2012/06/22 Business budgeting & Company Analysis Welcome to the session Thought for the session Through faith and perseverance, even the snails reached Noah’s ark Company and Share Analyses Assume you want to enter the capital market to buy shares, where do you start? – Exercise 1 Analysing shares and companies: – Fundamental analyses vs. Technical analyses – Quantitive and qualitative analyses Fundamental analyses: – Top Down approach vs. Bottom-up approach 1
2012/06/22 The Big Picture Top down or bottom up analysis Company Analysis Analysing a listed company requires information gathering from many sources: � Published results (investor relations) � SENS reports � Media reports � Company research � Quantitative Review – review of numeric data � Qualitative Review – Review of the company’s business model E.g. How does the company achieve a competitive advantage and is it sustainable ? For example; is undercutting competitors a sustainable strategy? Fun with financials Why do we analyse companies? – To see whether they are making profits? (Income statement) – To see what the value of the company is? (Balance sheet: Assets – Liabilities = Equity/Value) – To see whether they are generating cash? (Cash flow statement) Asset class returns 2
2012/06/22 Financial Statement analyses Purpose of analyses could differ: – Investment – Loan – Competitor – Merger or acquisition (Due diligence) “Purpose of financial statements is to help investors and creditors make informed decisions”. Financial Statement analyses Basic accounting principle Content Annual and interim results Financial Statements Balance Sheet – statement of financial position Assets - Liabilities = Owners Equity Sample Balance Sheet Current Assets Current Liabilities Cash Deferred T axes Accounts Receivable Accounts Payable Inventory Income taxes payable Investments (stocks) Long term Liabilities Other assets which may be Outstanding Bonds in issue Stockholders Equity converted to cash quickly Fixed Assets Ordinary share capital Property, Plant and Equipment Retained Earnings 3
2012/06/22 Financial Statements Sample Income Statement Turnover xxx - COGS xxx = Gross Profit XXX - Ops costs xxx = Operating XXX Profit - Depreciation xxx = EBIT XXX - Net Interest xxx Exp - Income T ax xxx Net Income XXX EPS xxx Note on COGS Includes direct costs which go into products a company sells. Example; COGS for an automaker would include � Material costs (stock cost) � Labour costs of people on assembly line Excluded would be: � Cost of labour to sell the car, admin labour � Cost of getting the car to dealerships Stock sold = Beginning Inventory + Purchases – Ending Inventory Above gives the total cost of inventory a company sold for a period Financial Statements Cash Flow Statement – NB! Cannot be manipulated, you either have cash or you don’t! CFF CFO - Dividends + Net Income + Increases in notes payable + Depreciation - Decreases in notes payable + Decreases Current Assets + New equity raised + Increases in Current Liabilities - Equity repurchased Increases in Current Assets - CFI (example: Receivables) - Decreases in Current Liabilities + Ending Fixed Assets - Beginning Fixed Assets + Depreciation Result = net change in cash figure on the balance sheet 4
2012/06/22 Notes to the Financial Statements Important source of useful info. Look out for info on: � Accounting methods and principles – such as inventory account methods (LIFO and FIFO). � Accounting policies that have been changed which may suit management and performance data. � Disclosure of information regarding long term debt (interest rates). Be aware of manipulation Big Bath behaviour Firms having a really bad year will try and draw in all potential expense and loss to report on all bad news at one time Firms will appear more profitable going forward Example of accounting and regulation changes: Potential legislation changes requiring employee stock options to be expensed in 2004 (US) resulted in Microsoft earnings decreasing from $11.1 billion to $7.3 billion! Financial Statements Where is the relationship between the key financial statements? Take a look at this example. – The income statement shows revenue of 500,000. – The cash flow statement shows the cash received from customers is 375,000. – The balance sheet shows under assets the difference, i.e. accounts receivables is 125,000. – All three financial statements are linked. – Note: The income statement = cash flow statement + balance sheet. In the example above: 500,000 = 375,000 + 125,000 5
2012/06/22 Financial Statements Further examples of the connection: Net Income is split between retained earnings (transferred to balance sheet) and dividend pay-out (Changes in equity) Transaction example: – Cash sale of an item that cost R100 for R120: Bank (B/S and cash-flow) would increase by R120 Stock (B/S) would decrease by R 100 Profit (I/S) would increase by R20 Limitations to accounting data Ratio Analysis NB! Interpretation of the results of ratios are most important. Consider the following: � Not useful in isolation, only when compared to previous years data, against a sector average and/or competitors. � Ratio’s do not always answer questions, but sometimes highlight those which need to be asked. � For example, current retail or automotive sector is in severe decline; companies may show; � Decreased revenue � Reduced profitability � Lower dividend payout � Reduced liquidity � Poor market conditions don’t necessarily mean poor management skill or ability. Ratio Analysis Performance Activity Financing / Gearing / Leverage Liquidity: NB is – Size – Growth – Comparison with others (e.g. peers) – Ratio’s & intrepretation 6
2012/06/22 Ratio Analysis Performance Ratio’s Gross profit margin serves as the source for paying additional expenses and future savings. (P3) For example, suppose that ABC Corp. earned $20 million in revenue from producing widgets and incurred $10 million in COGS-related expense. ABC's gross profit margin would be 50%. This means that for every dollar that ABC earns on widgets, it really has only $0.50 at the end of the day. Ratio Analysis Performance Ratio’s Net profit Margin = Net Income Revenue Looking at the earnings of a company often doesn't tell the entire story. Increased earnings are good, but an increase does not mean that the profit margin of a company is improving. (P5) For instance, if a company has costs that have increased at a greater rate than sales, it leads to a lower profit margin. This is an indication that costs need to be under better control. Ratio Analysis Performance Ratio’s Cash Flow to Assets = Cash Flow from Operations Total Assets Indicates the cash a company can generate relative to its size. (P2) Comparing to previous years is important; if the company’s ratio is decreasing they may run into cash problems. Cash flow is often overlooked, if this ratio declines below 10% there may be problems paying the bills. 7
2012/06/22 Ratio Analysis Performance Ratio’s Common Size Analysis = Entity (e.g. property) Total Entity (e.g. total assets) Indicates the proportion of asset/liability/expense to total assets/liability/expense. (P2) Very useful in comparing companies of different sizes to see if they have the same financial structure. Compares what proportion an expense reduces sales. Ratio Analysis Performance Ratio’s Return on Assets (ROA) = Net Income + Interest Expenses Total Assets Why add interest expense to net income? (P5) To ignore the cost of funding the assets. The assets of the company are comprised of both debt and equity. Both of these types of financing are used to fund the operations of the company. The ROA figure gives investors an idea of how effectively the company is converting the money it has to invest into net income. Also important ratio for companies deciding whether or not to initiate a new project. Simply put, if the ROA is above the rate the rate the company can borrow at – it should accept the project. Ratio Analysis Performance Ratio’s Net Income Return on Equity (ROE) = Shareholders Equity The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. (P5) 8
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