basics of financial statements alexander motola, cfa alexander motola, 20131
TRANSCRIPT
Alexander Motola, 2013 1
Basics of Financial StatementsAlexander Motola, CFA
Alexander Motola, 2013 2
Quality of Earnings, IntroPeople who learn more can beat
people who don’tAll earnings are not equal, hence
“Quality of Earnings”There is an extreme bias against
sell recommendations, which doesn’t make sense b/c clearly some stocks go down a lot
Alexander Motola, 2013 3
Quality of Earnings, Ch. 1 “Don’t Trust Your Analyst” The people that write brokerage reports
ultimately get paid via transactions; the chance you own a given stock (and they convince you to sell) is small, but there is much greater chance they can get you to buy a stock you don’t already own◦ Investment Banking fees are also a
consideration Jim Chanos (mentioned during the
chapter) subsequently became one the great investors of our time, mainly via skepticism
“Caveat Emptor” Who can you trust? Yourself…
Alexander Motola, 2013 4
Quality of Earnings, Ch. 1Bill Sharpe: “Without short
selling, market prices will be above consensus prices.” (pg. 4)
Sell side and buy side professional can be extremely well compensated◦Often financial careers start after
getting an MBA, where the analyst covers the industry they worked for prior to getting their degree
“Neutral” means sell, or avoid (pg. 7)
Alexander Motola, 2013 5
Quality of Earnings, Ch. 1“most analysts depend upon the
company as their prime source of information. Often they reheat the data and pass it on as original thinking”◦ This is mostly from earnings calls and
interviews◦ The IAC particularly would like student
analysts to think about the value and veracity of their sources
“Everybody talks to the same investor relations guy, who feeds them the same numbers.” How do you win this way?
Alexander Motola, 2013 6
Quality of Earnings, Ch. 1Really good (investment) ideas
are extremely hard to find◦No one gets more tips than Buffet◦He claims he’s lucky to get 1 or 2
good ideas per year◦He’s looking for new ideas constantly
Alexander Motola, 2013 7
Basics of the Basics“Financial Statements” generally
refers to the combination of the 3 most common statements – Balance Sheet, Income Statement, and the Statement of Cash Flows
Balance Sheet measures net worth, assets, and obligations at a single fixed point in time
Income Statement measures (effectively) your change in net worth over a period of time
SCF measures real time cash payments (like your checkbook) over a defined period of time
Alexander Motola, 2013 8
A Few ThoughtsWhy are you reading financial
statements?The “Author” has a vested
interestFinancial Statements are inter-
related and can provide a “checks and balances” approach
Absolute Numbers (USD $) are meaningless
Numbers can lie or mislead, just as words do
Alexander Motola, 2013 9
What does a Balance Sheet Look Like?(44, F&A) – “What you have”
◦Assets listed first (on the right, or top)
◦Most liquid assets first, divided in Current Assets and Long Term Assets
◦How valuable are A/R? Inventories?◦PP&E – how accurate is this? (MCD,
and future land example)◦Intangible Assets and Goodwill
Alexander Motola, 2013 10
What does a Balance Sheet Look Like? (44, F&A) – “What
you owe”◦ Liabilities (“the
right side”)◦ Also listed in order
of liquidity◦ What is Deferred
Revenue?◦ Debts (some are
OBS) “What’s Left”
◦ Shareholder’s Equity = Net Worth
◦ What’s Left is your Net Worth
Think of your own “Net Worth”◦ Everything you
OWN is an asset (including money owed to you, or things financed)
◦ Everything you OWE is a liability (debts, mostly; future expenses DON’T count)
◦ What’s Left is your Net Worth
Alexander Motola, 2013 11
Fridson & Alvarez, Ch. 2Book Value = Net Worth (A-L)Market Cap(italization) = what
the market values the entire equity of a company at (SO * MP)
Balance Sheet valuations are carried at values generated from a transaction. Does this make sense?
When those values (assets and liabilities, but mostly assets) are tested and fail, huge write downs occur. What is a “write down”?
Alexander Motola, 2013 12
F&A #2, Continued “Balance Sheet valuations are carried at
values generated from a transaction. Does this make sense?”
Twenty years ago, a company buys $1mm worth of land in Fukushima (Japan) and $1mm in downtown San Francisco. If they are depreciated over 20 years, they were both worth $1mm at the time they were bought (according to the books) and are now both worth $0. One of these numbers might be correct?
In this case, there would have been a small write down of the Japanese real estate (small because there wasn’t much value on the balance sheet left).
Alexander Motola, 2013 13
Fridson & Alvarez, Ch. 3(47) “The goal of analyzing an
income statement is essentially to determine whether the story it tells is good, bad, or indifferent”
Turn to page #48 (Exhibit 3.1)◦Is Peet’s profitable? (Did they make
money in FY09?) How do you know?Do absolute numbers matter
(USD $)?Turn to page #50-51
Alexander Motola, 2013 14
F&A #3, ContinuedCommon Sized Income
Statements calculate everything base on sales (revenues)
2 Most common margins used by analysts◦Gross (Profit) Margin◦Operating Margin◦Next month we will drill down on
analyzing these
Alexander Motola, 2013 15
F&A #3, ContinuedGross Margin
◦Costs associated with creating/providing goods and/or services
◦Marketing not usually included (except rebates)
◦Warehousing, labor for production, D, inputs, energy cost, returns, etc.
Why does SBUX have a better GM% than PEET? (see page 49)◦Do different customers pay different
prices? And have different costs to service?
Alexander Motola, 2013 16
F&A #3, ContinuedOperating Margin “Above the Line”
◦Operating costs include corporate overhead, R&D, SG&A, and other expenses NOT related to: production, taxes, capital structure (mostly)
◦SBUX has a way better GM, but a barely better OM than PEET – why?
◦Significant latitude in categorizing expenses, checked by auditor, and informally regulated by industry norms
Students provide expense examples
Alexander Motola, 2013 17
F&A, multi-statement analysis
RoE ties income statement and balance sheet together◦“Return” = net income (I/S), Equity
= Shareholder’s Equity (B/S); equity represents “paid in capital” + “retained earnings” – dividends (mostly)
◦What do you want to make on your investment?
Alexander Motola, 2013 18
F&A, multi-statement analysisTaxes
◦ Statutory Corporate rate is 39%◦ Median Effective Tax Rate for S&P 500
companies is 30%Tax Rate appears on Income
Statement◦ Differences between cash and accrual
(and other adjustments) appear on Balance Sheet as Assets and/or Liabilities
◦ Cash Flow Statement errata shows actual cash taxes paid (10-K only, optional otherwise)
Alexander Motola, 2013 19
Other Stuff from Ch#3
Economies◦Scope (pg. 63), breadth of offering
I couldn’t agree more with the comment “Analysts should be forewarned that claims of potential economies of scope often prove, in retrospect, to be exaggerated.” Does it make sense?
◦Scale (pg. 49) – “size matters” ??? Purchasing economies, advertising
leverage, R&D leverage, distribution advantages
Alexander Motola, 2013 20
Other Stuff from Ch#3Revenue
◦ Linearity – the shape of revenues over a quarter (how “back-end loaded” is the business model). Why does this matter?
◦ Earnings Quality (how real and sustainable are the earnings – this is a key focal point of an analyst’s job) (pg. 54) – “Often, a company’s earnings and cash flow diverge to an extent that becomes unsustainable” – what does this mean?
◦ How can a company manipulate revenue? (pgs. 54-55)
Alexander Motola, 2013 21
Other Stuff from Ch#3
Revenue (growth)◦This year revenue/Last year revenue
– 1◦F&A, pgs. 59-63; the chances are
very strong that your company has made or has announced a pending acquisition recently, understanding what this means is extremely relevant to your IAC presentation, understand these pages and bring questions to future sessions if something is not clear
Alexander Motola, 2013 22
Other Stuff from Ch#3 Revenue
◦ “Earnings drive stock prices”, how much your company grows has a lot to do with how valuable (multiple) it is/will be
◦ The amount a company exceeds or misses expectations will directly and dramatically effect stock prices
◦ Investors pay a lot for “Internal Growth” (high multiple) but very little for “External Growth” or “Manufactured Earnings” (low multiple
◦ Huge incentive for MGMT to mislead or blur the line about what’s internal and what’s external; in a few cases, it’s an impossible mystery, but many times a good analyst can determine the truth
Alexander Motola, 2013 23
In the MarketPandora earnings forecast disappoints, shares drop
Thu, Aug 22 2013
SAN FRANCISCO (Reuters) - Internet radio service Pandora Media Inc (P) said on Thursday that rising expenditures to acquire music and compete with rivals would push fiscal 2014 earnings below analyst expectations, and its shares slumped 5 percent.
Excluding certain items, Pandora said it expected to earn between 0 and 5 cents per share for the year. That was below the 5-cent profit expected by analysts polled by Thomson Reuters I/B/E/S.
Its shares fell 5 percent to $20.50 in extended trade.
For the second quarter ending in June, Pandora exceeded expectations, posting revenue of $162 million, a 58 percent rise, as it continued to pick up listeners. Its earnings of 4 cents also topped Wall Street expectations of 2 cents.
In an interview, Chief Executive Joe Kennedy said he felt confident the company has proven its mobile monetization strategy. But he signaled that earnings would be depressed in the near future as he pursued an aggressive investment strategy. In the past year, for instance, the company has increased its sales force by three-quarters, he said.
"We're taking the increased margin that we're getting and reallocating to invest in future growth," Kennedy said Thursday. "But everything says we're firing on all cylinders. We're still in the earliest days. We have to invest to make the most of a huge opportunity."
Pandora's shares, which fluctuated wildly for the first year after its June 2011 initial public offering, had surged to new highs in 2013. It closed on Thursday at $21.71.
(Reporting by Gerry Shih; Editing by Andre Grenon and Phil Berlowitz)
Alexander Motola, 2013 24
Questions?
Alexander Motola, 2013 25
A Day in the Life 5:00 AM – Alarm clock goes off (Mtn Time), in the car by
5:45 6:00 – at my desk, quick look at email, esp. from traders
and other internal people, parse voicemail 6:15 – on the trade desk with my team, reading market,
world, business, industry, and political news; all Street research on 80 or so companies
7:30 US Market starts trading 8:30 – start calling companies, modeling, reading
financials & transcripts 11:15 – Lunch 12:00 – more modeling, talking to the team,
management stuff 1:00 – investment presentation – 2 hours, 30 minutes
presentation followed by long and intensive Q&A session 3:00 – existing coverage, modeling, financials,
conference calls 5:30 – leave, and do it again tomorrow OTHER STUFF: internal firm mgmt. stuff, marketing,
client meetings, travel arrangement/planning, earnings calls, personnel matters (reviews), mentoring