E, F calculate and interpret ratios used in equity analysis and credit analysis; explain the requirements for segment reporting, and calculate and interpret segment ratios; Flashcards
Calculate and interpret the ratios used in equity analysis, credit analysis, segment analysis + Explain the requirements for segment reporting and calculate and interpret segment ratios
Credit Analysis ratios (fixed income risk analysis)
In assessing a company’s ability to service and repay its debt, analysts use interest coverage ratios (calculated with EBIT and EBITDA), return on capital, and debt to assets ratios
Altman Z-Score- A ratio used to predict firm bankruptcies : based on a firm’s working capital to assets, retained earnings to assets, EBIT to assets, market to book value of a share of stock, and revenues to assets
Segment Analysis ratios
Calculation: Examine the performance of business or geographic segments separately.
Segment profit margins, asset utilization (turnover), and return on assets can be very useful in gaining a clear picture of a firm’s overall operations. For forecasting, growth rates of segment revenues and profits can be used to estimate future sales and profits and to determine the changes in company characteristics over time.
Requirement for Segment Reporting
a ‘Business Segment’ - A portion of a larger company that accounts for more than 10% of the company’s revenues or assets, and is distinguishable from the company’s other lines of business in terms of the risk and return characteristics of the segment.
‘Geographic Segments’ - ^^Size criteria and geographic unit has a business environment that is different from that of other segments or the remainder of the company’s business
Most widely used valuation ratio
P/E ratio - the ratio of a current market price of a share of stock divided by the company’s earnings per share
Related measures based on Price per Share and (price multiples used for valuation)
Price-Earnings P/E: A firms stock price / earnings per share - widely used by analysts, cited in the press
Price-to-cash flow: The firms stock price/CF per share where CF may be defined as operating CF or Free Cash Flow
Price-to-sales: Firms stock price / sales per share
Price-to-book value: Firms stock price / book value of equity per share
EPS (a per share measure)
Basic: NI - Preff. Div / Weighted Average # of Common Shares Outstanding
Diluted: A Sensitivity value: =the lowest possible EPS that could have been reported if all firm securities that can be converted into common stock, and that would decrease basic EPS if they had been, were converted ‘aka if all dilutive securities had been converted’
Potentially dilutive securities: Convertible debt, convertible preferred stock, options and warrants issued by the company
Numerator of diluted EPS is increased by the after-tax interest savings on any dilutive debt securities and by the dividends on any dilutive convertible preferred stock.
The denominator is increased by the common shares that would result from conversion or exchange of dilutive securities into common shares.
Other per share measures and a note about them
EBIT per share, Cash Flow per Share, EBITDA per share
Per share measures aren’t comparable because the number of outstanding shares differs amongst firms.
Dividends
Dividends are declared on a per-common-share basis
Dividends Declared refer to total dividends on a firm-wide basis
EPS and NI aren’t reduced by the payment of common stock dividends.
NI - Dividends declared = RE
RE = The earnings that are used to grow the corporation rather than being distributed to equity holders
RE is an important determinant of a firms sustainable growth rate.
A firms sustainable growth rate(ex), dividends, RE
NI - Dividends = RE (which is an important determinant to a firms sustainable growth rate)
Sustainable Growth Rate: How fast the firm can grow without additional external equity issues while holding leverage constant
g = RR x ROE
RR = 1 - (dividends / earnings)
Ratios that are specific to certain industries
Net Income per Employee and Sales per Employee: Used in the analysis and valuation of service and consulting companies
Growth in same-store sales: Restaurant and retail industries to indicate growth without the effects of new locations that have been opened. Measures how well a firm is doing at attracting and keeping existing customers and, in the case of locations with overlapping markets, may indicate that new locations are taking customers from existing ones.
Sales per Square Foot: A measure used in retail
Business Risk Ratios (measure uncertainty about a firms performance)
The Standard Deviations of Revenue, Operating Income, Net Income
*All depend on the size of the firm so analysts employ a size-adjusted measure of variation
The coefficient of variation for a variable is its standard deviation divided by its expected value (Also used to measure portfolio risk)
Ratios that aid across time or among firms and its peers in assessing the relative and absolute degree of risk a firm faces in generating income for its investors
CV Sales = SD of sales / Mean Sales
CV Operating Income = SD of Op. Inc / Mean Op. Inc
CV Net Income = SD of NI / Mean NI
Other business risk terms
Capital Adequecy: The ratio of some dollar measure of the risk, both operational and financial, of the firm to its equity capital.
Value at Risk - A common measure of capital risk which estimates the dollar size of the loss that a firm will exceed only some specific percent of the time, over a specific period of time
Liquid Asset Requirement (banks): The ratio of a bank’s liquid assets to certain liabilities.
The performance of financial companies that lend funds = Net Interest Margin (Interest Income / Firms Interest Earnings assets)
