Samenvatting
Summary Financial Statement Analysis and Valuation
- Instelling
- Tilburg University (UVT)
Summary of all the lectures of FSAV, including some specific cases. Used in combination with the slides to get a 9/10 for the final exam.
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Financial statement analysis and valuationWeek 1: Value Drivers
Accounting: measuring and communication firm performance
Financial statement analysis: interpreting firm communication to learn about the true firm
performance
a framework to assess current firm performance in order to understand its operations,
suggest improvements and look at their impact, and forecast future performance
e.g.: inventory turnover was derived from the financial statements and compared to
competitors, the big difference acknowledged the suspicions and confirmed that they were
committing fraud
Categories: operational activities; investing activities and financing activities
Equity valuation: understand the past (what
does the firm do, who are the competitors,
do the numbers reflect the business well,
identify key drivers and
strengths/weaknesses) II forecasting the
future (collect information and forecast
reasonably) III valuation
- NPV: discount future dividends rarely
used directly since is doesn’t reflect
performance and dividends are often held in
order to pay them out later dividend
irrelevance theorem: dividend policy
shouldn’t affect stock price since investors can choose to sell their stocks at any given
point forecasting needed to value a company
- Earnings: Equity rises with the retained earnings and the rest is paid out as dividend to the
investors investment growth (g), risk (r) and profitability (RoE) are the core value drivers
- Valuing equity using earnings: P0 =CE +
Core value drivers:
1. Profitability (RoE)
earnings for the period
- RoI = RoE =
Investment at the beginning of the period
- RoE > r needed for a firm to create value
- is the rate of return that the equity owners get and in order to generate value it should be
higher than the opportunity costs (r) opportunity costs (r) are the cost of equity capital
2. investment growth (g)
- profitability is important, but the amount that is invested is crucial as well 10% RoE on
$100 vs 10% on $1000000 is a big difference in return
- investments depreciate and become obsolete over time new assets should be bought to
not become obsolete and stay competitive
3. risk (r)
- measure of uncertainty about future payoffs looking at market beta
- computing the right discount rate is one of the most difficult / unresolved issues in finance
,Continuous growth model:
Earnings torpedo: investors naively extrapolate high short-term sales growth rates, leading
to a sharp drop of the stock prices when growth rates slow down e.g. when the earnings
announcement states that the earnings won’t be as high as expected
Earnings announcement: the most important information event, given in quarter 3
around the EA-date, absolute returns and share turnover increase dramatically especially
sales growth rates and gross margins are the most critical forecasting assumptions
- Raising sales growth causes a higher share price, but the share prices only rises marginally
- Gross margin = (sales-COGS)/sales Gross Margin = 100% - (COGS/sales)
- After forecasting look if the numbers in the financial statement make sense in this case it
doesn’t because the forecasted number is too high in reality the sales are 70 billion,
instead of 640 billion To prevent future earnings to be too high, the growth percentage
should be lowered much faster, in order to receive a better forecast use best case
scenarios
- High sales growths don’t last high percentages drop down very fast since they aren’t
sustainable average growth rate is 3-5%, in terminal year: never pick a number that is
higher than 5%!
- growth theory: long-run growth rate for an economy is long-run rate of technological
change
- P0 = growth and
profitability reinforce each other. E.g. the profitability of tesla is huge, so investing cash
would generate more cash very fast
- Not a single company can grow
forever, all past stars are dogs at
the moment. High growth levels
can barely be sustained It can
be done in for example a
monopoly or in new markets with
a lot of potential
- growth and profitability factors
reinforce each other growth
firms have a steeper line, since it
is reinforced by the profitability
Takeaways:
- Sales growth rates and gross
margins are usually the most critical forecasting assumptions
- extrapolating ST growth rates in the future causes unnatural results
,- high sales growth not sustainable
- terminal values are strongly governed by economic theory
Week 2: Understanding the Business
The heart of a good valuation
is a good forecast, which
depends on the quality of the
information and reasoning
that went into it
Normally about half of the
variation in price is firm-
specific, other differences arise
from industry and macro
trends but mainly focus on
company-specifics to get a
competitive advantage
dimensions: input vs. output markets; macro effects vs. industry effects; domestic vs. foreign
currency
Figuring out a business: Look at big positions on the balance sheet and income statement
look at cash flow statement and the performance look how cash is earned with different
segments check notes at important decisions management commentary
- The financial statements give a good indication on where to look, but you need
logical thinking (using macro/industry trends) to come up with the correct business of
a firm.
- Try to formulate key success and risk factors
Important things to think of:
- strategy: cost leadership versus product differentiation
- sustainability of return on investment what is the competition?
- sustainability of growth on investment what opportunities has this market? Saturated
markets don’t have a lot of potentials any more for example
- possible synergies: tax savings, increasing market power, economies of scale, leverage
Accounting can have measurement issues:
- GAAP =/ economic reality due to reliability issues e.g. contingent liabilities
- Uncertain forecasts e.g. pensions
- Managerial manipulation: channel stuffing (push method), off balance sheet
financing, capitalizing operating costs
Old plant trap: a plant is completely depreciated but still makes money. Boosts the ROE
because you have 0 equity that still generates money for the firm
, Earnings is the best way to review periodic performance, because it is timely and less
noisy matching principle: matching costs with the generated benefits from it
- conservative accounting: immediately expensing all costs it understates the investment
low ROE in first year but too high ROE in next periods
- aggressive accounting: write-off costs in the first period when no more benefits are
received it overstates the investment higher ROE in the first periods, but too high ROE
in period after that
The presence of conservative of aggressive accounting could distort the profitability of the
company because you can’t see the ‘real’ ROE of each period use matching principle
- Accounting conservativism leads to hidden reserves where
Preventing misleading through financial statements in GAAP:
- Consolidate a firm so that you bear the risks (when regarding franchises
- Provision for bad debt be ahead of the problem and flow the possible defaults over
multiple years
Week 3: ratio analysis
Financial ratio analysis: used to discuss company performance focus on performance
- No generally accepted set of rules for ratios ROA calculated differently
- Don’t give answers, but direct you in a search for answers
- Window dressing: investors focus on some ratios and managers that know this will
take advantage of it
ROE: average equity because equity bought during the year
can also generate extra profits if possible: make a time-based equity determination
- High profitability: efficient use of
operating assets, pricing power,
cost advantages and leverage
effect (using borrowed money to
boost profits)
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