Flashcards in Topic 6: Financial Statement Analysis & Equity Valuation Deck (19)
What are economic earnings?
- sustainable cash flow that can be paid out to stock holders without impairing the productive capacity of the firm
What are accounting earnings?
- affected by some conventions (inventories, depreciation); business cycles
What does total asset turnover measure?
- measures how efficient a firm uses its assets (for every dollar of assets, how many sales the firm generates)
What does a high interest coverage ratio indicate?
- shows the likelihood of bankruptcy is low because annual earnings are significantly greater than annual interest obligations
What determines the intrinsic value of a firm’s stock?
- Expectations of future dividends and earnings
What happens if ROA is greater than borrowing rate?
- a firm earns more on its money than it pays out to creditors the surplus earnings are available to the firm’s owners (shareholders), which increases ROE
What happens if ROA is less than borrowing rate?
- ROE will decline
by an amount that depends on the debt-to equity ratio
What is the compound leverage factor made of?
= Interest burden * Leverage
What does a low P/B ratio mean?
- A low P/B ratio stock can be a safer investment, since the book value can be a floor supporting the market price
What does a high P/B ratio indicate?
- A high P/B ratio is an indication that investors think a firm has chance of earning a return on investment > market capitalization rate (K)
What does a low P/E ratio indicate?
- Low P/E ratio stocks may be good bargains since you can acquire a claim on a dollar of earnings more cheaply if the P/E ratio is low
What does a high P/E ratio indicate?
- Current earnings may differ from future earnings, so high P/E stocks may still be bargain if their earnings and dividends are expected to grow faster
What is the difference between LIFO & FIFO?
- LIFO- assumes goods are valued at todays cost
- FIFO- assumes goods are valued at original cost
- LIFO: cost of goods sold (COGS) of $1.1 million,
the end-of-year balance sheet value of the 1
million units in inventory remains $1 million
- FIFO: COGS of $1 million, the end-of-year
balance sheet value of the inventory would be
Which is the preferred way of presenting inventory and why?
- LIFO firm has both a lower reported profit and a lower balance sheet value of inventories than the FIFO firm
- LIFO is preferred in computing economic earnings since it uses up-to-date prices to evaluate the COGS
- IV (Intrinsic value) > MP (Market Price)
- Buy or long
IV < MP
- Sell or short
IV = MP
- Hold or fairly priced
Intrinsic value $50 is higher than current price $48, so ABC is what?
- Underpriced and we should buy