Equity analysis and credit analysis

Financial Analysis 0

Valuation ratios (5) 

  • Price to earning 
  • Most widely used valuation ratio
  • Ratios of 
    • Current market price of a share of stock
    • Company’s earnings per share
  • Price to cash flow 
  • Price to sales 
  • Price to book value 

Per-share valuation (6)

  • Earnings per share 
  • Basic EPS: ratios of
    • Net income available to common 
    • And weighted average number of common shares outstanding
  • Diluted EPS 
  • A what-if value
  • The lowest possible EPS that could have been reported if 
    • all firm securities can be converted into common stock
    • That decrease basic EPS
  • Dilutive securities 
    • Convertible debt
    • Convertible preferred stock
    • Option
    • Warrants 
  • Numerator of diluted EPS increased by:
    • After-tax interest savings on dilutive debt securities
    • Dividends on any dilutive convertible preferred stock
  • Denominator of diluted EPS increased by:
    • Common share that result from conversion of exchange of dilutive securities 
  • Other per-share measures 
    • Cash flow per share 
    • EBIT per share
    • EBITDA per share 
  • Per share measures are not comparable due to difference in outstanding shares

Dividends (7)

  • Declared on per-common-share basis
  • Dividends declared (8)
    • Total dividends on a firm-wide basis
    • Net income – dividends declared = retained earnings
      • Used to grow the corporation
      • Being distributed to equity holders
    • Sustainable growth rate (9)
      • Proportion of a firm’s net income that is retained to fund growth 
      • Retention rate (RR) (10)
        • Proportion of earnings reinvested

Some other ratios 

  • Net income per employee and sales per employee
    • Used in service and consulting companies 
  • Growth in same-store sales
    • Used in restaurant and retail industries
  • Sales per square foot
    • Metric commonly used in the retail industry

Business risk 

  • Uncertainty about a firm’s performance: 
    •  Standard deviation of 
      • Revenue 
      • Net income
      • Operating income
  • Coefficient of variation (CV) (11)
    • Standard deviation/expected value
  • Capital adequacy (12) 
    • Dollar measure of risk of the firm to equity capital
    • Value-at-risk (13)
      • Measure of capital risk
      • Dollar size of the loss that a firm will exceed only some specific percent of the time over a specific period of time
    • Reserve requirements
      • Ratios of various liabilities to central bank must be the minimums
    • Liquid asset requirement
      • Bank’s liquid assets to certain liability
  • Net interest margin (14)
    • Performance of financial companies that lend funds

Credit Analysis

  • To assess company’s ability to service and repay its debt
  • Use following indexes:
    • Interest coverage ratios 
    • Return on capital 
    • Debt -to-asset ratios
  • Use to analyze and predict bankruptcies
  • Z-score: useful in predicting firm bankruptcies based on:
    • Working capital to assets, 
    • Retained earnings to assets, 
    • EBIT to asset, 
    • Market to book value