Financial Analysis and Valuation Concepts

A company's decision to invest in a new project based on a comparison of the project's return on capital and the company's cost of capital.

Increased costs of commodities and labor lead to higher prices, even without changes in demand.

A conflict impacting a country's oil production (e.g., 2% of global oil production) can affect global prices and impact companies dependent on supplied products.

Value cyclical companies using metrics that adjust for economic fluctuations to get a more reliable valuation. This helps find a more stable basis for decision-making.

It measures the increase in earnings relative to the increase in revenue. Used to forecast next year's profits, given a company's current margins.

Value cyclical companies that are greatly influenced by economic conditions, by using metrics that account for those fluctuations.

The rate of return a company must earn on its investments to maintain its market value.

The profit generated per unit of invested capital.

When a company has significant revenue growth, methods like Price-to-Sales (P/S) and Enterprise Value-to-Revenue (EV/Rev) are often preferred over those that rely heavily on earnings, like EV/EBITDA.

In an unlevered DCF analysis that disregards debt, depreciation expense has the least direct impact compared to factors like EBITDA margin, interest expense and capital expenditures.

GAAP (Generally Accepted Accounting Principles) often results in higher depreciation expense, while non-GAAP versions typically exclude some items to get a more flattering picture. Straight-line depreciation is a common method used in GAAP reporting.

Goodwill, indefinite trademarks and software development costs aren't usually depreciated, but instead they are amortized as periodic expenses over their useful lives, which is reflected on the income statement.

Shorter reported depreciation compared to the asset's useful life will artificially increase earnings.

Inflation usually has a short-term positive but long-term minimal effect on consumer staples profitability, especially for the staples sector whose products are largely discretionary for consumers.

Normalized earnings take into account cyclical factors and eliminate peaks and troughs in earnings.

Large variation in a company's PE ratio usually suggests cyclical patterns or significant growth changes.

A PE ratio significantly higher than industry peers might point to a growth stock or one that is currently undervalued.

Financial leverage is the extent to which a company relies on debt to finance its assets. It measures creditors' claims over a company's assets versus the shareholders' equity.

Enterprise Value (EV) is the total value of a company, representing the value of its operations and net debt (liabilities minus cash).

When the Federal Reserve raises interest rates, it can have a different effect on different financial sectors. While financial institutions' earnings may decrease in value, others like banks may experience an increase in earnings during these economic shifts.

Companies return cash to shareholders primarily through cash dividends and stock buybacks, not stock splits which are not related to cash.

Research analysts use various sources to understand the barriers to entry and exit an industry, including annual reports, financial media publications and patent filings.

An increase in EPS estimates for the next year is often associated with changes in the inventory recognition strategy, particularly a move away from LIFO inventory to FIFO during periods of inflation—this leads to an increase in earnings.

A significant increase in inventory (usually in excess of sales growth) can lead to a decrease in gross margin.

During a pandemic, consumer staples and pharmaceuticals are often less affected than consumer discretionary and travel sectors.

Interest expense during the construction of a facility appears in the cash flow from financing activities.

A declining domestic currency can negatively impact companies with significant international operations, especially if they sell products or operate in countries with a rising currency.

Interest rate risk can have varying impacts for different business types. Banks often benefit from higher rates, but volatility can hurt asset managers with sensitive portfolios.

Industries with significant barriers to exit have challenges in leaving the industry, even when unprofitable.

When researching a new player in an industry, research of industry 10-K filings and interviews with industry players is important to understand its nuances and the overall industry trends.

When a company has growing sales but a cyclical revenue stream, using valuation metrics like Price/Sales (P/S) or Enterprise Value/Revenue (EV/Rev) can better capture value than standard Price/Earnings metrics.

When calculating tangible book value, intangible assets (goodwill, patents, etc.) and other non-physical assets associated with a company are excluded.

One-time gains affect the bottom line of a company. Investors might be concerned about the persistence of such gains in future periods.

To calculate a valuation on a Price/Forward Free Cash Flow basis, treat the 'Other Operating Income' item according to its specific nature.

Price elasticity of demand describes how responsive consumers are to price changes, measured in percentages.

Leading economic indicators offer insight into the likely future direction of the economy.

Companies with high debt levels and variable capital expenditures might benefit from using an EV/EBITDA multiple instead of a standard P/E multiple for valuation analysis.

If the US dollar declines in value, companies dependent on exports or having foreign operations can face a decrease in revenue or a rise in costs.

The formula used to calculate the percentage of a company's net income distributed as dividends to shareholders. It's calculated by dividing dividends paid by net income.

The actual tax rate a company pays on its taxable income. It is calculated by dividing the company's total tax expense by its total taxable income.

A measure of a stock's volatility compared to the overall market. A higher beta typically indicates a more volatile stock, while a lower beta implies less volatility.

Companies with high fixed costs experience a faster increase in profit margins when they sell more units. This is because fixed costs are spread over a larger number of units, leading to a higher contribution margin per unit.

Inflation in the consumer staples sector can lead to a short-term increase in earnings as companies pass on higher costs to consumers, but in the long term, this can be detrimental as it can lead to a decline in consumer demand.

A publicly traded company with a public float of $75-$700 million or more. Accelerated filers have shorter deadlines for filing periodic reports with the SEC.

A valuation metric that combines a company's P/E ratio and expected earnings growth rate. It helps to assess the value of a stock relative to its growth potential.

In a merger or acquisition, the most important factor for long-term value creation is achieving positive changes in the combined company's operating margins.

The most important factor in forecasting earnings for a coal mining equipment manufacturer is the expected operating rates for utilities. This is because coal-fired power plants are a major customer for mining equipment.

Depreciation expense affects earnings. Accelerated depreciation can result in lower earnings initially, but it can have an impact on cash flows. Following GAAP standards ensures consistent reporting.

A measure of how efficiently a company uses its assets to generate revenue. It is calculated by dividing net sales by average total assets.

A lower-than-expected EPS can negatively impact stock price, particularly if it's below analyst consensus.

Highly leveraged companies with a high proportion of debt can benefit from falling interest rates as they reduce their debt-servicing costs. This can positively impact their financial performance.

Research analysts can obtain information on barriers to entry and exit for specific industries by conducting discussions with industry participants.

A financial ratio that measures how efficiently a company uses its assets to generate sales. It is calculated by dividing sales by average total assets.

A profitability ratio that measures a company's operating profitability by comparing its earnings before interest and taxes (EBIT) to its sales.

A profitability ratio that measures a company's overall profitability by comparing its net income to its sales.

A financial ratio that measures how efficiently a company collects its receivables. It is calculated by dividing sales by average accounts receivable.

Reducing inventory can increase asset turnover and potentially increase ROE.

When a company repurchases shares at a price higher than its book value, the book value per share decreases, but ROE increases because equity decreases.

When a company retires debt by issuing stock, the WACC increases because the cost of equity is typically higher than the cost of debt.

Beta can be calculated using the CAPM model (Cost of Equity = Risk-Free Rate + Beta * (Market Risk Premium)). WACC depends on the cost of equity and debt and their proportions in the capital structure.

Retiring debt increases WACC, doesn't affect unlevered FCF, and decreases terminal value.

FCFF is the cash flow available to both debt and equity holders of a company. It is calculated by subtracting capital expenditures and working capital changes from EBIT (1-Tax Rate).

Terminal value is the present value of all future cash flows beyond the explicit forecast period. It is calculated using a terminal growth rate and a suitable valuation multiple.

ROE can be calculated using the DuPont Formula: ROE = Net Profit Margin * Asset Turnover * Equity Multiplier. This breaks down ROE into its key components.

Earnings adjusted to remove cyclical or unusual factors, providing a more stable picture of a company's earnings potential.

Large variation in a company's PE ratio often reflects cyclical business patterns or significant changes in growth prospects.

A higher WACC (weighted average cost of capital) leads to a lower valuation or terminal value of a company.

Medicare reimbursement rates significantly impact healthcare REITs, as these REITs invest in properties used in healthcare.

Zoning regulations impacting beachfront properties are a major risk for a healthcare REIT providing senior housing.

Rent control regulations pose the most significant risk to apartment REITs due to their potential to limit rent increases.

A free cash flow multiple can be used to determine a company's price by multiplying the multiple by the free cash flow per share.

Once a construction project is complete, interest expense is reflected in the company's footnotes, not in the cash flow statements.

EBITDA Margin and EV-to-EBITDA ratio are best for valuing unlevered companies (companies with no debt) due to their focus on operating performance.

Cash flow from operations is calculated by adjusting net income for changes in working capital and non-cash items like depreciation.

A write-down of inventory reduces assets and net income, lowering shareholders' equity with no impact on operational cash flow.

Free cash flow after capital expenditure is used to estimate a company's dividend outlook, reflecting the company's ability to pay dividends.

A decline in depreciation increases net income but has no impact on retained earnings.

A stronger US dollar negatively affects foreign companies with earnings in weaker currencies, particularly those with significant operations in Europe.

A weaker US dollar can negatively impact companies with a high proportion of revenue coming from foreign countries with a stronger currency.

The price-to-earnings ratio calculated using next year's estimated earnings per share.

A company with a high PE ratio but slowing growth, indicating investors are expecting future growth to moderate.

A company whose earnings fluctuate significantly with the business cycle.

A company that sells essential goods and services whose demand remains relatively stable regardless of economic conditions.

Free cash flow yield is the most relevant valuation metric as it reflects the cash flow available to investors after accounting for capital expenditures.

Declaration of cash dividends does not impact earnings per share as it's merely a distribution of existing profits.

Intangible assets like goodwill and software development costs are periodically expensed over their useful lives, instead of being depreciated.

When a company acquires another, the combined revenue and income are calculated by eliminating any inter-company transactions.

A valuation approach where the price-to-cash flow multiple is assumed to remain consistent over time.

CAGR measures the average annual growth rate of an investment over a specified period.

An industry with zero economic profit means that companies in that industry are not earning a return on their capital that is greater than their cost of capital.

If demand for a product remains high after a tax credit is removed, this may be due to factors affecting purchasing decisions, like price or consumer perception of the products value.

Companies in the consumer durables sector tend to show the highest earnings momentum when the economy is at its peak.

When a country imposes tariffs on imported goods, it can lead to reduced exports from the exporting country and potential inflation in the importing country.

Companies that make non-durable goods, which are consumed quickly, are less likely to issue long-term debt.

The supply curve slopes upward because producers are willing to supply more of a good at a higher price due to the potential for greater profits.

The quick service food industry benefits from lower gas prices and stable paper product prices.

A successful, growing company typically has positive working capital that is also growing.

The margins of companies producing durable goods tend to rise during economic expansions and fall during contractions.

The dividend growth model uses expected future dividends and the cost of equity to estimate a stock's intrinsic value.

During a pandemic, sectors like consumer staples and pharmaceuticals are typically less impacted than consumer discretionary and travel/lodging industries.

Industries with high fixed costs, like aerospace contractors, have greater operating leverage and benefit more from GDP growth.

During the early stages of a recession, sectors like pharmaceuticals tend to perform better than those sensitive to economic downturns, like luxury retailers.

The snack food industry tends to have the most stable margins among the given options.

The greatest long-term risk to the print media business is the shift to online advertising and alternative news sources.

A drop in global LNG supply is likely to increase LNG prices as demand remains high. Domestic companies that rely on LNG will experience higher costs.

Financial leverage is the extent to which a company uses debt in its capital structure. It measures the amount of debt relative to equity.

Demand elasticity measures how much the quantity demanded of a good changes in response to a price change. Elastic demand means a significant change in quantity, while inelastic demand means a small change.

Government loan forgiveness can impact higher education. Increased forgiveness may encourage more borrowing for college, potentially leading to continued inflation in college costs.

Book value is the total assets minus liabilities. Tangible book value excludes intangible assets like goodwill or patents.

When a company acquires another, the combined revenue and net income of both companies are calculated to create a pro-forma consolidated financial statement.

Goodwill is calculated as the difference between the purchase price and the fair market value of a company's net identifiable assets. It represents the premium paid for intangible assets, like brand reputation or customer relationships.

Increases in input costs, like raw materials or manufacturing expenses, directly impact a company's gross margin, reducing profitability.

A company aims to restore its debt-to-equity ratio to its historical level. This involves balancing debt and equity to achieve a targeted financial leverage.

Actions that improve a company's financial health, such as a strong EBITDA-to-interest expense ratio, can enhance the company's creditworthiness and make it more attractive to lenders.

Analysts use historical data to forecast future earnings per share (EPS). Studying past revenue trends is crucial for predicting potential earnings growth.

To value cyclical companies, analysts use P/normalized earnings, which smooths out earnings fluctuations and provides a more stable metric for valuation.

A new competitor entering an oligopoly (market with a few dominant players) can disrupt the existing balance. It may lead to decreased market share for the existing companies or the oligopoly may respond by increasing prices.

To build an industry model, start by collecting historical data about the industry's growth rates. Download time series of indicators from reliable data sources.

Factors that prevent new businesses from easily entering a particular market. These can include high startup costs, government regulations, strong brand loyalty, or exclusive access to resources.

Analysts worry when a company's earnings per share (EPS) drastically increases due to a one-time gain, like litigation settlement, wondering if the growth is sustainable.

A valuation technique that assumes all convertible securities, like preferred shares, are converted into common stock, adjusting the equity and share count.

A weaker domestic currency makes exports cheaper for foreign buyers but increases costs for companies importing goods and services, potentially hurting their profits.

Certain intangible assets like goodwill and software development costs are recognized as expenses gradually over their useful lives, reflecting their gradual decline in value.

The supply curve slopes upwards because producers are willing to provide more goods at higher prices, as this leads to greater profits.

The risk that a company might not be able to meet its financial obligations, primarily due to its reliance on debt and the potential for default.

The degree to which a company's operating costs are fixed. Companies with high fixed costs experience greater changes in profits for a given change in sales.

When a company's discount rate increases, its valuation decreases because future cash flows are discounted at a higher rate.

If demand for a product remains high even after a tax credit expires, it suggests strong underlying demand or a lack of substitutes.

A company maintains the same proportion of its earnings paid out as dividends, regardless of changes in earnings.

A measure of how efficiently a company uses its assets to generate sales. Higher is better — meaning generating more sales from existing assets.

Rising accounts receivable and increasing accounts receivable turnover indicate sales growth.

A deceptive practice where a company artificially inflates sales by shipping more goods to retailers than they can sell, leading to rising accounts receivable and falling inventory.

When a company pays off debt by issuing stock, its WACC increases because the cost of equity is typically higher than the cost of debt.

Cash dividends, stock dividends, depreciation changes, and changes in inventory valuation methods (FIFO to LIFO) all affect EPS.

Cyclical companies have fluctuating earnings, so their PE ratio can vary significantly over time.

The extent to which a company uses debt financing. Higher leverage means more debt relative to equity.

Free Cash Flow Yield is a good metric for companies with low capital expenditures (CAPEX) and steady sales growth.

The Forward P/E ratio, using future year's forecasted earnings, is a suitable metric for a retail company recovering from a pandemic, expecting future profit growth.

The P/S ratio is a good valuation metric for an unlevered company, meaning no debt, as it focuses on sales and not debt.

The tax rate of the combined company is determined by weighting the tax rates of the individual companies by their respective ownership proportions.

Earnings per share calculated assuming all convertible securities (like options and bonds) are converted into common stock, showing the potential impact on earnings if these securities are exercised.

Higher interest rates can benefit banks by increasing their net interest margin, but other sectors may find their earnings negatively impacted, such as asset managers with interest-sensitive portfolios.

Companies primarily return cash to shareholders through dividends and stock buybacks. Stock splits simply split existing shares, not returning capital.

Companies with high dividend payout ratios, like those paying out 25% of their earnings, are more susceptible to rising interest rates as they rely heavily on current earnings.

Deregulation in a market with many players and commodity products can lead to increased competition and potentially lower prices.

High operating leverage means a company's fixed costs are significantly higher than its variable costs. In this case, falling interest rates can have the biggest impact on valuation.

Price elasticity of demand measures how responsive consumers are to price changes. It's calculated by dividing the percentage change in quantity demanded by the percentage change in price.

A publicly traded company with a public float of between $75 million and $700 million. These companies have shorter deadlines for filing reports with the SEC.

An inventory write-down decreases assets and net income, but doesn’t affect operational cash flow.

A breakdown of ROE (Return on Equity) into its key components: ROE = Net Profit Margin * Asset Turnover * Equity Multiplier. This offers insight into a company's profitability, efficiency, and leverage.

A phenomenon where a company can reduce production costs by producing a wider range of products or services. This can be achieved through shared resources, manufacturing facilities, or distribution channels.

EBITDA Margin and EV-to-EBITDA ratio are good choices for valuing companies without debt, as they focus on profitability and cash flow generation.

A strong US dollar makes US goods and services expensive for foreign consumers, potentially hurting foreign companies' revenue and earnings.

A leverage ratio that measures a company's ability to meet its interest payments from its earnings. It's calculated by dividing earnings before interest and taxes (EBIT) by interest expense.

The total value of a company, including its market capitalization and net debt (liabilities minus cash). It represents the price a buyer would hypothetically pay for the entire company.

The cash flow available to a company after paying for its operating expenses, taxes, and capital expenditures. It represents the cash flow that can be distributed to investors.

The cash flow available to both debt and equity holders of a company after deducting capital expenditures and changes in working capital.

Actions taken by a central bank to buy or sell government securities in the open market to control the money supply and adjust interest rates.

The proportion of a company's net income that is returned to shareholders through dividends and share buybacks. Calculated by dividing total distributions (dividends + buybacks) by net income.

A valuation metric that measures the free cash flow generated per dollar of market cap. It's calculated by dividing Free Cash Flow by Market Cap.

Cost savings achieved by producing a wider variety of goods or services. This happens because shared resources and infrastructure can be utilized more efficiently.

Changes in interest rates can have varied effects on different sectors of the economy and companies with different financial structures. Higher rates typically benefit banks, but can hurt asset managers with sensitive portfolios.

Inflation can lead to a short-term increase in earnings for consumer staples companies as they pass on higher costs, but long-term effects are less certain given potential decline in consumer demand.

A valuation model that estimates a stock's intrinsic value based on the present value of its future dividend payments.