitability
Efficiency
Leverage
(Book)
Liquidity
Value
Multiples
Leverage
(Market)
Fundamental
Analysis
Unifying concept:
g* = Sustainable
growth rate
(Lectures 5 and 6)
A mix of
the two
Financial Ratios
Reliance on Debt to
support business
Performance
Value
Multiples
Economic
Value expected
of Company
Ability
to weather
bad surprises
Profitability
Efficiency
Leverage
(Book)
Liquidity
Value
Multiples
Leverage
(Market)
Fundamental
Analysis
Unifying concept:
g* = Sustainable
growth rate
(Lectures 5 and 6)
A mix of
the two
Financial Ratios
Reliance on Debt to
support business
Performance
Value
Multiples
Economic
Value expected
of Company
Ability
to weather
bad surprises
Profitability
Efficiency
Leverage
(Book)
Liquidity
Markets
Opinion
Value
Multiples
Leverage
(Market)
Your
Opinion
Fundamental
Analysis
Unifying concept:
g* = Sustainable
growth rate
(Lectures 5 and 6)
APPENDIX
The above comments make this figure less useful for comparing between companies. Two
exact companies, selling the same exact amount, could have very different levels of Interest
Expense (one borrows more than the other one). It also has (as noted above) a denominator
which includes more than what were investing.
Once again, the above comments make this figure less useful for comparing companies. Two
exact companies, selling the same exact amount, could have very different levels of Interest
Expense (one borrows more than the other one). It also has (as noted above) a denominator
which ignores the fact that there is more capital (in the form of Long Term Debt) that might
be in use alongside equity to invest.
DO YOU SEE THE CHALLENGE OF USING THIS AS A RELIABLE COMPARISON FIGURE?
Note: There are few exceptions where using ROE is better than the alternative. One such exception is to use ROE for financial services (banks) companies. Notwithstanding, this is beyond the scope of the course.
ROIC as more than just a ratio: The DuPont Model (starting with ROE)
Originally, the DuPont Model was developed using ROE
ROIC as more than just a ratio: The DuPont Model (starting with ROE)
Originally, the DuPont Model was developed using ROE
Shareholders equity as recorded on balance sheet
ROE = NI/ SE
But, remember that LTD + SE equals IK, which stands for Invested Capital
ROE = NI/ SE
[NI/ Sales]
ROE
[Assets Turnover]
ROIC as more than just a ratio: The DuPont Model (starting with ROE)
Originally, the DuPont Model was developed using ROE
Shareholders equity as recorded on balance sheet
ROE = NI/ SE
But, remember that LTD + SE equals IK, which stands for Invested Capital
ROE = NI/ SE
[NI/ Sales]
ROE
[Assets Turnover]
With this re-composition of ROE, you can compare 2 companies with each other and can actually
see, even if the 2 companies have equal ROEs, whats different between them
Now, we know that ROE is distorted by capital financing artifacts (Net Inc has the effects of
financing). Even considering the Equity Multiplier effect as a separate contributor to ROE, Total
Assets includes more than what we want (it is not strictly Invested Capital!!!)
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
Originally, the DuPont Model was developed using ROE
Shareholders equity as recorded on balance sheet
ROE = NI/ SE
But, remember that LTD + SE equals IK, which stands for Invested Capital
ROE = NI/ SE
[NI/ Sales]
ROE
[Assets Turnover]
With this re-composition of ROE, you can compare 2 companies with each other and can actually
see, even if the 2 companies have equal ROEs, whats different between them
ROIC = EBIT(1-T)/ IK
Now, we know that ROE is distorted by capital financing artifacts (Net Inc has the effects of
financing). Even= considering
the
Equity
Multiplier effect
separate
ROIC
[EBIT
x (1-T)
/ Sales]
x as a[Sales
/ IK]contributor
x
1 to ROE, ROE is
still saddled by the very core of its weakness: it still remains ROE!
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
Originally, the DuPont Model was developed using ROE
Shareholders equity as recorded on balance sheet
ROE = NI/ SE
But, remember that LTD + SE equals IK, which stands for Invested Capital
ROE = NI/ SE
[NI/ Sales]
ROE
[Assets Turnover]
With this re-composition of ROE, you can compare 2 companies with each other and can actually
see, even if the 2 companies have equal ROEs, whats different between them
ROIC = EBIT(1-T)/ IK
Now, we know that ROE is distorted by capital financing artifacts (Net Inc has the effects of
financing). Even= considering
the
Equity
Multiplier effect
separate
ROIC
[EBIT
x (1-T)
/ Sales]
x as a[Sales
/ IK]contributor
x
1 to ROE, ROE is
still saddled by the very core of its weakness: it still remains ROE!
ROIC
[ Efficiency ]
1
In ROIC, we dont
need Equity multiplier,
as we are evaluating
returns based on
whole invested
capital
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
Originally, the DuPont Model was developed using ROE
Shareholders equity as recorded on balance sheet
ROE = NI/ SE
But, remember that LTD + SE equals IK, which stands for Invested Capital
ROE = NI/ SE
[NI/ Sales]
ROE
[Assets Turnover]
With this re-composition of ROE, you can compare 2 companies with each other and can actually
see, even if the 2 companies have equal ROEs, whats different between them
ROIC = EBIT(1-T)/ IK
Now, we know that ROE is distorted by capital financing artifacts (Net Inc has the effects of
financing). Even= considering
the
Equity
Multiplier effect
separate
ROIC
[EBIT
x (1-T)
/ Sales]
x as a[Sales
/ IK]contributor
x
1 to ROE, ROE is
still saddled by the very core of its weakness: it still remains ROE!
ROIC
[ Efficiency ]
1
In ROIC, we dont
need Equity multiplier,
as we are evaluating
returns based on
whole invested
capital
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
Originally, the DuPont Model was developed using ROE
Shareholders equity as recorded on balance sheet
With this re-composition of ROE, you can compare 2 companies with each other and can actually
see, even if the 2 companies have equal ROEs, whats different between them
Now, we know that ROE is distorted by capital financing artifacts (Net Inc has the effects of
financing). Even considering the Equity Multiplier effect as a separate contributor to ROE, ROE is
still saddled by the very core of its weakness: it still remains ROE!
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
Originally, the DuPont Model was developed using ROE
Shareholders equity as recorded on balance sheet
With this re-composition of ROE, you can compare 2 companies with each other and can actually
see, even if the 2 companies have equal ROEs, whats different between them
Now, we know that ROE is distorted by capital financing artifacts (Net Inc has the effects of
financing). Even considering the Equity Multiplier effect as a separate contributor to ROE, ROE is
still saddled by the very core of its weakness: it still remains ROE!
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
ROIC = EBIT(1-T)/ IK
ROIC
ROIC
[Sales / IK]
[ Efficiency ]
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
ROIC = EBIT(1-T)/ IK
ROIC
ROIC
[Sales / IK]
[ Efficiency ]
ROIC as more than just a ratio: The DuPont Model (adapting it to ROIC)
ROIC = EBIT(1-T)/ IK
ROIC
ROIC
[Sales / IK]
[ Efficiency ]
With the DuPont model, we can say that, in spite of both companies having same ROIC, Company X has lower After Tax
Operating Income margin, but makes up the difference with respect to competitor by generating more sales for every dollar of
capital invested (in other words, it has lower profitability margin but is more efficient than its competitor!)
When we talk about Leverage Ratios, we think of Long Term Debt as % of Enterprise Value
Why?
When we talk about Leverage Ratios, we think of Long Term Debt as % of Enterprise Value
Why? Lets examine this ratio (and see why Market vs. Book Value) through an example
When we talk about Leverage Ratios, we think of Long Term Debt as % of Enterprise Value
Why? Lets examine this ratio (and see why Market vs. Book Value) through an example
What does this
ratio appear to tell
us?
Calculation
CL
CA
LTD
LTD + SE
0.95
1.04
24,283
25,497
18,154
17,441
30%
13,656
13,656+31,635
DM
DM+ EM
50%
20,568
20,658+20,745
7%
15%
13,656
13,656+177,690
20,568
20,568+114,120
When we talk about Leverage Ratios, we think of Long Term Debt as % of Enterprise Value
Why? Lets examine this ratio (and see why Market vs. Book Value) through an example
What does this
ratio appear to tell
us?
Calculation
CL
CA
LTD
LTD + SE
0.95
1.04
24,283
25,497
18,154
17,441
30%
13,656
13,656+31,635
DM
DM+ EM
50%
20,568
20,658+20,745
7%
15%
13,656
13,656+177,690
20,568
20,568+114,120
When we talk about Leverage Ratios, we think of Long Term Debt as % of Enterprise Value
Why? Lets examine this ratio (and see why Market vs. Book Value) through an example
What does this
ratio appear to tell
us?
Calculation
CL
CA
LTD
LTD + SE
0.95
1.04
24,283
25,497
18,154
17,441
30%
13,656
13,656+31,635
DM
DM+ EM
50%
20,568
20,658+20,745
7%
15%
13,656
13,656+177,690
20,568
20,568+114,120
When we talk about Leverage Ratios, we think of Long Term Debt as % of Enterprise Value
Why? Lets examine this ratio (and see why Market vs. Book Value) through an example
What does this
ratio appear to tell
us?
Calculation
CL
CA
LTD
LTD + SE
0.95
1.04
24,283
25,497
18,154
17,441
30%
13,656
13,656+31,635
DM
DM+ EM
50%
20,568
20,658+20,745
7%
15%
13,656
13,656+177,690
20,568
20,568+114,120
Soooooo, ratios are all good to quickly understand self and competition. However,
-Please be VERY careful using Profitability ratios that are affected by financing effects
- Using these type of distorted ratios makes it difficult to compare apples to apples
-When calculating Leverage Ratios (to see how much long term debt there is as % of total Enterprise
Value) please rely on market values versus book values (historical figures):
-Using book value figures blatantly ignores that companies could have raised lots of capital that
today, as things may have turned out, may be worth more or less than
- The Invested Capital may have led to great value creation since first raised and, as such,
companies can actually be less leveraged than historical data suggests
-Yet, calculating market leverage ratios is not possible when companies are not public