Financial Statement Analysis & Valuation
6314M0405Y
Table of Contents
Week 1 ..................................................................................................................................................... 4
Lecture 1 .............................................................................................................................................. 4
Jackson and Lui (2010) – The Allowance for Uncollectible Accounts, Conservatism, and Earnings
Management ................................................................................................................................... 6
Jackson and Liu [2010] “The Allowance for Uncollectible Accounts, Conservatism, and Earnings
Management” ..................................................................................................................................... 7
Easton et al. (2021) - Module 1: Framework for Analysis and Valuation ............................................ 8
Step 1: business environment and accounting ................................................................................ 8
Financial statements: demand and supply ...................................................................................... 9
Review of financial statements ........................................................................................................ 9
Analyzing the business environment ............................................................................................. 10
Step 2: adjusting and analyzing financial data............................................................................... 10
Step 3: forecasting financial numbers ........................................................................................... 10
Step 4: business valuation ............................................................................................................. 11
Easton et al. (2021) - Module 2: Review of Business Activities and Financial Statements................ 11
Interpreting a balance sheet ......................................................................................................... 11
Interpreting an income statement ................................................................................................ 11
Interpreting a statement of stockholders’ equity .......................................................................... 12
Interpreting a statement of cash flows.......................................................................................... 12
Articulation of financial statements .............................................................................................. 12
Analyzing transactions and adjustments ....................................................................................... 13
Additional information sources ..................................................................................................... 13
Analyzing global reports ................................................................................................................ 14
Week 2 ................................................................................................................................................... 14
Lecture 2 ............................................................................................................................................ 14
Cash Flow Analysis and Accrual Accounting .................................................................................. 14
Ratio analysis and reformulation ................................................................................................... 15
Easton et al. (2021) – Module 3: Profitability Analysis and Interpretation ....................................... 19
ROE disaggregation: DuPont analysis ............................................................................................ 20
Return on assets and its disaggregation ........................................................................................ 20
Balance sheet analysis with an operating focus ............................................................................ 22
Income statement analysis with an operating focus ..................................................................... 22
Page 1 of 70
, Return on net operating assets (RNOA) ........................................................................................ 23
RNOA disaggregation into margin and turnover ........................................................................... 23
Analyzing global reports ................................................................................................................ 24
Appendix 3A: Operating versus nonoperating classification ......................................................... 24
Appendix 3B: nonoperating return component of ROE ................................................................ 25
Appendix 3C: Vertical and horizontal analysis ............................................................................... 25
Summary of ratios ......................................................................................................................... 26
Easton et al. (2021) – Module 4: Credit Risk Analysis and Interpretation ......................................... 26
Market for credit ........................................................................................................................... 26
Credit risk analysis process ............................................................................................................ 27
Measuring credit risk ..................................................................................................................... 28
Credit ratings ................................................................................................................................. 30
Predicting bankruptcy risk ............................................................................................................. 31
Week 3 ................................................................................................................................................... 31
Lecture 3 ............................................................................................................................................ 31
Advanced ratio decomposition...................................................................................................... 31
(Other) Comprehensive Income .................................................................................................... 34
Forecasting .................................................................................................................................... 34
Valuation ........................................................................................................................................ 36
Easton et al. (2021) – Module 11: Financial Statement Forecasting ................................................. 37
Forecasting process ....................................................................................................................... 37
Forecasting the income statement ................................................................................................ 38
Forecasting the balance sheet ....................................................................................................... 39
Building forecasts from the bottom up ......................................................................................... 41
Appendix 11A: forecasting the statement of cash flows ............................................................... 42
Appendix 11C: Parsimonious method for forecasting NOPAT and NOA ........................................ 42
Easton et al. (2021) – Module 12: Cost of Capital and Valuation Basics ........................................... 42
Basics of valuation ......................................................................................................................... 42
Estimating cost of capital ............................................................................................................... 43
Dividend discount model ............................................................................................................... 45
Easton et al. (2021) – Module 13: Cash-flow Based Valuation .......................................................... 46
Equity valuation models ................................................................................................................ 46
Discounted cash flow (DCF) model ................................................................................................ 47
Analyzing global reports ................................................................................................................ 49
Week 4 ................................................................................................................................................... 49
Lecture 4 ............................................................................................................................................ 49
Page 2 of 70
, Forecasting .................................................................................................................................... 49
Valuation models ........................................................................................................................... 49
Hand et al. (2017) – The use of residual income valuation methods by U.S. sell-side equity
analysts .......................................................................................................................................... 51
Tutorial notes................................................................................................................................. 52
Hand, Coyne, Green, and Zhang [2017] “The Use of Residual Income Valuation Methods by U.S.
Sell-Side Equity Analysts” .................................................................................................................. 52
Easton et al. (2021) – Module 14: Operating-Income-Based Valuation ............................................ 55
Residual operating income (ROPI) model ...................................................................................... 55
Steady state in valuation ............................................................................................................... 56
Managerial insights form the ROPI model .................................................................................... 57
Assessment of valuation models ................................................................................................... 58
Week 5 ................................................................................................................................................... 58
Lecture 5 ............................................................................................................................................ 58
Valuation models ........................................................................................................................... 58
Market-to-book ratio and abnormal ROE ...................................................................................... 58
Multiples valuation ........................................................................................................................ 59
Security analysis ............................................................................................................................ 60
Park et al. (2024) – Sell-side analysts’ assessment of ESG risk ...................................................... 61
Park, Yoon, and Zach [2024] “Sell-Side Analysts’ Assessment of ESG Risk” ...................................... 62
Easton et al. (2021) – Module 15: Market-Based Valuation .............................................................. 64
Valuation using balance sheet multiples ....................................................................................... 65
Valuation using income statement multiples ................................................................................ 65
Selecting comparables for market multiples ................................................................................. 66
Interpreting and reverse engineering market multiples ............................................................... 66
Week 6 ................................................................................................................................................... 67
Lecture 6 ............................................................................................................................................ 67
Valuation ........................................................................................................................................ 67
Research insights ........................................................................................................................... 69
Understanding market reactions to earnings news....................................................................... 69
Basic versus diluted EPS ................................................................................................................ 69
Value investing ............................................................................................................................... 69
Page 3 of 70
, Week 1
Lecture 1
Financial Statement Analysis (FSA)
This course gives you a toolbox for analyzing and extracting information from companies’ financial statements, from
the perspective of the user of the financial statement.
Financial statements (FS) provide a lens on a company’s business. Financial equity analysts use financial statements
to forecast performance and value the company. They evaluate a company’s current performance, the quality of the FS
numbers in reflecting the underlying business, the sustainability of current performance as a basis for expectations of
future performance and the value of the company and its common shareholders’ equity.
The primary sources of information for the purposes of analysis will be: (1) Income statements (“Statements of
Operations”), (2) Balance sheets (“Statements of Financial Position”), (3) Statements of cash flows, (4) Statements
of changes in equity, (5) Statements of comprehensive income, and (6) Notes. We will find additional useful
information in (7) Company press releases / interim statements, and (8) Management discussion and analysis (MD&A)
and performance expectations.
The fundamentals of valuation
In the long run, common shareholders care about receiving a return on their
investment. This return can take two forms: (1) a constant periodic payoff
(cash dividend), and/or (2) the ability to liquidate the investment at a higher
price. The expected (or “required”) payoff structure from buying an equity share
is shown in figure 1. As such, the value of an equity share can be estimated
through the present value of expected future dividends (including a Figure 1
“liquidating” dividend at the end of the investment horizon / company’s life).
𝐷𝑖𝑣1 𝐷𝑖𝑣 𝐷𝑖𝑣
The Discounted Dividends Model (DDM) formalizes this idea: 𝑉0𝑆𝐻𝐴𝑅𝐸 = 𝑡=1 (1+𝑟 )𝑡 . In
+ (1+𝑟 2)2 + ⋯ = ∑∞ 𝑡
(1+𝑟𝑒 ) 𝑒 𝑒
𝐹𝐶𝐹𝐹1 𝐹𝐶𝐹𝐹2
practice, the Discounted Cash Flow (DCF) model is used: 𝑉0𝑆𝐻𝐴𝑅𝐸 = + (1+𝑟 )2
+ ⋯ − 𝑉0𝐷𝐸𝐵𝑇 =
(1+𝑟𝑤𝑎𝑐𝑐 ) 𝑤𝑎𝑐𝑐
𝐹𝐶𝐹𝐹𝑡
∑∞
𝑡=1 (1+𝑟𝑤𝑎𝑐𝑐 )𝑡
− 𝑉0𝐷𝐸𝐵𝑇 . Where 𝐹𝐶𝐹𝐹 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 − 𝐶𝑎𝑠ℎ 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑖𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 =
𝐹𝑟𝑒𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤. → To determine value, we need to make forecasts, as it depends on what happens in the future.
We will focus on determining the “intrinsic” or “fundamental” value of a company, not its stock price. This is because a
company’s value does not always equal its stock price (which is based on supply and demand)! The intrinsic (or
fundamental) value of a company refers to its true economic worth based on expected future performance. This is
different from the stock price, which reflects market sentiment, supply/demand dynamics, and sometimes speculative
behavior.
FSA and valuation
To create proper forecasts, we first need to understand current performance. Accordingly, FSA consists of the following
steps:
1. Understanding the business environment and accounting information (modules 1-2) [business or strategy
analysis]
a. Q: what are the company’s primary business, key profit drivers, and risk areas?
2. Adjusting and assessing financial information using ratio and cash flow analysis (modules 1-4)
a. Q: do the financial statements accurately reflect the underlying business? [accounting analysis]
b. Q: what factors drive current performance and how sustainable is this performance? [financial analysis]
3. Forecasting financial information (module 11) [prospective analysis]
a. Q: how will the company’s business and past performance translate into performance in the next years?
4. Using information for valuation (modules 12-15) [prospective analysis]
a. Q: what is the company worth, and should we make an investment?
Page 4 of 70
6314M0405Y
Table of Contents
Week 1 ..................................................................................................................................................... 4
Lecture 1 .............................................................................................................................................. 4
Jackson and Lui (2010) – The Allowance for Uncollectible Accounts, Conservatism, and Earnings
Management ................................................................................................................................... 6
Jackson and Liu [2010] “The Allowance for Uncollectible Accounts, Conservatism, and Earnings
Management” ..................................................................................................................................... 7
Easton et al. (2021) - Module 1: Framework for Analysis and Valuation ............................................ 8
Step 1: business environment and accounting ................................................................................ 8
Financial statements: demand and supply ...................................................................................... 9
Review of financial statements ........................................................................................................ 9
Analyzing the business environment ............................................................................................. 10
Step 2: adjusting and analyzing financial data............................................................................... 10
Step 3: forecasting financial numbers ........................................................................................... 10
Step 4: business valuation ............................................................................................................. 11
Easton et al. (2021) - Module 2: Review of Business Activities and Financial Statements................ 11
Interpreting a balance sheet ......................................................................................................... 11
Interpreting an income statement ................................................................................................ 11
Interpreting a statement of stockholders’ equity .......................................................................... 12
Interpreting a statement of cash flows.......................................................................................... 12
Articulation of financial statements .............................................................................................. 12
Analyzing transactions and adjustments ....................................................................................... 13
Additional information sources ..................................................................................................... 13
Analyzing global reports ................................................................................................................ 14
Week 2 ................................................................................................................................................... 14
Lecture 2 ............................................................................................................................................ 14
Cash Flow Analysis and Accrual Accounting .................................................................................. 14
Ratio analysis and reformulation ................................................................................................... 15
Easton et al. (2021) – Module 3: Profitability Analysis and Interpretation ....................................... 19
ROE disaggregation: DuPont analysis ............................................................................................ 20
Return on assets and its disaggregation ........................................................................................ 20
Balance sheet analysis with an operating focus ............................................................................ 22
Income statement analysis with an operating focus ..................................................................... 22
Page 1 of 70
, Return on net operating assets (RNOA) ........................................................................................ 23
RNOA disaggregation into margin and turnover ........................................................................... 23
Analyzing global reports ................................................................................................................ 24
Appendix 3A: Operating versus nonoperating classification ......................................................... 24
Appendix 3B: nonoperating return component of ROE ................................................................ 25
Appendix 3C: Vertical and horizontal analysis ............................................................................... 25
Summary of ratios ......................................................................................................................... 26
Easton et al. (2021) – Module 4: Credit Risk Analysis and Interpretation ......................................... 26
Market for credit ........................................................................................................................... 26
Credit risk analysis process ............................................................................................................ 27
Measuring credit risk ..................................................................................................................... 28
Credit ratings ................................................................................................................................. 30
Predicting bankruptcy risk ............................................................................................................. 31
Week 3 ................................................................................................................................................... 31
Lecture 3 ............................................................................................................................................ 31
Advanced ratio decomposition...................................................................................................... 31
(Other) Comprehensive Income .................................................................................................... 34
Forecasting .................................................................................................................................... 34
Valuation ........................................................................................................................................ 36
Easton et al. (2021) – Module 11: Financial Statement Forecasting ................................................. 37
Forecasting process ....................................................................................................................... 37
Forecasting the income statement ................................................................................................ 38
Forecasting the balance sheet ....................................................................................................... 39
Building forecasts from the bottom up ......................................................................................... 41
Appendix 11A: forecasting the statement of cash flows ............................................................... 42
Appendix 11C: Parsimonious method for forecasting NOPAT and NOA ........................................ 42
Easton et al. (2021) – Module 12: Cost of Capital and Valuation Basics ........................................... 42
Basics of valuation ......................................................................................................................... 42
Estimating cost of capital ............................................................................................................... 43
Dividend discount model ............................................................................................................... 45
Easton et al. (2021) – Module 13: Cash-flow Based Valuation .......................................................... 46
Equity valuation models ................................................................................................................ 46
Discounted cash flow (DCF) model ................................................................................................ 47
Analyzing global reports ................................................................................................................ 49
Week 4 ................................................................................................................................................... 49
Lecture 4 ............................................................................................................................................ 49
Page 2 of 70
, Forecasting .................................................................................................................................... 49
Valuation models ........................................................................................................................... 49
Hand et al. (2017) – The use of residual income valuation methods by U.S. sell-side equity
analysts .......................................................................................................................................... 51
Tutorial notes................................................................................................................................. 52
Hand, Coyne, Green, and Zhang [2017] “The Use of Residual Income Valuation Methods by U.S.
Sell-Side Equity Analysts” .................................................................................................................. 52
Easton et al. (2021) – Module 14: Operating-Income-Based Valuation ............................................ 55
Residual operating income (ROPI) model ...................................................................................... 55
Steady state in valuation ............................................................................................................... 56
Managerial insights form the ROPI model .................................................................................... 57
Assessment of valuation models ................................................................................................... 58
Week 5 ................................................................................................................................................... 58
Lecture 5 ............................................................................................................................................ 58
Valuation models ........................................................................................................................... 58
Market-to-book ratio and abnormal ROE ...................................................................................... 58
Multiples valuation ........................................................................................................................ 59
Security analysis ............................................................................................................................ 60
Park et al. (2024) – Sell-side analysts’ assessment of ESG risk ...................................................... 61
Park, Yoon, and Zach [2024] “Sell-Side Analysts’ Assessment of ESG Risk” ...................................... 62
Easton et al. (2021) – Module 15: Market-Based Valuation .............................................................. 64
Valuation using balance sheet multiples ....................................................................................... 65
Valuation using income statement multiples ................................................................................ 65
Selecting comparables for market multiples ................................................................................. 66
Interpreting and reverse engineering market multiples ............................................................... 66
Week 6 ................................................................................................................................................... 67
Lecture 6 ............................................................................................................................................ 67
Valuation ........................................................................................................................................ 67
Research insights ........................................................................................................................... 69
Understanding market reactions to earnings news....................................................................... 69
Basic versus diluted EPS ................................................................................................................ 69
Value investing ............................................................................................................................... 69
Page 3 of 70
, Week 1
Lecture 1
Financial Statement Analysis (FSA)
This course gives you a toolbox for analyzing and extracting information from companies’ financial statements, from
the perspective of the user of the financial statement.
Financial statements (FS) provide a lens on a company’s business. Financial equity analysts use financial statements
to forecast performance and value the company. They evaluate a company’s current performance, the quality of the FS
numbers in reflecting the underlying business, the sustainability of current performance as a basis for expectations of
future performance and the value of the company and its common shareholders’ equity.
The primary sources of information for the purposes of analysis will be: (1) Income statements (“Statements of
Operations”), (2) Balance sheets (“Statements of Financial Position”), (3) Statements of cash flows, (4) Statements
of changes in equity, (5) Statements of comprehensive income, and (6) Notes. We will find additional useful
information in (7) Company press releases / interim statements, and (8) Management discussion and analysis (MD&A)
and performance expectations.
The fundamentals of valuation
In the long run, common shareholders care about receiving a return on their
investment. This return can take two forms: (1) a constant periodic payoff
(cash dividend), and/or (2) the ability to liquidate the investment at a higher
price. The expected (or “required”) payoff structure from buying an equity share
is shown in figure 1. As such, the value of an equity share can be estimated
through the present value of expected future dividends (including a Figure 1
“liquidating” dividend at the end of the investment horizon / company’s life).
𝐷𝑖𝑣1 𝐷𝑖𝑣 𝐷𝑖𝑣
The Discounted Dividends Model (DDM) formalizes this idea: 𝑉0𝑆𝐻𝐴𝑅𝐸 = 𝑡=1 (1+𝑟 )𝑡 . In
+ (1+𝑟 2)2 + ⋯ = ∑∞ 𝑡
(1+𝑟𝑒 ) 𝑒 𝑒
𝐹𝐶𝐹𝐹1 𝐹𝐶𝐹𝐹2
practice, the Discounted Cash Flow (DCF) model is used: 𝑉0𝑆𝐻𝐴𝑅𝐸 = + (1+𝑟 )2
+ ⋯ − 𝑉0𝐷𝐸𝐵𝑇 =
(1+𝑟𝑤𝑎𝑐𝑐 ) 𝑤𝑎𝑐𝑐
𝐹𝐶𝐹𝐹𝑡
∑∞
𝑡=1 (1+𝑟𝑤𝑎𝑐𝑐 )𝑡
− 𝑉0𝐷𝐸𝐵𝑇 . Where 𝐹𝐶𝐹𝐹 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 − 𝐶𝑎𝑠ℎ 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑖𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 =
𝐹𝑟𝑒𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤. → To determine value, we need to make forecasts, as it depends on what happens in the future.
We will focus on determining the “intrinsic” or “fundamental” value of a company, not its stock price. This is because a
company’s value does not always equal its stock price (which is based on supply and demand)! The intrinsic (or
fundamental) value of a company refers to its true economic worth based on expected future performance. This is
different from the stock price, which reflects market sentiment, supply/demand dynamics, and sometimes speculative
behavior.
FSA and valuation
To create proper forecasts, we first need to understand current performance. Accordingly, FSA consists of the following
steps:
1. Understanding the business environment and accounting information (modules 1-2) [business or strategy
analysis]
a. Q: what are the company’s primary business, key profit drivers, and risk areas?
2. Adjusting and assessing financial information using ratio and cash flow analysis (modules 1-4)
a. Q: do the financial statements accurately reflect the underlying business? [accounting analysis]
b. Q: what factors drive current performance and how sustainable is this performance? [financial analysis]
3. Forecasting financial information (module 11) [prospective analysis]
a. Q: how will the company’s business and past performance translate into performance in the next years?
4. Using information for valuation (modules 12-15) [prospective analysis]
a. Q: what is the company worth, and should we make an investment?
Page 4 of 70
