STOCK ANALYSIS

WEEK 4: QUANTITATIVE ANALYSIS

Quantitative analysis refers to economic, business or financial analysis that aims to
understand or predict behavior or events through the use of mathematical measurements
and calculations, statistical modeling and research. Quantitative analysts aim to represent a
given reality in terms of a numerical value. Quantitative analysis is employed for a number
of reasons, including measurement, performance evaluation or valuation of a financial
instrument, and predicting real world events such as changes in a country's gross domestic
product.
It basically uses mathematics instead of Qualitative factors; here the statistics come into
play to address the health of a company. Quantitative factors are important in financial
forecasting i.e. predication and valuation. A very crude example would be using a company’s
annual report and stock market data to predict certain factors using some formulae. You can
make a stock price predictor using Quantitative analysis and machine learning.
To judge a company’s health you need data, and as per government guidelines all the firms
need to make their balance sheets public. Along with balance sheet we will be using income
statements and Cash flow statements to calculate certain features.
Why do we need Quantitative analysis, because of the following reasons –
1. To examine the relationship between variables (i.e. dependent, independent and
extraneous)
2. Performs a descriptive research and tells everything in the form of numbers.
3. Statistical models are used to crunch the numbers which in turn provide a better
overview.
4. It’s more rigid and provides sort of a statistical report.

Balance Sheet:
Balance sheet is basically the grade card of a company. It lists all the profits, assets,
liabilities, shareholder’s equity etc. By looking at a balance sheet you can determine how
well a company is performing.
Assets = Liabilities +Shareholder’s Equity
Amazon’s balance sheet is given, take a look at that and try making out the meaning
of terms. Some of the important terms have been discussed later.

Cash flow statements:

Cash flow or funds flow statements is basically a record of the cash and cash
equivalents (one of the asset classes along with stocks and bonds) entering and exiting the
company. Cash inflows refer to receipts of cash whereas cash outflows to payments or
disbursements. Cash flows are classified into three activities operating, investing and
financing. All inflows are presented in positive figures while all outflows are in negative (in
parenthesis). After inflows and outflows are presented, the net increase or decrease in cash
is computed and is added to the beginning balance of the cash to get the balance at the end.
The cash balance at the end should match to that in the company’s balance sheet.
A model cash flow statement is presented here.

Income Statements:
Also known as the profit and loss statement or statement of revenue and
expense, the income statement provides an overview of company sales and income.
The income statement provides performance information about a time period. The
income statement is divided into two parts: operating and non-operating.
It contains the following line items:
1. Revenues
“Revenues” is just a fancy term for “Total Sales”. It is the aggregate of all the sales of the
company’s products or services that have been achieved through the year. For example,
Apple’s revenue for the year 2010 would basically be the sum of the retail prices of all
the iPods, iPhones, iPads, MacBooks, etc. that Apple sold over that year
2. Cost of Goods Sold (COGS)
COGS are reported under expenses as the costs directly related to either the product
or goods sold by a company or the costs of acquiring inventory to sell to consumers.
If the cost of goods sold exceeds the revenue generated by the company during the
reporting period, the revenue did not generate a profit. Keep in mind that any loss
due to one business activity may be offset by another income-generating activity and
still result in a net profit for the company.

COGS = Beginning Inventory + Purchases Made During the Reporting Period - Ending
Inventory

3. Gross Profits
Gross Profit is a required income entry that reflects total revenue minus COGS. Gross profit
is a company’s profit before operating expenses, interest payments and taxes. Gross profit is
also known as gross margin.

Gross profits = Total revenue - COGS

4. Selling, General and Administrative Expenses (SG&A)

Selling expenses represent the costs of selling the product – salaries of salespeople,
commissions and travel expenses, advertising costs, shipping costs, etc.
General & Administrative expenses represent costs of managing the business, and
include the salaries of company executives, legal & professional fees, cost of office
supplies, etc.

5. Earnings before Interest, Tax, Depreciation and Amortization (EBITDA)

EBIDTA is a measure of a company's operating performance. Essentially, it's a way to
evaluate a company's performance without having to factor in financing decisions,
accounting decisions or tax environments.

EBITDA = Operating Profit(EBIT) + Amortization Expense + Depreciation Expense

6. Dividends
Unlike debt holders, shareholders are not legally entitled to fixed payments every
year. Their returns are through share price appreciation, and the issue of dividends.
Normally, a company pays out a certain amount of its yearly profits as dividends to
keep shareholders happy, and stops paying those dividends if it is need of that extra
cash. Companies cannot antagonize shareholders too much, however, since that
much lead to the dumping of the company’s shares in the market, causing the
company’s stock price to take a dive. In some (unusual) cases, companies have taken
on additional debt just in order to keep paying dividends and prevent that from
happening.
 There are some more terms which we would like you to research and know about
such as –
a. Depreciation and Amortization
b. Earnings before Interest and Tax(EBIT)
c. Net interest Expense
d. Profit before tax (PBT)
e. Income Tax Expense
f. Reported Profit After Tax (PAT)
g. Retained Earnings

Some important terms related to Balance Sheet:

1. Current Assets -
These assets can easily be converted to cash within one operating cycle -- the
amount of time the company needs to sell a product and collect cash from that
sale, often anywhere between 60 and 180 days.

2. Cash and Cash Equivalents –

Examples of Cash are coins, currency, cash in checking accounts, money orders,
etc. Examples of cash equivalents are Commercial paper, marketable securities,
money market funds, Treasury bills, etc.

3. Inventory –
‘Inventory’ refers to unsold goods that represent a probable future economic
benefit since they can be sold at any time, i.e., they are ready to be sold
immediately. Inventory can arise either as a result of production from raw
materials, or direct acquisition from suppliers. In the financial statements,
inventory is tied to COGS and purchases from suppliers through the following
formula:
Ending Inventory = Starting Inventory + purchases from suppliers + COGS

4. Accounts Receivable (A/R) :

The accounts receivable line item in companies’ balance sheets represents the
aggregate of the money owed them by their customers. So, when a sale is made,
but the customer does not pay the cash up front, the company’s accounts
receivable increases by the price of the product just sold, rather than the
company’s cash balance. When, eventually, the customer does cough up the
cash, accounts receivable is converted to cash – the former decreases while the
latter increases by the same amount.

5. Prepaid expenses :
Some costs, such as rent, electricity bills, etc. can be estimated to a reasonable
degree of certainty. Some companies choose to pay large advances that cover
multiple periods of cost. This makes prepaid expenses an asset. Since very few
 companies would pre-pay for periods exceeding a year in duration, this line-item
is almost always a current asset.

6. Non-current assets:
Also referred to as “fixed assets”, this set of line items describes assets that
cannot easily be converted into cash, that cannot usually be sold directly to the
firm’s end-customers, and that give probable economic benefits which extend
beyond a year from the date of purchase.

7. Gross Fixed Assets (Property, Plant, & Equipment) :

It refers to items of value - such as land and buildings, motor vehicles, furniture,
office equipment, computers, and plant and machinery - that will be used over
an extended period of time. This line item represents the value of these items at
the time of purchase of each.

8. Accumulated Depreciation:
The sum of the depreciated amounts of all the company’s assets is equal to
accumulated depreciation.

9. Net Fixed Assets:

Net fixed assets is gross fixed assets less accumulated depreciation.

10. Investments:
This line item represents the company’s investments in other companies, where
a non-controlling stake of less than 50% is held.

11. Intangible assets:

These are defined as identifiable non-monetary assets that cannot be seen,
touched, or physically measured, but which are created through time and effort.
There are two primary forms of intangibles – legal (trade secrets, copyrights,
patents, trademarks) and competitive (know-how, goodwill).

12. Current Liabilities:

Current liabilities, like current assets, have obligations coming due within 12
months of the originating transaction.

13. Accounts Payable (A/P)

A/P is the exact opposite of A/R – it is the amount owed by the company to its
suppliers due to the purchase of raw materials etc. on credit.

14. Unearned revenues:

These are accrued by a company when a customer pays for a product or service
in advance of the product being delivered or the service being rendered. Only
 when the product is finally delivered (or service rendered), can the company
reduce its unearned revenue account and increase its revenues.

15. Net Current Assets:

Some balance sheet formats net current assets against current liabilities to
obtain net current assets, which is place in the asset section of the balance sheet.

16. Shareholders’ Equity:

Equal to the firm’s total assets less total liabilities, the shareholders’ equity line
item represents the combined net worth of all the owners (shareholders) of the
firm.

17. Share Capital:

These are the funds raised by issuing shares in the company in exchange for cash.
The amount of share capital a company reports on its balance sheet only
accounts for the initial amount for which the original shareholders purchased the
shares during its IPO. Subsequent changes in stock price as a result of
transactions in the secondary market are not included.

18. Preferred Stock:

This is the dollar value of the preferred stock issued by the firm over its lifetime.

19. Accumulated Retained Earnings:

Accumulated retained earnings are the earnings of a business that have piled up
since its inception, rather than being paid to shareholders in the form of
dividends or some other form of distribution.

Ratio Analysis:
The numbers in a company’s financial statements carry very little meaning by
themselves – knowing a company made $100,000 in profits last year does not tell us how
good the business is at converting resources to earnings. This is where ratios come in – they
provide meaningful relationships between individual line items in the financial statements.
We will restrict our use of ratio analysis to the finding of ratios that will help us evaluate five
aspects of a company – its operating performance, activity levels, liquidity position,
leverage, and stock valuation multiples.

1. Operating performance
a. EBITDA margin = (EBITDA/Net sales)
b. Net profit margin = (Net profit/Net sales)
c. Total Asset turnover = (Net sales/Total assets)
d. Return on assets = (Net profit/Total assets)
e. Return on equity = (Net profit/Shareholders’ equity)
 2. Liquidity Position
a. Current ratio = CA/CL (CL=Current Liabilities)
3. Leverage
a. Debt to equity = (Debt/Shareholders’ equity)
4. Stock Valuation Multiples
a. P/E = (Share price/Earnings per share)
b. P/S = Share price/(Sales/No. of shares outstanding)

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