Financial

 analysis  
 What  is  this?  
•  Goal  of  this  lecture:  learn  how  to  make  a  financial  
analysis  
–  Focus  on  corporate  accounts…  
–  …To  obtain  a  photograph  of  the  firms’  economics  
–  Not  real  valuaAon,  but  good  first  pass  
•  sources:  
–  Financial  statements  
–  Market  info  
(-­‐    Info  on  comparable  companies  
–  Market  studies,  analyst  research  
–  Direct  contact  with  the  company)  
 Outline  

1  Financial  statements:  the  economic  view  

2  The  4  step  method  

3  ExtracAng  info  from  the  stockmarket  

 Textbook  references  
•  Economic  view  of  financial  statements  
–  Vernimmen:  chapters  2-­‐10    
•  4  steps  method  
–  Vernimmen:  chapters  11-­‐16  

•  Financial  analysis  is  NOT  accounAng  

–  I  am  no  accountant  !  
–  AccounAng  from  a  finance  perspecAve  
•  I  don’t  want  to  be  as  precise  and  exhausAve  as  an  accountant  
•  Want  to  focus  on  big  items  that  are  economically  meaningful  
 Financial  statements:    
a  refresher  
•  Three  main  statements  
–  Income  statement  
•  «  meaningful  »  cash  movements  
–  Cash  flow  statement  
•  True  cash  movements  
–  Balance  sheet  
•  Cumulated  investments  and  their  financing  (through  
retained  earnings  or  security  issues)    
 Income  Statement,  «  by  Nature  »  
 +      Net  Sales  
 +      change  in  inventories  of  finished  goods  
 =      Produc=on  
   -­‐        purchase  of  raw  materials  
 +      change  in  inventories  of  raw  materials    
   -­‐        personnal  expenses    
   -­‐        taxes  other  than  corporate  income  tax  
   -­‐        write  downs  /  offs  of  trade  assets  &  inventories  
 =      EBITDA  
   -­‐        amorAzaAon,  depreciaAon  of  fixed  assets    
 =      EBIT  
   -­‐        Financial  expenses  
 +        Financial  income  
 =      Profit  before  tax  and  non  recurrent  items   ~  τ  x  (profit  before  tax)  
 +/-­‐    Non  recurring  items   à   deprecia=on  is  tax  free    
   -­‐        Corporate  Income  Tax  (  T  )   à   interest  is  tax  free  
 =      Net  income  (  r  E  .E  )  
   -­‐        Dividends  
 =      Retained  earnings  (   ΔRE    )  
 «  theore=cal  »  cash  flow  statement  
 +      operaAng  receipts  
   -­‐      operaAng  expenses  
 =      Opera=ng  Cash  flows  
   -­‐      capital  expenditure  
 +      fixed  assets  disposals  
 =      Free  cash  flow  before  tax  
   -­‐        Financial  expenses  
 +        Financial  income  
   -­‐      Dividends  
 +    proceeds  from  share  issues  
   -­‐        Share  Buybacks  
   -­‐        Corporate  Income  Tax  
 =      net  decrease  in  debt  /  net  incr.  in  cash  

…  but  in  prac=ce  different  presenta=on  à  

 PresentaAon  #1  
From  EBITDA  to  operaAng  cash  flows  
•  OCF  =  EBITDA  -­‐  ΔWC  

•  OperaAng  receipts  =  Net  sales  –  change  in  trade  receivables  

•  OperaAng  expenses  =  operaAng  costs  (excl.  DepreciaAon)  –  
change  in  trade  payables  +  change  in  inventories  (material)  
 
è    OCF  =  operaAng  receipts  –  operaAng  expenses  
             =    net  sales  –  operaAng  costs    
     +  ΔTrade  Pay.  -­‐  ΔTrade  rec.  -­‐  ΔInv(mat.)  
               =    EBITDA  –  ΔInv(finished  Goods)    
     +  ΔTrade  Pay.  –  ΔTrade  rec.  -­‐  ΔInv(mat.)  
             =  EBITDA  -­‐    (-­‐ΔTrade  pay.  +  ΔTrade  rec.  +  ΔInv)  

Δ Working Capital
cash  flow  statement  
presenta=on  #1:  «  star=ng  »  from  EBITDA  
 EBITDA  
   -­‐      ΔWC  
 =      Opera=ng  Cash  flows  
   -­‐      capital  expenditure  
 +      fixed  assets  disposals  
 =      Free  cash  flow  before  tax  
   -­‐        Financial  expenses  
 +        Financial  income  
   -­‐      Dividends  
 +    proceeds  from  share  issues  
   -­‐        Share  Buybacks  
   -­‐        Corporate  Income  Tax  
 =      Net  decrease  in  debt  
 PresentaAon  #2  
From  Net  Inc  to  CF  from  op.  
 someAmes:  we  use  Net  Inc.  to  compute  cash  
flows,  &  use  a  different  CF  concept  
   
 CF  from  op.  =  operaAng  receipts  –  operaAng  
expenses  –  interest  expenses  
                     =    EBITDA  -­‐  ΔWC  –  interest  expenses  
             =    Net  Inc  +  D&A  -­‐  cap.  gains  -­‐  ΔWC  
cash  flow  statement  
presenta=on  #2:  «  star=ng  »  from  Net  inc.  
           Net  income  
 +      Amor=za=on  and  Provision  
   -­‐      ΔWC  
 =      Cash  flows  from  opera=ons  
   -­‐      capital  expenditure  
 +      fixed  assets  disposals  
 =      Free  cash  flow  before  tax  
   -­‐        Financial  expenses  
 +        Financial  income  
   -­‐      Dividends  
 +    proceeds  from  share  issues  
   -­‐        Share  Buybacks  
   -­‐        Corporate  Income  Tax  
 =      Net  decrease  in  debt  
 Examples  
 
•  on  the  web  
–  Look  at  Starbuck’s  or  General  motors  
 
•  Gremlin  case  
Balance  sheet:  details  

-­‐   trade  receivables   -­‐ Prepaid  products  

-­‐   inventories  of:   -­‐ Trade  payables  
-­‐ Finished  product   -­‐ Tax  liabiliAes  
-­‐ Semi  finished  
-­‐ Materials   -­‐ Commercial  paper  
-­‐ short  term  bank  debt  

  -­‐ Long  term  bank  debt  

-­‐ Intangible  fixed  assets   -­‐ Bonds  
-­‐ Patents   -­‐ ConverAble  bonds  
-­‐ Brands  
-­‐ Preferred  stock  
-­‐ Tangible  fixed  assets   -­‐ Common  stock  
-­‐ Land&buildings   -­‐ Retained  earnings  
-­‐ Machines   -­‐ Net  Income    
 The  “economic”  balance  sheet  
•  Assets  are  a  bad  indicator  of  “employed  
capital”  
–  assets  increase  when  suppliers  are  paid  later,  and  
the  firm  stores  addi4onal  inputs  
–  assets  increase  when  the  firm  retains  earnings  to  
hold  more  cash  
 è  to  remove  these  OPTICAL  ILLUSIONS  
       remove  cash  on  both  sides  
       remove  trade  payables  on  both  sides  
 è  idea:  focus  on  “financial  investors”  
 Removing  ficiAous  assets&liabiliAes  
Assets Liabilities Operating capital Capital invested

Fixed Assets:
(machines, land, Equity
Fixed Assets Equity
patents)

Convertible
inventories debt Working Capital NET
Bank debt DEBT
Cash&equivalents

Trade recevables Trade payables,

prepaids

WC = Inventories + trade receivables - trade payables - prepaids

NET DEBT = DEBT – cash – cash equivalents
 examples  
•  Deutsche  telekom  

•  Microsok  

•  Walmart  
 Pilalls  of  simplificaAon  
•  aggregaAng  balance  sheet  items  requires  
assumpAons  
–  compuAng  equity  is  harder  than  you  think  
–  CompuAng  debt  is  harder  than  you  think  
–  CompuAng  assets  is  harder  than  you  think  
 
è  let’s  discuss  some  of  these  assumpAons  
 It’s  hard  to  compute  equity  
•  From  a  financial  viewpoint  
–  converAble  bonds  are  partly  equity  
–  preferred  stock  is  equity  

•  Only  do  the  adjustment  when  this  is  worth  it  

–  When  this  is  BIG  
 It’s  hard  to  compute  debt  
•  Some  liabiliAes  are  off  balance  sheet  
–  Info  in  the  footnotes  of  the  financial  statements  
•  Examples  
–  Leased  assets:  commitment  to  rent  an  asset  
•  is  big:  16%  of  assets  (~  long  term  debt)  
•  if  operaAng  lease:  off  balance  sheet  
•  If  capital  lease:  on  balance  sheet  but  creditors  cannot  seize  it  
–  Defined  benefit  pension  obligaAons    
•  Pension  funds  =  30%  of  large  firms’  financial  debt  
•  Backed  by  assets,  but  firm  has  to  inject  capital  if  underfunded  
è  =  added  leverage  
example    
10K  filing,  footnote  18  
 It’s  hard  to  compute  fixed  assets:  
goodwill  
Acquiror   Buys  at  price  200  
Target  

Fixed  assets     Equity  =  100  

=  120   Fixed  assets    
Equity  =  80  
=  80  

W.cap.  =  30   Debt  =  50  

Merged  en=ty  

Fixed  assets     Equity  =  ???  

=  ??  

W.cap.  =  ??   Debt  =  ???  

Assume acquiror issues 200 of new stock, or 200 of new debt

what is the important convention??? How does it affect measured leverage?
 The  4  step  method  
1.  Value  crea=on:    
 à  trends  in  sales&margins  
2.  Investment  Analysis:    
 à  trends  in  CAPX&  working  capital  
3.  Financing  Analysis:  
 à  trends  in  cash  flows&balance  sheet  fragility  
4.  Profitability  Analysis:  
 à  compute  profitability  raAos:  ROE,  ROCE  
 
…  while  we  walk  through  the  steps:  Gremlin  case    
 Step  #1:  value  creaAon    
•  Goal:  isolate  trends  in  EBITDA  

•  Start  with  some  broad  economic  analysis  

–  On  the  environment:  
•  Is  it  a  mature  or  growing  industry?  
•  Is  it  a  cyclical  or  stable  industry?  
•  Any  pressure  to  consolidate?  
•  Any  regulatory  risk?  
–  On  the  firm  
•  How  does  it  deal  with  compeAAon?  
•  Who  owns  the  firm?  A  family,  the  public,  a  fund?  
 Value  creaAon:    
 the  scissors  effect  
•  Insight:  look  at  the  trends  in  sales  &  costs  
separately  

•  Nega=ve  cissors  effect  

–  When  costs  grow  faster  than  sales  
–  EBITDA  decreases  
–  EBITDA/sales  («  EBITDA  margin  »)  decreases  

•  Posi=ve  cissors  effect  

–  The  opposite  
 Value  creaAon:    
breakeven  point  
•  Insight:    
–  find  the  level  of  sales  required  to  make  profit  =  0  
–  &  see  how  far  the  firm  is  from  that  level  

•  To  do  this,  need  a  model  of  how  costs  depend  

on  sales:  
     Costs  =  Fixed  +  c.Sales  
 Value  creaAon:    
breakeven  point  
•  breakeven  point:  Sales  that  lead  to  profit  =  0  
   
 0  =  SalesBE  –  Fixed  Cost  –  c  x  SalesBE    
           
     è    SalesBE  =  Fixed  cost  /  (1-­‐c)  
 
•  Higher  if  Fixed  cost  is  big,  or  if  c  is  big  
 Value  creaAon  
breakeven  point    
•  In  pracAce,  how  do  I  compute  the  cost  
funcAon?  
•  Use  the  income  statement  by  funcAon  
–  Cost  of  goods  sold  :  mostly  variable  
–  R&D,  SG&A:  mostly  fixed  
–  MartkeAng&sales  :  both  
•  The  horizon  maters  
–  In  the  long  run,  more  costs  are  variable  
 Value  creaAon:  
operaAng  leverage  
•  Impact  of  a  1%  change  in  sales  on  profits    
–  If  sales  are  close  to  BE  point?  

–  If  sales  >>  BE  point?    

 Value  creaAon:    
operaAng  leverage  
•  If  firm  close  to  BE  point,  profits  are  volaAle  
–  Conversely:  volaAle  profits  è  close  to  BE  
•  MathemaAcally:  
EBITDA = Sales − c × Sales − Fixed cost
= (1 − c) × sales − (1 − c )salesBE
ΔEBITDA ΔSales & Sales )
⇒ = ×( BE +
EBITDA Sales ' Sales − Sales *

Big if sales ~ salesBE

€
 Value  creaAon:  
operaAng  leverage  
•  Explain:  
Company in 2003 Sales Net income
growth growth
Tesco + 18 % + 22 %

Roche + 11 % + 24 %

Heidelberg Cement +9% + 215 %

 Value  creaAon:  
operaAng  leverage  
•  Which  company  has  the  biggest  fixed  costs?  

Company in 2003 Sales Net income

growth growth
Volkswagen -2% -4%

BMW -2% - 48 %
 Step  #2:  
investment  analysis  
•  Discusses  trends  in  overall  assets  

•  First,  look  at  bumps  and  trends  in  fixed  assets  

•  cash  flows  from  investment    
•  CAPEX  –  depreciaAon  
•  goodwill  

•  Second,  look  at  working  capital:    

   WC  =  Inventories  +  Receivables  –  Payables  -­‐  
prepaid  
 Fixed  assets:  an  example  

Explain what is happening to Danone

 Working  capital  

•    Working  capital  pros  and  cons:  

 Cons  
–  Needs  to  be  financed  with  costly  debt  or  equity  
 Pros  
–  avoids  botlenecks  in  producAon  
–  trade  credit  more  expensive  than  bank  debt  
•  Classical  arrangement  in  US  manufacturing:  “2/10  net  30”  
•  2%  discount  if  paid  <  10  days,  else  full  price  paid  in  30  days  
•  Equivalent  interest  rate  of  the  loan  …  70%  annual  !!!  why?  
•  This  cost  is  oken  implicitly  omited  in  WC  analysis  
 working  capital  
•  In  general:  low  WC  is  considered  as  good  
–  WC  analysis  classic  tool  to  detect  anomalies  &  
management  quality  

•  But  keep  in  mind  that:  

–  WC  depends  on  the  industry  
–  WC  depends  on  the  business  cycle  
–  WC  may  have  strong  seasonal  paterns  
 Investment  analysis:    
working  capital  raAos  
•  Typical  raAos  
WC
WC Turnover = 365 ×
Annual Sales
# Accounts Receivables
%Receivables = 365 × Annual Sales
%
% Accounts Payables
$Payables = 365 ×
% Annual Purchases
% Inventories
%Inventories = 365 ×
& Annual Sales
 Step  #3:  
financing  analysis  
•  Two  quesAons  related  to  firm  survival:  
Are  cash  flows  large  enough  to  pay  interest  on  debt  ?  
Is  there  a  liquidity  risk  ?  
Perspec0ve  of  bondholder,  not  shareholder  
•  Tools:  
–  analysis  of  cash  flow  statement  
à Compare  operaAng  cash  flows  &  financial  expenses  
–  compare  dura4ons  of  assets  and  liabili4es  
à  Compare  WC  &  short  term  debt  net  of  cash    
 Financing  analysis  
the  cash  flow  statement  
•  First,  look  at  all  components  of  “decrease  in  
net  Debt”  and  their  evoluAon:  
 
 Net  Inc.  +  Deprec.  –  ΔWC                    (=CF  from  Op.)  
   -­‐  (CAPEX  –  Asset  sales)                                (=CF  from  inv.)  
   –  dividends  +  proceeds  from  equity  issues
                             (=CF  from  fin.)  
 =  Decrease  in  Net  Debt    
 
 Financing  analysis:  
raAos  
•  Leverage  (not  very  informaAve)  informaAve  

Financial Debt
  Leverage =
Total Assets

•  Credit  analysts  prefer  “cash  flow-­‐based”  measures  

Net Debt
Debt Service Coverage =
EBITDA
EBITDA
Interest Coverage =
Interests
 Why  leverage  ra=o  is  not  so  reliable:    
The  Tale  of  Two  Companies  

Company in 2003 Net Debt / Net Debt /

Assets EBITDA
Unilever 71 % 2.2

Rémy Cointreau < 50 % 3.8 !

Unilever’s operations are so profitable that it can afford

more debt !

è Prefer Net Debt / EBITDA to leverage !!!

 Financing  analysis:  
raAos  
 è  How  much  should  Net  Debt  /  EBITDA  be  worth  ?  

•  Standards:  
 <=  3  years    :  Healthy  situaAon  
 4  years  :  CriAcal  (but  also  LBOs)  
 5,6  years  :  Debt  becomes  «  junk  »,  distress  likely    

•  Beware  !  
 à  stable  industries  may  tolerate  raAos  of  4,5  or  6  
 à  firms  with  «  good  collateral  »  (land)  also  !  
 à  private  equity  typically  takes  6  (more  before  crisis)  
 Financing  analysis:  
balance  sheet  liquidity  
•  Risk  of  liquidity  mismatch  
–  Even  if  PV  of  assets  >  PV  of  liabiliAes    
–  Assets  mature  in  the  long  run  (investment)  
–  LiabiliAes  mature  in  the  short  run  (short  term  debt)  
 (give examples of industries where this is common)  
•  In  theory,  not  a  problem  if  rollover  is  possible  
•  But  in  pracAce:  « Rollover risk »
–  Creditors  have  doubts,  they  want  to  cash  in  &  run  
–  Cheap  short  run  credit  can  dry  up  suddenly  (Crisis)  
Rollover  risk  in  the  banking  system  
 tradiAonal  banking  system  

large  
depositors,  
retail  
investors    

bank   loans
borro
wer  
 US  shadow  banking  system  

money   CP
large   shares ABCP  
market  
depositors,   conduit  
mutual  funds   ABS     loans
retail   vehicle,   origin
investors     CDO fanny   ator  
mae,  
CDO   freddy  
repo

mac  
securiAes  
lenders   borro
wer  
 
hedge  funds  
broker  -­‐   prop  trading  
dealers  
Rollover  risk  in  shadow  banks  
 Financing  analysis:  
raAos  
•  Three  ra4os  to  measure  maturity  mismatch:  
  Current Assets (< 1 year)
Current Ratio =
Current Liabilities (< 1 year)
Current Assets (< 1 year) − Inventories
Quick Ratio =
Current Liabilities (< 1 year)
Cash
Cash Ratio =
Current Liabilities (< 1 year)
 Liquidity  risk  
•  How  to  deal  with  it?  
–  Secure  LT  financing  
–  Backstop  liquidity:  credit  lines  
–  Hold  cash  /  short  term  assets  
Which firms hold more cash ?
 Step  #4:  
profitability  analysis  
•  QuesAon:  is  the  firm  profitable  enough?    
–  Is  EBIT  high  enough?  
–  Is  Net  Income  high  enough?  
 Profitability  analysis:  
ROCE  
•  Is  EBIT  high  enough?  
•  Compute  Return  on  Capital  Employed:  

       ROCE  =  (1-­‐τ)  x  EBIT  /  CE    

 
where  τ  =  corporate  income  tax  rate  
•  Idea:  «  operaAng  return  »  
•  (1-­‐τ)  x  EBIT  =  «  Net  OperaAng  Profit  Aker  Tax  »    
•  ROCE  overesAmates  taxes  
 Profitability  analysis:  
ROE  
•  Is  Net  Income  high  enough?  
•  Compute  Return  on  Equity:  

       ROE  =  Net  Income  /  Equity    

 
•  IntuiAon:  
–  Normalize  Net  Income  by  the  investment  of  those  
who  receive  it  (shareholders  only)  
 Profitability  analysis:  
leverage  effect  
•  SubsAtute  debt  for  equity:  which  effect  on  
ROE  ?  
•  2  opposite  forces  
1.  Reduces  shareholders’  investment  
2.  Reduces  Net  Income  (more  interest)  
•  In  pracAce,  (1.)  dominates  à  ROE  goes  up.  
–  b/c  interest  income  <  ROCE  (see  later)  
–  This  is  the  «  leverage  effect  »  à  
 Profitability  analysis:  
leverage  effect  
A project, of operating return (ROCE) = 10%
costs 100 and pays 110:

100   110  

There is no debt:
ROE =(110 – 100)/100 = 10/100
=10%
 Profitability  analysis:  
leverage  effect  

59  
50  
 
 
 
50  
51  

Entrepreneur borrows 50, with interest rate 2%

ROE =(110 – 50 – 50*(1+0.02))/50 = 9/50
= 18% !!!!
A money machine ?
 Profitability  analysis:  
leverage  effect  
Bad luck: the project is not profitable (ROCE=0%)
costs 100 et generates 100 only :

100   100  

When there is no debt:

ROE =(100 – 100)/100 = 0
=0%
 Profitability  analysis:  
leverage  effect  

50   49  
   
50   51  

Entrepreneur has borrowed 50, with interest rate 2%

ROE =(100 – 50 – 50*(1+0.02))/50 = -1/50
= -2% !!!!

en thou gh pr oj ect is not loss making !!!

Ev
 Profitability  analysis:  
leverage  effect  
Very bad luck: the project only makes ROCE = - 10%
costs 100 et generates 90 only :

100   90  

When there is no debt:

ROE =(90 – 100)/100 = -10/100
=-10%
 Profitability  analysis:  
leverage  effect  

50   39  
   
50   51  

Entrepreneur has borrowed 50, with interest rate 2%

ROE =(90 – 50 – 50*(1+0.02))/50 = -11/50
= -22% !!!!
Leverage = more risk !!!
 Profitability  analysis:  
leverage  effect  
•  Leverage  makes  ROE  much  more  volaAle  
–  Debtholders  are  always  senior  to  shareholders  
–  first  dollars  of  EBIT  are  pledged  to  debtholders  
•  In  exchange  for  their  contribuAon  to  capital  
•  In  exchange  for  low  interest  rate  

•  If  success,  shareholders  get  big  profit  for  small  

investment  
•  If  failure,  shareholders  absorb  all  the  loss  
 Profitability  analysis:  
leverage  effect  
•  Easy  to  show  that:  

     ROE  =  ROCE  +  (NetDebt  /  Equity)  

           x  (  ROCE  –  (1-­‐τ)xinterest  )  

–  Net  Debt  /  Equity  :  «  gearing  raAo  »  

–  ROE  increases  with  gearing  if  interest  is  low  
–  ROE  more  sensiAve  to  ROCE  shocks  if  gearing  is  big  
 raAo  analysis  to  evaluate  solvency  
(back  to  step  #3)  
 
       ROCE    ROE  
Firm  A        7%        20%  
Firm  B          10%        10%  
Firm  C        10%                    6%  
Firm  D        12%            20%  

•  each  of  these  firms  issue  bonds.  which  one  will  

have  the  lowest  spread?    
 Leverage  effect:  A  numerical  example  
•  MegaBank:  
–  Lends  @  4%  to  its  borrowers  
–  Borrows  @  2%  from  money  markets  &  depositors  
–  Has  a  leverage  raAo  of  90%    
–  A  corporate  tax  rate  of  50%  
 
How large is the leverage effect at
MegaBank?
(i.e. what is its contribution to ROE ?)  
 Hidden  vs  Official  Leverage:  
Back  to  shadow  banks  

Sponsoring bank:
guarantees that
ABCP issued by
conduit will pay off
(gets a fee in exchange)
what is the effect sponsoring bank ROE?
Total  ABCP  issuances  
Total  ABCP  issuances  
ABCP investors
exert put option
conduits go back
to balance
sheet

what is the effect on sponsoring bank ROE?

 Using  market  informaAon:  
raAos  
•  Stock  price  =  PV  of  expected  future  dividends  

•  Three  raAos:  
–  PER:  stock  price  scaled  by  earnings    
–  Price  to  Book:  stock  price  scaled  by  book  equity  
–  Dividend  Yield:  dividends  scaled  by  stock  price  

•  All  three  ra4os  serve  to  measure  market  

expecta4ons  of  future  growth  
 Using  market  informaAon:  
PER  
•  Price  Earnings  raAo  (or  «  P/E  raAo  »)  
   PER  =  Stock  Price  /  Expected  earnings  Per  Share  
•  Gordon-­‐Shapiro  formula  
         PER  =  b  /  (re  –  g)  
–  re  =  cost  of  equity    
–  g  =  expected  (constant)  growth  rate  
–  b  =  payout  raAo  =  Dividends  /  Net  Income  
•  High  P/E  means  «low  risk»  or  «high  growth»    
–  In  2003,  Renault  =  7,  Google  =  76  !!!  
•  Is  the  market  forming  good  expectaAons  ?  NO  à  
 average  PER  varies  over  Ame  
(source:  bob  shiller’s  website)  
CAPE Price E10 Ratio
50
2000
45

40 1981

35 1929
30
Price-Earnings Ratio (CAPE)

1901
25 1966
Price-Earnings Ratio 21.45
20

15
1921
10

0
1860 1880 1900 1920 1940 1960 1980 2000 2020

Year
 Cumula=ve  Return  of  P/E  strategy  
Long  low  P/E,  Short  high  P/E  
market  neutral  –  Sharpe  ra4o  =  0.9  
70  

60  

50  

40  

30  

20  

10  

0  
1952  1954  1956  1958  1960  1962  1964  1966  1968  1970  1972  1974  1976  1978  1980  1982  1984  1986  1988  1990  1992  1994  1996  1998  2000  2002  2004  2006  2008  2010  2012  
 Real  estate  market:    
price-­‐to-­‐rent  raAo  in  the  US  
6.50%

6.00%

5.50%

5.00%

4.50%

4.00%

3.50%

3.00%

2.50%

2.00%
1960.1 1966.1 1972.1 1978.1 1984.1 1990.1 1996.1 2002.1 2008.1
•  Price  to  rent  raAo  in  France  
 Using  market  informaAon  
Price  to  Book  
•  Price  to  Book    
       PB  =  Stock  Price  /  Equity  per  share  
•  Price  to  book  is  related  to  PER  
       PB  =  PER  x  ROE  

–  What  firms  typically  have  a  high  PB  ?  

 Using  market  informaAon  
Dividend  Yield  
•  Dividend  Yield    
       DY  =  Dividend  per  Share  /  Stock  Price  

•  Which  firms  typically  have  a  high  DY  ?  

 how  well  have  dividend  paying  stocks  
been  doing  recently?  

•  look  @  a  specialized  mutual  fund,  to  monitor  

performance    
–  Acker:  VHDYX  

•  htp://www.google.com/finance?
q=VHDYX&ei=KlWlUODrJer1wAOlTg  
 
 0.2  
0.4  
0.6  

-­‐0.6  
-­‐0.4  
-­‐0.2  
0  
0.8  
1  
1928  
1930  
1932  
1934  
1936  
1938  
1940  
1942  
1944  
1946  
1948  
1950  
1952  
1954  
1956  
1958  
1960  
1962  
1964  
1966  
1968  
1970  
1972  
1974  
1976  
1978  
1980  
1982  
1984  
1986  
market  neutral  -­‐  sharpe  ra4o  =  0.1  

1988  
1990  
1992  
1994  
Cumula=ve  Return  of  DY  strategy  

1996  
1998  
2000  
2002  
2004  
2006  
2008  
2010  
2012  
 Using  market  informaAon:  
example  
 

Compute PER, DY, PB, ROE for both corporations

Comment on the differences…
which stock
is this?
 Financial  analysis:    
wrapping  up  
•  Use  financial  statements  to  understand  the  
dynamics  of:  
–  value  creaAon  
–  assets  (in  parAcular  WC)    
–  Net  cash  holdings  
–  Profits  
•  Use  market  prices  to  understand  market  
expectaAon  of  future  profits