Financial Reporting & Analysis Lecture 7

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. ...

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Chapter 7 For the Investor = a person that owns shares = shareholder = stockholder Information for investors; Dividends © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Introduction Certain types of analyses particularly concern investors. In addition to the analysis, we are going to cover in this session, an investor would also be interested in liquidity, debt, and profitability ratios covered in previous sessions. An investor owns shares (Fr: actions) : - Common stock (Fr: actions ordinaires) - Preferred stock ===== Priority to receive dividends / no voting rights / © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1/ Earnings per Common Share (EPS) The amount of income earned on a share of common stock during an accounting period Required disclosure for corporate income statements Investors prefer higher ratios, indicating a higher probability of receiving dividends Pertains only to common stock Common shares outstanding : number of shares owned currently by the shareholders, Net Income  Preferred Dividend Earning per Share = Weighted Average Number of Common © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Weighted Average Common Outstanding Shares Months Shares Are Shares Fraction of Year Weighted Outstanding Outstanding × Outstanding = Average January–June 10,000 6/12 5,000 July–September 12,000 3/12 3,000 October–December 15,000 3/12 3,750 11,750 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Earnings per Common Share— Continued Current guidelines require basic and diluted earnings per share presentation (DEPS) – Diluted earnings per share is calculated the same as basic plus the dilutive effect of potentially dilutive securities ==== when additional shares are included in the calculation (Eg: a debt is converted into shares) – DEPS < EPS © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2/ Price/Earnings Ratio (PER) Market Price per Share Price/ Earings Ratio = Earnings per Share ¿ Measures the relationship between ¿ the market price of a share of common stock and that stock’s current earnings per share – Use of diluted earnings per share gives a more conservative price/earnings ratio – A high ratio ; eg: Market price = €100, EPS = €1 === Means that the investor purchase the shares for € 100 to earn potential 1 € ==== In this case , the investor is optimistic, the growth potential of this firm is high. High PER is the case for startup – Another interpretation of a high PER is that overestimated == not the real value of the firm © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Price/Earnings Ratio—Continued Interpretation – High-growth-potential firms have higher P/E ratios Compare with – Competitors – Industry average © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Example © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3/ Percentage of Earnings Retained Reflects the proportion of current earnings retained for internal growth (the % of profit that will not be distributed) Trend analysis is improved by exclusion of nonrecurring items A low percentage of earnings retained more generous in its dividend policy Higher percentage typically found in growth firms Net Income ( ) Percentage of − All Dividends = Earnings Retained Net Income © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 4/ Dividend Payout (DP) Measures the portion of current earnings per common share being paid out in dividends Lower payout typically found in growth firms This ratio indicates the dividend policy of the firm Dividends per Common Share Dividend Payout ratio = 𝐷𝐸𝑃𝑆𝑜𝑟 𝐸𝑃𝑆 Eg: the EPS is €10 and the firm distributes €4 per share. So DP ratio = 4/10 = 40% © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Example of ratio 3 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 5/ Dividend Yield (DY) Indicates the relationship between the dividends per common share and the market price per common share The yield depends on a firm’s dividend policy and market price A low dividend yield satisfies many investors if the company has a record of above average return on common equity. === indicates that the investor prefers long-term consideration ( the investor does not want dividends but control over the firm) © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Dividend Yield (DY) Dividends per Common Share Dividend Yield = Market Price per Common Share © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 6/ Book Value per Share = it is the value of shares in the balance sheet) Preferred equity should be measured at liquidation value, if available Market value and book value – Book value reflects the of assets (available on the accounting books) value – Market value reflects the potential of the firm (available on Bloomberg …..) == high market value indicates that investors are OPTIMISTIC Total Shareholders' Equity  Preferred Stock Equity Book Value per Share = Number of Common Shares Outstanding © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.