Financial Analysis Concepts

A company should invest in a project if its return on capital exceeds its cost of capital. Otherwise, it should not.

Increased commodity and labor costs can lead to higher prices without changes in demand, affecting regulated monopolies and industries like agriculture less than duopolies or monopolies.

A conflict between countries impacting the production of global resources or supply chain will affect prices, as a disruption in supply can cause supply shortages and price increases.

Value cyclical companies using metrics relevant to their full economic cycle (e.g. normalized earnings, EV/EBITDA) not short-term metrics.

To calculate expected EBIT with a given incremental margin for a projected revenue increase, use the formula: Incremental margin × Revenue increase + Current EBIT

Cyclical companies are valued using metrics relative to a full cycle rather than just using simple metrics (like PE).

The return a company gets if it takes a project. It is used to determine if a project is profitably using the capital invested.

A profitable investment should return more than the cost to fund it, resulting in increased profit for the company.

When a company has significant revenue growth, valuation methods focusing on revenue, like Price-to-Sales (P/S) and Enterprise Value to Revenue (EV/Rev), are more appropriate than those based on earnings, like EV/EBITDA.

Depreciation expense, reflecting the decrease in the value of assets over time, is crucial in Discounted Cash Flow (DCF) valuations, and it has a significant impact on cash flows and valuation, while other factors like EBITDA margin, interest expense, or capital expenditure are also important.

GAAP (Generally Accepted Accounting Principles) and Non-GAAP earnings differ in how specific items, like stock-based compensation, are reported. Often, non-GAAP earnings remove these items for a more simplified view of core business performance.

Goodwill, representing the value of a company's intangible assets, isn't amortized (i.e. systematically expensed). This is in contrast to other assets with a specific useful life.

If the GAAP depreciation method uses a shorter life than the IRS' method, it understates the tax depreciation, so earnings for GAAP will be understated, or reported earnings under GAAP standards will be lower.

In the short term, rising inflation might positively impact consumer staples' profitability. However, long-term inflation could negatively impact the company's profitability as pricing power might get impacted.

Normalized earnings aim to smooth out cyclical fluctuations for better comparisons and predictions. This includes considering cyclicality of sales, average performance and peaks/troughs of the sector, and not necessarily the growth itself.

Analyzing a company's historical PE ratio (past 10 yrs) helps in understanding the company's trend and whether the valuations are high or low compared to historical performance.

Comparing a company's Price-to-Earnings Ratio (PE) to the overall market (e.g., S&P 500) shows relative value. High relative PE suggests the company may be a growth stock.

Financial leverage refers to the amount of debt in a company's capital structure; this debt allows for greater potential returns, but it also increases the risk.

Enterprise Value (EV) is the sum of a company's market capitalization and net debt.

A raise in interest rates by the Federal Reserve (Fed) can have mixed effects and impacts on certain firms, especially financials such as bank stocks, which tend to improve with higher rates.

Companies return cash to shareholders through dividends, buybacks, repurchases or other ways to increase EPS.

Barriers refer to factors that could make it difficult to enter or leave an industry based on the unique characteristics of the industry, including regulation and costs.

When inventory value decreases (write-down), assets and net income decrease, impacting equity also. Operational cash flow usually stays the same.

The proportion of a company's net income that is distributed to shareholders as dividends. It's calculated by dividing dividends paid by net income.

The actual percentage of a company's income that is paid in taxes. It's calculated by dividing total taxes paid by taxable income.

A measure of a stock's volatility relative to the overall market. A beta of 1 means the stock moves in line with the market, while a beta greater than 1 indicates higher volatility.

Companies with a high proportion of fixed costs experience a larger increase in profit margins when sales increase, as fixed costs are spread over a larger number of units.

Short-term: Earnings may be squeezed due to rising input costs. Long-term: Consumers may switch to cheaper alternatives, impacting earnings.

A publicly traded company with a market capitalization of $75 million or more, requiring faster reporting deadlines for financial statements.

A valuation metric that compares a company's price-to-earnings (P/E) ratio to its expected earnings growth rate. A lower PEG ratio indicates a better value.

The key driver of long-term value creation in an acquisition is the growth of the combined companies.

The most important factor is expected operating rates for utilities, as coal mining equipment is heavily dependent on these rates.

Accelerated depreciation, while reducing reported earnings early on, doesn't necessarily affect overall cash flow and is usually reflected in the notes to financial statements.

A measure of a company's efficiency in using its assets to generate sales. Calculated as net sales divided by average assets.

Removing an after-tax gain from earnings per share (EPS) can result in a lower-than-expected EPS, which may negatively affect stock price as it falls short of market expectations.

The Consumer Confidence Index (CCI) is a leading indicator that reflects positive momentum in the economy when consumer sentiment is high.

For a highly leveraged company, a significant impact is a slowdown in sales growth, as it reduces earnings and weakens the ability to service debt.

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

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

A valuation metric comparing a company's current stock price to its expected future earnings per share (EPS). It reflects the market's expectations for the company's future growth.

A valuation metric comparing a company's PE ratio to the average PE ratio of its industry or a benchmark index. It indicates if a company is overvalued or undervalued relative to its peers.

Industries that rely heavily on capital investments for their growth and expansion, such as technology and industrials, would typically benefit from increased capital spending.

Achieving cost savings by producing different products or services together, sharing resources and processes, and leveraging economies of scale.

The actions of a central bank to buy or sell government securities in the open market to influence interest rates and the money supply, ultimately impacting economic activity.

A monetary policy tool used by central banks to combat inflation by increasing borrowing costs and reducing spending.

A monetary policy tool used by central banks to stimulate economic activity by reducing borrowing costs and encouraging spending.

An open market operation where a central bank buys government securities, injecting money into the economy, lowering interest rates, and encouraging borrowing and spending.

An open market operation where a central bank sells government securities, taking money out of the economy, raising interest rates, and discouraging borrowing and spending.

The total return received by shareholders, including dividends and stock buybacks, as a percentage of their investment.

A valuation metric measuring the free cash flow generated by a company relative to its market capitalization. It indicates the efficiency of the company in generating cash flow from its operations.

Healthcare REITs rely heavily on government healthcare policies, especially Medicare and Medicaid reimbursement rates.

Reductions in Medicare reimbursement rates can significantly impact healthcare REITs' revenue due to healthcare costs being controlled by the government.

Besides government policies, factors like interest rates, aging population, regulations, and competition also influence healthcare REITs.

Healthcare REITs owning property near coasts face a higher risk of hurricanes.

Changes in zoning regulations, especially those affecting beachfront properties, can significantly impact the profitability of healthcare REITs.

Rent control regulations pose the most significant risk to apartment REITs.

A free cash flow multiple is used to estimate a company's value based on its free cash flow.

To determine a company's price using the free cash flow multiple, multiply the multiple by the forecasted free cash flow per share.

After construction completion, interest expense is reported in the footnotes of financial statements.

EV-to-EBITDA ratio is a suitable valuation metric for an unlevered company.

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

Free cash flow after capital expenditures is used to estimate a company's dividend outlook.

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

A stronger U.S. dollar negatively affects companies with revenues primarily in foreign currencies.

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

Measures the profitability of a company's operations. It's calculated by dividing EBIT (earnings before interest and taxes) by sales.

Measures the percentage of sales that turn into profit after all expenses, including taxes and interest, are paid. It's calculated by dividing net income by sales.

Measures how quickly a company collects on its receivables. It's calculated by dividing sales by average accounts receivable.

Measures how effectively a company uses its invested capital to generate profits. It's calculated by dividing EBIT by invested capital.

Actions that lead to higher profits (EBIT) or a more efficient use of invested capital can increase Return on Capital.

Reducing debt can increase ROE if the increase in asset turnover outweighs the decrease in equity multiplier.

Repurchasing shares at a price above book value per share reduces book value per share but increases ROE due to a smaller equity base.

Reducing debt by issuing stock typically increases WACC because the cost of equity is generally higher than the cost of debt.

Beta measures a company's volatility relative to the market. It can be calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-Free Rate + Beta * (Market Risk Premium).

When a company has no debt, WACC is equal to the cost of equity since there's no cost of debt.

Reducing debt has no impact on unlevered FCF but increases WACC, which can decrease terminal value.

Unlevered free cash flow (FCFF) represents the cash flow available to both debt and equity holders of a company before interest payments.

Represents the value of a business beyond the explicit forecast period, usually calculated using a discounted cash flow analysis.

A forward PE of 13 suggests a company with slowed growth, potentially a cyclical company with earnings variability. Not necessarily a consumer staple.

For companies with consistent growth, low capital spending, steady sales, and consistent dividends, free cash flow yield is a better valuation metric than PE ratio.

Declaring a cash dividend doesn't directly impact earnings per share (EPS). EPS reflects net income divided by outstanding shares.

Software development costs are amortized, recognized as an expense over time, unlike goodwill or intangible assets.

When Company A acquires Company B, the pro-forma consolidated revenue is the combined revenue before eliminating intercompany sales. Pro-forma income eliminates intercompany sales.

A constant cash flow multiple can help forecast share price. The forward multiple (P/FCFE) applied to forecasted cash flow gives a future price.

The Compounded Annual Growth Rate (CAGR) is calculated as: (Ending Value / Beginning Value)^(1/Number of Years) - 1

An industry with zero economic profit still allows individual companies to earn accounting profits. Economic profit includes opportunity costs.

An analyst's price target is based on assumptions. A range of share values, considering different scenarios, is preferable to a single point.

If demand for a product remains high after a tax credit expires, it suggests the product is valuable beyond the tax incentive.

Increasing the discount rate in a DCF (Discounted Cash Flow) model will decrease the terminal value. Higher risk means lower future value.

Banks benefit most from rising interest rates, typically seeing increased profits from higher lending rates.

Falling interest rates increase the present value of future pension liabilities.

When a company uses LIFO (Last-In, First-Out) accounting and experiences significant inventory growth, it can lead to a mismatch between sales and inventory values, potentially resulting in a decline in gross margin.

The order of industries affected during a pandemic, from least to most impacted, is typically: 1. Consumer Staples, 2. Pharmaceuticals, 3. Consumer Discretionary, 4. Travel & Lodging. These industries are categorized by their necessity level and sensitivity to economic downturns.

Interest expense incurred during the construction phase of a new facility is classified as an investing cash flow. This is because it is directly related to the acquisition of a long-term asset.

A weakened US dollar negatively impacts US-based companies selling goods and services globally, as they become more expensive in foreign markets. This could affect their sales and profits.

Interest rate changes have varying impacts on EPS. Banks benefit as higher rates increase lending profit, Financial services with diversified segments may be less affected, while Asset managers experience volatility due to interest rate fluctuations.

Two primary indicators of long-term value are: 1. Return on Invested Capital (ROIC): measures profitability relative to invested capital, and 2. Accretive EPS: earnings per share that increase due to acquisitions or other strategic moves.

To assess an industry's barriers to exit, look at the 10-K reports and annual supplements, conduct interviews with industry competitors, and examine proxy statements.

When initiating coverage on a new player in an industry, start with the company's 10-K report for financial insights and conduct interviews with customers to understand their needs and market trends.

Trailing 12 Months (TTM) stock price refers to the historical stock price performance over the past year. It is used to calculate metrics like trailing 12-month dividend yield and can be compared to the company's current stock price.

Determining when a company's Debt-to-Equity (D/E) ratio recovers to pre-distress levels requires analyzing historical and projected financial statements. Calculate the D/E ratio based on total debt (short-term + long-term) and equity, and track its recovery over time.

For cyclical companies, valuation methods beyond simple P/E multiples are preferable. Consider EV/Revenue, EV/EBITDA, or P/S, as they account for the company's full economic cycle and factor in leverage and capital structure.

Tangible book value excludes intangible assets such as goodwill, patents, and other intangibles. It focuses on assets with physical substance that can be easily valued.

When valuing a company on a Price/Forward FCF basis, other operating income needs to be treated carefully. It may need to be added back or ignored, depending on its nature, to accurately reflect the company's true free cash flow.

Price elasticity of demand measures the sensitivity of a product's demand to changes in price. If demand changes significantly with price changes, it is elastic. If demand remains relatively unchanged, it is inelastic.

An analyst might choose to use an EV/EBITDA multiple over a P/E multiple when valuing a company with significant debt and variable capital expenditures. EV/EBITDA accounts for debt and non-cash items, providing a more comprehensive valuation.

A declining US dollar negatively impacts US-based companies with significant global sales, as their products become more expensive in foreign markets. This can lead to reduced export demand and lower profits.

To calculate a share price, you can use the Dividend Discount Model (DDM) or other valuation methods. Consider ROE, cost of equity, dividends, EPS, and dividend payout ratio when applying these formulas.

Free Cash Flow to Firm (FCFF) represents the cash flow available to all investors after accounting for operating expenses, taxes, and capital expenditures. It is a measure of a company's financial health and potential for future growth.

To forecast a share price based on a forward earnings multiple, use the current share price, the projected earnings, and the expected multiple for the upcoming period. This assumes the multiple will remain constant.

Businesses with high leverage to GDP growth are more likely to see significant earnings increases during economic expansions. These are usually companies selling discretionary or cyclical goods and services.

Industries that benefit from capital expenditures (capex) are typically those that require significant investments in technology and infrastructure. Examples include technology, industrials, and energy.

A one-time after-tax gain can impact earnings per share (EPS), but it is essential to consider the underlying operating performance. An analyst might be concerned about dilution, which can occur if the gain is used to issue new shares.

Dilution can occur due to various events, such as issuing convertible notes, selling new shares, employee stock options, and stock splits. Share repurchases can reduce dilution.

A domestic company that produces Liquefied Natural Gas (LNG) will likely experience rising LNG prices due to a decrease in global supply.

Financial leverage refers to the amount of debt a company uses in its capital structure. It amplifies both profits and losses.

Elasticity refers to how much demand changes in response to a price change. Inelastic demand means little change, while elastic demand means a large change.

If the government forgives student loans, it could lead to increased spending and inflation among college students, as they have more disposable income.

Book value includes all assets, while tangible book value excludes intangible assets like goodwill, patents, and trademarks.

Normalized earnings adjust for cyclical fluctuations, helping to provide a clearer picture of a company's long-term profitability.

Goodwill arises when a company is acquired for more than its book value. It represents the excess purchase price over the fair market value of identifiable assets.

The largest impact on gross margin is the expense that represents the largest proportion of the total input expenses.

A company with wiped-out equity can restore its historical debt-to-equity ratio by generating profits and using them to increase equity while managing its debt.

Improving a company's creditworthiness can be achieved by increasing its EBITDA-to-interest expense ratio over time, a key indicator of its ability to service debt.

The first step in forecasting EPS is to analyze past revenue trends over a sufficiently long period, typically 6 years, to identify patterns and estimate future growth.

A new entrant in an oligopoly can either reduce the market share of existing companies or expand the market without necessarily decreasing their shares.

To build an industry model, a good starting point is to collect time-series data of industry-specific indicators from a reputable data vendor.

When a country imposes a tariff on imports from another country, it increases the cost of imported goods, leading to a decrease in demand for those goods. This could lead to a decline in exports from the exporting country and possibly increased prices in the importing country.

Companies producing non-durable goods typically have shorter product lifecycles, requiring them to frequently invest in new equipment and technologies. They may also utilize financing options like leases to mitigate the impact of these investments.

The supply curve slopes upward because producers are willing to supply more of a good at a higher price. This is driven by the goal of maximizing profits, as higher prices allow for greater earnings.

The quick service food industry benefits from a stable economy with low gas prices. When people have more disposable income and are less concerned about fuel costs, they tend to eat out more.

A successful company with growing revenue often has positive and increasing working capital. This indicates efficient management of current assets and liabilities, allowing for sustained growth.

The margins of companies producing durable goods typically fluctuate with the economic cycle. They tend to expand during periods of economic growth and contract during recessions, reflecting changes in consumer spending patterns.

Companies use strategies like cash dividends and share buybacks to return cash to shareholders. These actions increase shareholder value and can be used to improve earnings per share (EPS).

The dividend growth model estimates a stock's intrinsic value based on expected future dividends and the cost of equity capital. However, misapplication of the model, like using an incorrect cost of capital or an overestimated dividend growth rate, can lead to inaccurate valuations.

Industries like consumer staples and pharmaceuticals were relatively less impacted by the pandemic compared to those directly affected by travel restrictions and social distancing, such as travel and lodging, and consumer discretionary spending.

The consumer staples industry faces a significant risk from rising input costs and the possibility that consumers may switch to cheaper alternatives during periods of inflation.

When evaluating the market for a new product, factors like disposable income, target audience age, and the product's potential for both personal and business use are crucial considerations, particularly for high-priced products.

While rising inflation can initially boost consumer staples' profits due to increased pricing power, in the long term it poses a risk as consumers could shift to cheaper alternatives, impacting their share of the market.

Companies with high fixed costs, like those involved in manufacturing complex goods (e.g., aircraft parts), benefit significantly from increased sales during an expanding economy, leading to higher operating leverage and amplified profitability.

Pharmaceuticals, due to their essential nature and steady demand, are likely to perform better than sectors heavily reliant on discretionary spending, like luxury retailers or travel and lodging.

Industries producing staple goods, like snack foods, tend to have more stable margins compared to sectors like oil services, truck manufacturing, or media, which are more susceptible to economic fluctuations.

Factors that make it difficult for new companies to enter an industry. Examples include: high startup costs, government regulations, strong brand loyalty, and unique resources or technology.

A decrease in earnings per share (EPS) due to an increase in the number of outstanding shares, often resulting from issuing new stock.

The potential consequences or impacts of a legal agreement, including financial, operational, and reputational effects.

The response of shareholders to company news or events, which can influence stock price.

A valuation method that assumes all convertible securities are converted into common stock, which increases the number of shares outstanding.

If a company pays off debt by issuing stock, increasing the cost of equity, the weighted average cost of capital (WACC) usually increases.

Accelerated filers (companies with a market cap of $75 million or more) have 40 days after the end of a fiscal quarter to file their 10Q report.

The process of spreading the cost of an intangible asset over its useful life. Only certain intangible assets are amortized, like software development costs.

The supply curve slopes upwards because producers typically offer more of a good or service at a higher price, as this means higher profits.

During a pandemic, the travel/lodging sector is typically most impacted, followed by consumer discretionary (like restaurants and entertainment), then consumer staples (like groceries and hygiene products). Pharmaceuticals are least affected.

In the early stages of a recession, healthcare tends to perform best, as people continue to need healthcare services regardless of economic conditions.

The likelihood that a company won't be able to meet its financial obligations, especially related to its debt levels.

When the discount rate increases, the present value of future cash flows decreases, making investments less attractive.

When a tax credit for a product ends, demand may remain high if the product's value outweighs the lost benefit, or if the product has no substitutes.

When a company maintains a consistent ratio of earnings distributed as dividends, it provides predictable dividend payments.

Measures how efficiently a company uses its assets to generate sales; a higher ratio indicates better asset utilization.

Increasing accounts receivable and accounts receivable turnover indicate a company's sales are expanding.

A practice where a company artificially boosts sales by pushing more inventory into the distribution channel, leading to rising receivables and falling inventory.

When a company raises equity to pay off debt, it can impact its capital structure and cost of capital.

Declaring cash dividends, paying stock dividends, and changing depreciation methods do not directly affect earnings per share.

Companies with cyclical earnings exhibit significant variability in their PE ratios, often driven by economic cycles and industry trends.

For companies with steady sales growth, low capital expenses and increasing EPS, FCF yield is an effective valuation metric.

When assessing a retail company recovering from a setback, a forward P/E ratio based on forecasted EPS over the next few years is useful.

P/S ratio is a suitable valuation metric for a debt-free company with positive earnings.

The minimum rate of return a company needs to earn on its investments to satisfy its investors.

The earnings per share that would result if all convertible securities were exercised, reflecting the potential dilution of earnings.

A company's fixed costs relative to its variable costs. High leverage companies tend to have higher profit margins in good times, but lower profit margins in bad times.

An adjustment made to the value of inventory on a company's balance sheet when the market value of the inventory falls below its carrying cost.

A valuation metric comparing a company's PE ratio to the average PE ratio of its industry or a benchmark index. It indicates if a company is overvalued or undervalued relative to its peers.

When a company buys back its own shares from the open market, reducing the number of outstanding shares and potentially increasing EPS.