steps how to analyze a company 1227386736224244 9

7/31/2019 Steps How to Analyze a Company 1227386736224244 9

1/18

Stockmarket.Valuation andAnalysis

Alexander Gilles, CFA


2/18

Part 1

Valuation and Discount Factors


3/18

Concerned about valuation

Board

Management

Marketing Production

OperationsBuyers Suppliers

Finance

Equity Analyst Credit analyst

Strategist Rating agency

Stockholders Lenders

Equity funds, VCfunds, raiders

Potential

stockholders

Potential

lenders

Bond funds, high-yield (junk) bonds

Financialstatements

Investment bankers


4/18

4

Value of a building

Dividends on a building = rent payments

ex. IF Rent: 2million, and required returnis 25%, then 2 million / .25 =

If required return is 0.15: 2 / 0.15 = ..If required return is 0.08: 2 / 0.15 = ..

Observation:

ex. Rent of 1 bn, required 12%, value ofthe building is:


5/18

5

Value of a business

w Stable business, generates P20m a year

w Earnings / r = Value. PER

w 20 / .15 = 133m 1/.15 = 6.6x

w 20 / .20 = 100m 1/.20 = 5.0xw 20 / .30 = 66m 1/.30 = 3.3x

PER multiple = 1/ required return

w

Value of 133/earnings of 20 = 6.6xw Earnings of 20/Value of 133 = 15%


6/18

6

Value of a business

wStock PeR multiple= Price / EarningswEarnings x multiple = value.

Definitions:

Net income x multiple = value

Sales x multiple = value Cash flow x multiple = value

w This business earns 30,000 a year. Other businesses ofthis same type are valued at a multiple of 15x. This

business must be worth Pw This business earns 4 million a year. Other businesses

of this same type are valued at a multiple of 12x. Thisbusiness must be worth P


7/187

Value of a businessEarnings

300,000 a year Take the same earnings of 300,000

at 15x = 4.5m discounted using 0.066667 =.




8/18

Part 2

Company analysis


9/18

How elastic is the demand for the companys products/services? Is the demand seasonal? What is the raw material situation?

What are the key products for the company and what is their contribution? How is the company competitively placed in that product segment?

Which geographies are key revenue contributors to the company revenues? How competitively poised is the company in that geography? How risk free is the geography?

Which product contributes maximum to the companys profits Which geographies contribute the maximum to the companys profits

Does the company have a unique selling proposition (USP)? How strong/sustainable is the companys USP? Does the company enjoy an important position in the market (like largest player etc)?

Business

Product

Segments

Geographic

Segment

Key Profit

Contributors

USP


10/18

Raw Material 1

Raw Material 2

Raw Material 3

Manufacturer

(Production Processes)

Distributor/Wholesaler

Retailer

Allied Components

Allied Services like

Transportation;

security etc

Exclusive Showrooms

Intermediaries in Raw

Material Procurement

Value Chain Analysis Quality of Components Cost of components Speed of Delivery Time for scaling up

Factory location (near RM or

customer) Production time/rate Error Rate/Quality

Ability to scale up Wastages

Transportation Time Efficiency of routing and

scheduling

Cost-Benefit of having

exclusive show rooms Benefit of additional visibility

through showrooms

Margins/incentives to dealers Timely distribution (wh salers) Competition from local products Retail level promotions

Cost of Raw Mat Procurement time Adequacy of supply Long term supply

contracts Cost of Transport


11/1811

Value chainsimpact

Cost of Rawmaterials

Warehousing

Trucking

Cost ofGoods

Sales Otherincome

Workers

salaries

Selling Gen

Admin

expenses

Tax savings

Lower

Interest

expenses

Making money or saving money, from manufacturing process or

from any other process.

Value


12/1812

What will be the impact of the news/development on the companys business?

Is the news/development a positive or a negative aspect about the company?

Why will a particular development/news affect the business of the company?

In case of a threat, can the company escape it?

How profound will be the impact of a news/development on the companys

business

What?

Why?

How Much?


13/18

Part 3

Financial statement analysis


14/18

Growth in Prices

Growth in Volumes

REVENUEGROW

TH

Volume Growth Because of: Better marketing/brand promotion by the company Improved/enhanced distribution by the co. Expansion into new region/product/variant Take over of a competitor Industry wide demand increase One time increase because of a special order

Is the Price Growth Sustainable Price increase is industry wide/individual initiative? How elastic is the demand for the product? What is the competition scenario (fragmented?)

Does the industry operate on a premium concept? Is there scope for another price increase?

Decline in Prices

Decline in Volumes

REVENUEDECLINE

Volume Decline Because of: Better brand promotion by competitors Obsolete/outdated technology; quality issues Problems in supply chain management

Failing relationships with workers/distributors

Reasons for Price Decline: Competition induced price decline. not always sustainable) Product un-sellable (forced to reduce price) Regulatory price fixing (my force out small players) More efficient production (should reflect positively in volumes)

Favorable tax policy (should reflect positively in volumes)

Analysing Revenue Changes: Growth/Decline in Revenues


15/18

Cost of Goods Sold

(COGS)

Selling, General & Admin

Expenses(Includes MarketingExpenses)

Salaries & Wages

Interest

Income/Expenses

COGS Increase : Increase in RM prices (is this rise more than revenue increase?) Increase in production/take over of new company (should reflect positively in revenues)

COGS Decline:

COGS decline More efficient raw material procurement/ use of alternative RM COGS decline More cost efficient production process

SG&A Increase: Intensive Marketing and Promotion Campaign (should reflect in revenues) Acquisition/expansion activity going on (check whether earlier acquisitions were compatible) Company caught in litigations/legal activity (this cost is also categorized as Professional Exp)

Increase in Salaries and Wages: Increase in average wage rate (check whether this is a because company is doing good?) Additional hiring in marketing/production/legal departments (does it reflect in co performance) Payment of performance oriented bonus/ bonus for employee retention (is labor mkt stressed)

Interest Expense Increase: Additional debt taken by the company (check how company expects to use this debt) Earlier default by company, new interest is penal interest New liabilities taken over due to new acquisitions (check whether acquisition was profitable, i.e

assets greater than liabilities) If new acquisition not profitable, did company get a government aid for acquisition

Analysing Cost Changes

Note: Also check reasons for increase in depreciation & amortisation; unusual expenses and use of deferred tax asset/liability


16/1816

w A balance sheet indicates all sources of funds for a company and where it

applies those funds

w Liabilities reflect the various ways in which a company has raised short term

and long term funds

w Assets are where such funds are utilised

w All sources of funds come at a cost.

w All application of funds should come at a profit

w A balance sheet analysis involves analysing efficiency of use of funds,

measuring solvency (asset-liability matching) and operational efficiency


17/18

17

w

Current Ratio Quick Ratio

Gearing Ratio (Long term Liabilities/Net Worth)

Working Capital should be positive (current assets - current liabilities)

Long term assets should be backed by long term liabilities only

Inventory Days of Handling

A/c Receivables Days of Handling

A/c Payables Days of Handling

Working Capital Turnover (Sales/Working capital *100)

w

Return on Equity Return on Capital Employed

Return on Assets

Compare Ratios

with Peers to get

Industry view


18/18

18

Ratios: what they mean for business

Solvency Ratios

Ratio for measuring

operational efficiency

Ratios for measuring

efficient use of capital/assets

An adverse short term solvency ratio (current ratio/quick ratio) indicates a short term liquidity

crunch A high gearing ratio means that much more interest expenses

A high gearing ratio may also make it difficult for the company to raise new debt Long term assets backed by short term liabilities (current liabilities) is a potential liquidity

problem

High inventory days of handling (especially as compared to peers) may indicate problems with

inventory management. This ratio say that either demand is low for products or company is producing more than

needed. Both will affect profits

High A/c receivables days of handling means receivables are not quickly converted to cash.Hence operating cash flow will not grow in sync with profits

Low a/c payable days of handling means credit period from suppliers is very low. This will

reflect into greater requirement of working capital, hence more short term loans

Adverse ratio (in comparison to competitors) means company is not utilizing its capital/assets

as well as its competitors Adverse ratio could reflect problems with low revenues or high costs. High costs may also

reflect in to problems with pricing of products

Also Check:

Maintenance CAPEX: Is maintenance CAPEX as a percentage of revenues going up. Check why and is that rational

Expansion CAPEX: Expansion capex drains out cash reserves. Check whether expenditure will help company

Additional Debt: Additional Debt means more interest costs. Check how company expects to use new debt.

Debt substitution: debt substitution means taking low cost debt to pay off high cost debt. This is a positive sign

steps how to analyze a company 1227386736224244 9

Documents