AFM 212 Week 1 Financial Analysis and Valuation Framework PDF

Week 1: Financial Analysis and Valuation Frame Work and Industry Analysis 9/5/24 Presented by: Haihao Lu (Ross) School of Accounting and Finance professionals go #beyondideas SCHOOL OF ACCOU...

Week 1: Financial Analysis and Valuation Frame Work and Industry Analysis 9/5/24 Presented by: Haihao Lu (Ross) School of Accounting and Finance professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 2 Framework for Analysis § Financial statement analysis―the process of extracting information from financial statements to better understand a company’s current and future performance and financial condition. § Financial statements serve many objectives § Management § Investors and analysts § Creditors, lenders, and rating agencies § Regulatory agencies professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 3 Benefit and cost of high quality financial disclose Compliance and Access to Capital audit costs Monitoring cost Good reputation Proprietary costs Valuation and analysis Litigation cost Risk Assessment Others others professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 4 Supply of Financial Accounting Information Two primary reports that companies MUST supply: § Form 10-K: the audited Annual Report § Four financial statements § Explanatory notes § Management’s discussion and analysis (MD&A) § Form 10-Q: the unaudited Quarterly Report § Summary versions of the four financial statements § Limited additional disclosures Managers consider the benefits and costs of disclosure when deciding on the quantity and quality of accounting information to supply. professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 5 Information Beyond Financial Statements § Financial statement footnotes § Management Discussion and Analysis (MD&A) § Independent auditor report § Regulatory filings, including proxy statements (DEF 14A) and other SEC filings (8K) § Prospectus (S1) § Analyst Research Reports professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 6 SEC’s Regulation Fair Disclosure (FD) Goal is to curb the practice of selective disclosure by public companies. Reg FD reads as follows: “Whenever an issuer discloses any material nonpublic information regarding that issuer, the issuer shall make public disclosure of that information... simultaneously, in the case of an intentional disclosure; and... promptly, in the case of a non-intentional disclosure.” professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Different assurance of financial reports Notice to Reader Review Engagement Audit Engagement (Compilation) Assurance level - Assurance level - Assurance level - None Limited Reasonable Cost: Low Cost: Moderate Cost: High Complexity: Complexity: Complexity: Simple Intermediate Complex Scope: Organizing Scope: inquiry and Scope: inquiry and information from analytical procedure analytical procedure management to provide limited to provide limited without verification assurance assurance Use: internal use or Use: Small Use: public small companies companies seeking companies, large loans or private private companies companies with issuing bonds or external investors requiring loans professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 8 Framework for Analysis and Valuation Porter’s 5 forces Industry Analysis Economic Cycle Business Model Competitive Business Analysis advantage Business Cycle Financial Ratio Analysis Statement Common Size Statement Analysis Analysis Financial Forecasting and modeling Valuation/Credit DCF/Multiple Analysis Collateral professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 9 Framework for Analysis and Valuation Porter’s 5 forces Industry Analysis Economic Cycle Business Model Competitive Business Analysis advantage Business Cycle Financial Ratio Analysis Statement Common Size Statement Analysis Analysis Financial Forecasting and modeling Valuation/Credit DCF/Multiple Analysis Collateral professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 10 What is an Industry? § An industry is a group of companies and organizations that produce similar products or provide similar services. Industries are classified based on the primary business activities of the companies within them. Example of FF 12 Industry professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Commonly used industry Code system § NAICS (North American Industry Classification System): Used primarily in the United States, Canada, and Mexico to classify business establishments by type of economic activity. § SIC (Standard Industrial Classification): An older system that is still in use in some contexts, particularly for historical data comparison and some specific industries § GICS (Global Industry Classification Standard): Developed by MSCI and Standard & Poor's for use by the global financial community, particularly for investment research and portfolio management. professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE § NAICS Code: 452311 (North American Industry Classification System) § Sector: 45 - Retail Trade § Subsector: 452 - General Merchandise Stores § Industry Group: 4523 - General Merchandise Stores, including Warehouse Clubs and Supercenters § Industry: 45231 - Warehouse Clubs and Supercenters § National Industry: 452311 - Warehouse Clubs and Supercenters § SIC Code: 5399 ( standard Industrial classification) § Major Group: 53 - General Merchandise Stores § Industry Group: 539 - Miscellaneous General Merchandise Stores § Industry: 5399 - Miscellaneous General Merchandise Stores (Membership Warehouse Clubs) § GICS Code: 30101040 ( Global Industry Classification Standard) Sector: 30 - Consumer Staples Industry Group: 3010 - Food & Staples Retailing Industry: 301010 - Food & Staples Retailing Sub-Industry: 30101040 - Hypermarkets & Super Centers professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE © Cambridge Business Publishers, 2021 13 Porter’s Five Forces Porter, M. 1998. “Competitive Strategy: Techniques for Analyzing Industries and Competitors.” professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Barrier to Entry § Unique industry characteristics reduce the rate of entry of competitors, therefore maintaining profit level of existing companies in the industry § Barriers to entry may result from the followings: § Organizational economic of scale- Minimum efficient scale § Patents and proprietary knowledge § Regulatory / Government § Asset specificity professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Existing Competition § Number of Companies § More companies means companies must compete for the same buyers and resources. § when companies have similar market share, company fight for market leadership. § Herfindahl–Hirschman index § Slow Industry growth § Slow industry industry growth cause companies to fight for increased market share § In growing market, companies are able to improve revenues simply due o access to an expanding market. § Low Switching Cost § When buyers can easily switch to competitor's products, competition is high. § High Fixed Costs and/or high storage costs § Industry with high fixed cost must maximum their capacity to attain lower per unit cost, leading to a fight for market share § High Exit Barrier § Companies have to stay in competition although they may be earning little or even negative returns on investment. professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Entry and Exit Entry is easy if there are Entry is difficult if there are A low scale threshold High scale threshold Access to distribution Channels Restriction distribution channels Common/ accessible technology Patented or proprietary knowledge Low switching costs High brand switching costs Exit is easy if there are Exit is difficult if there are Markable assets Specialized assets Low exit costs High exit costs Independent business Interrelated business professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Threat of substitute products § In Porter’s model, substitute products refer to products in other industries; However, it can also be used for individual products. § Competition is high when § Buyers have no brand loyalties and/or there is no established brands § Changing to another product saves money without sacrificing features or performance § Simple and inexpensive to change to another product § The producers of substitute products have very high margins and can easily attract buyers through price reductions. professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Bargaining power of buyers § Buyer’s are powerful if.. § They purchase large volumes relative to supplier sales § Product is standard or undifferentiated § They can produce the product themselves § Supplier have high fixed costs § The product is not of strategic importance to the buyers. professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Bargaining power of suppliers § Suppliers are powerful if … § The supply market is dominated by a few companies § The buyers are neither large nor concentrated § They do not have to contend with substitute products § Their products are differentiated or the suppliers have build up switching costs § They poses a credible threat of forward integration. professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Industry Analysis Each axis represents one of the five forces, and the intensity of each force is indicated by the distance from the center. professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Economic cycle professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE Industry, business and Product life cycle professionals go #beyondideas SCHOOL OF ACCOUNTING AND FINANCE External Factors that affect industries § Some Factors, which are beyond control of the company, may cause the company’s future results differ significantly from those currently expected or desired. External Factors Example Economic Environment Recession Interest rate Taxes International: Local economic and labor conditions Political instability Tax laws Local and national government regulation Political environment Regulations President election Trade Agreement Any government policies affecting supply and demand Social Environment Customs and conventions Cultural Fashion trend Ethic/issues professionals go #beyondideas Technology SCHOOL OF ACCOUNTING AND FINANCE New process New Product