Financial statement analysis and evaluation (FSAV)
Content
Lecture 1: Valuation drivers............................................................................................................................ 2
Cynk case ............................................................................................................................................................ 2
Gulf case ............................................................................................................................................................. 2
Practice session 1 – Value Drivers & Intel’s Earnings Torpedo ......................................................................... 6
Intel Earnings Announcement Torpedo .............................................................................................................. 6
Lecture 2: Business analysis ............................................................................................................................ 9
Example: Hudson’s Bay’s business.................................................................................................................... 11
Example: accounting to understand the business - Netflix ............................................................................... 14
Ecom example .................................................................................................................................................. 15
Practice session 2: Boston Case .................................................................................................................... 18
Lecture 3: Ratio Analysis .............................................................................................................................. 19
Paypal case ....................................................................................................................................................... 19
Lehman Brothers repo 105 ............................................................................................................................... 20
Practice session 3: Sirius Satellite Radio ....................................................................................................... 26
Lecture 4: Information collection.................................................................................................................. 28
Determinants: Facebook................................................................................................................................... 30
Zoomlion case ................................................................................................................................................... 32
Practice session 4: Disney case ..................................................................................................................... 34
Lecture 5: Forecasting .................................................................................................................................. 38
Practice session 5: Netflix ............................................................................................................................. 45
Lecture 6: Equity valuation ........................................................................................................................... 49
Practice session 6: Tesla case........................................................................................................................ 58
Financial statement analysis in PE practice ................................................................................................... 59
Lecture 7 – Capita selecta ............................................................................................................................. 60
1
,Lecture 1: Valuation drivers
Cynk case
Cynk Technology, Inc. offers you a social network. It started off as a penny stock (below $5 per
share). In July 2014, the firm’s market value exceeded 6 bn US dollars for 1 hour only. What
happened? Momentum traders put their trust in penny firm financial gossips.
o Cynk had no assets according to the financial statements. The company did not have any
revenues either. One of the worst things is 0 employees.
o The firm claimed that the firm was run from the headquarter the Matalon. They claimed it was
run from suite 400 (doesn’t exist). Actually, there is nothing à fake suite, no revenues, no
employees. How can a company than be worth under 6bn dollars? Pump and dump scheme
à you and your friends start investing to trigger real investors to get lured into the transaction.
Some things that need to be clear
o The purpose of FS is NOT to provide an estimation for equity value.
o Equity investing is not a game against nature, but against other investors (more information, or
betting).
o Investing should be more like watching paint dry or watching grass grow. Slow and
unexciting process.
o Little need to discover the “true” intrinsic value; rather understand how you think differently
from others.
o Intrinsic value is an “elusive concept”; inputs are uncertain.
What is firm value?
Economic value of the firm is the discounted sum of expected FCFs.
Is economic value equal to market value?
That is what we aim to find out with valuation.
What is accounting?
A language to measure and communicate firm performance.
What is financial statement analysis?
FSA is about analyzing a firm's accounting information to learn about its true performance.
Gulf case
Gulf Resources, Inc. is a chemical company listed on Nasdaq. It is an industrial salt producer. Bronte
(capital investment service) shorted Gulf Resources on behalf of its clients. The company looked
suspicious since it is a high inventory turnover rate.
o Inventory turnover rate = Sales/Average inventories
o 169.5x per year, they turned over their inventory stock. Such a high turnover rate indicates
that goods are sold really fast. If you’d compare it to a similar firm, the turnover rate was less
than 5. Therefore, the company looks suspicious, so they short on this firm.
Three steps of equity valuation:
2
,Understanding the past
Goal: understand a firm’s financials in the context of its business strategy and the industry and
economy it operates in.
o Understand the business
o Accounting analysis à check how the busines is mapped into the numbers. Do they reflect the
business well?
o Ratio analysis à understand key strengths and weaknesses of the firm’s strategy. Identify key
drivers of value and spot any irregularities.
Forcasting the future
Goal: forecast firm’s value creation in the future.
o Information collection to broaden your view and inform your predictions.
o Forecasting: Framing the forecasting problem using the same ratios as we used for
understanding the past.
NPV – Net Present Value
What is the max you are willing to pay for an investment that you expect to yield 100 for 3 years while
a comparable risky investment is expected to return 8% per year?
Value of an equity interest is based on the PV of expected future cash dividends to be received.
The dividend discount formula is rarely used directly:
• Dividends don’t directly reflect performance
• Dividends are to a large extent discretionary
• Many firms don’t pay high dividends right now, but promise pay later.
• Dividend irrelevance theorem à cum dividend payout is not affected. Need to
forecast things very far in the future.
Earnings-based valuation
CE= common shareholders’ equity.
- Based either on NI or DIV.
o All gains and losses go through the income statement.
Calculation of the price.
3
, - Price is a function of both past information and expectations regarding the future.
Core value drivers
1. Investment growth (g)
2. Risk ( r)
3. Profitability (RoE)
Structured approach to valuation
1. Understanding the past
2. Forecasting the future
3. Valuation
Profitability, RoE
- RoE is the RoI for equity investors
- RoI = Earnings for the period / Investment at the beginning of the period
-
- RoE is the rate of return that equity owners get.
- RoE must be higher than the opportunity cost (r ) in order to generate value.
- We call these opportunity cost (r ) “expected return” or “cost of equity capital”.
Investment growth, g
- Profitability is only part of the picture
- Amount of capital invested is crucial too
- Investment depreciates and becomes obsolete
o Investment needs to grow to expand the business
o Investment in new assets to not become obsolete and stay competitive
Risk, r
4
Content
Lecture 1: Valuation drivers............................................................................................................................ 2
Cynk case ............................................................................................................................................................ 2
Gulf case ............................................................................................................................................................. 2
Practice session 1 – Value Drivers & Intel’s Earnings Torpedo ......................................................................... 6
Intel Earnings Announcement Torpedo .............................................................................................................. 6
Lecture 2: Business analysis ............................................................................................................................ 9
Example: Hudson’s Bay’s business.................................................................................................................... 11
Example: accounting to understand the business - Netflix ............................................................................... 14
Ecom example .................................................................................................................................................. 15
Practice session 2: Boston Case .................................................................................................................... 18
Lecture 3: Ratio Analysis .............................................................................................................................. 19
Paypal case ....................................................................................................................................................... 19
Lehman Brothers repo 105 ............................................................................................................................... 20
Practice session 3: Sirius Satellite Radio ....................................................................................................... 26
Lecture 4: Information collection.................................................................................................................. 28
Determinants: Facebook................................................................................................................................... 30
Zoomlion case ................................................................................................................................................... 32
Practice session 4: Disney case ..................................................................................................................... 34
Lecture 5: Forecasting .................................................................................................................................. 38
Practice session 5: Netflix ............................................................................................................................. 45
Lecture 6: Equity valuation ........................................................................................................................... 49
Practice session 6: Tesla case........................................................................................................................ 58
Financial statement analysis in PE practice ................................................................................................... 59
Lecture 7 – Capita selecta ............................................................................................................................. 60
1
,Lecture 1: Valuation drivers
Cynk case
Cynk Technology, Inc. offers you a social network. It started off as a penny stock (below $5 per
share). In July 2014, the firm’s market value exceeded 6 bn US dollars for 1 hour only. What
happened? Momentum traders put their trust in penny firm financial gossips.
o Cynk had no assets according to the financial statements. The company did not have any
revenues either. One of the worst things is 0 employees.
o The firm claimed that the firm was run from the headquarter the Matalon. They claimed it was
run from suite 400 (doesn’t exist). Actually, there is nothing à fake suite, no revenues, no
employees. How can a company than be worth under 6bn dollars? Pump and dump scheme
à you and your friends start investing to trigger real investors to get lured into the transaction.
Some things that need to be clear
o The purpose of FS is NOT to provide an estimation for equity value.
o Equity investing is not a game against nature, but against other investors (more information, or
betting).
o Investing should be more like watching paint dry or watching grass grow. Slow and
unexciting process.
o Little need to discover the “true” intrinsic value; rather understand how you think differently
from others.
o Intrinsic value is an “elusive concept”; inputs are uncertain.
What is firm value?
Economic value of the firm is the discounted sum of expected FCFs.
Is economic value equal to market value?
That is what we aim to find out with valuation.
What is accounting?
A language to measure and communicate firm performance.
What is financial statement analysis?
FSA is about analyzing a firm's accounting information to learn about its true performance.
Gulf case
Gulf Resources, Inc. is a chemical company listed on Nasdaq. It is an industrial salt producer. Bronte
(capital investment service) shorted Gulf Resources on behalf of its clients. The company looked
suspicious since it is a high inventory turnover rate.
o Inventory turnover rate = Sales/Average inventories
o 169.5x per year, they turned over their inventory stock. Such a high turnover rate indicates
that goods are sold really fast. If you’d compare it to a similar firm, the turnover rate was less
than 5. Therefore, the company looks suspicious, so they short on this firm.
Three steps of equity valuation:
2
,Understanding the past
Goal: understand a firm’s financials in the context of its business strategy and the industry and
economy it operates in.
o Understand the business
o Accounting analysis à check how the busines is mapped into the numbers. Do they reflect the
business well?
o Ratio analysis à understand key strengths and weaknesses of the firm’s strategy. Identify key
drivers of value and spot any irregularities.
Forcasting the future
Goal: forecast firm’s value creation in the future.
o Information collection to broaden your view and inform your predictions.
o Forecasting: Framing the forecasting problem using the same ratios as we used for
understanding the past.
NPV – Net Present Value
What is the max you are willing to pay for an investment that you expect to yield 100 for 3 years while
a comparable risky investment is expected to return 8% per year?
Value of an equity interest is based on the PV of expected future cash dividends to be received.
The dividend discount formula is rarely used directly:
• Dividends don’t directly reflect performance
• Dividends are to a large extent discretionary
• Many firms don’t pay high dividends right now, but promise pay later.
• Dividend irrelevance theorem à cum dividend payout is not affected. Need to
forecast things very far in the future.
Earnings-based valuation
CE= common shareholders’ equity.
- Based either on NI or DIV.
o All gains and losses go through the income statement.
Calculation of the price.
3
, - Price is a function of both past information and expectations regarding the future.
Core value drivers
1. Investment growth (g)
2. Risk ( r)
3. Profitability (RoE)
Structured approach to valuation
1. Understanding the past
2. Forecasting the future
3. Valuation
Profitability, RoE
- RoE is the RoI for equity investors
- RoI = Earnings for the period / Investment at the beginning of the period
-
- RoE is the rate of return that equity owners get.
- RoE must be higher than the opportunity cost (r ) in order to generate value.
- We call these opportunity cost (r ) “expected return” or “cost of equity capital”.
Investment growth, g
- Profitability is only part of the picture
- Amount of capital invested is crucial too
- Investment depreciates and becomes obsolete
o Investment needs to grow to expand the business
o Investment in new assets to not become obsolete and stay competitive
Risk, r
4
