 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin  Financial Statement Analysis 1  19-2 • Financial statement analysis can be used to discover mispriced securities. • Financial accounting data are widely available, but – Accounting earnings and economic earnings are not always the same thing!  !! 2  19-3 • Income Statement: – Profitability over time • Balance Sheet: – Financial condition at a point in time • Statement of Cash Flows: – Tracks the cash implications of transactions. ! 3  19-4 "#$!$%%$& $&$'()*'%+,, 4  19-5 "#+$!$%%-&$' ()*'%+,, 5  19-6 "#.$&!-$(!&$' ()*'%+,, 6  19-7 $/0'!/!$$'0! • Economic earnings – Sustainable cash flow that can be paid to stockholders without impairing productive capacity of the firm • Accounting earnings – Affected by conventions regarding the valuation of assets 7  19-8 '$1" !/'! • ROE measures profitability for contributors of equity capital. – After-tax profit/book value of equity • ROA measures profitability for all contributors of capital. – EBIT/total assets 8  19-9 !2!#//' • ROE is a key determinant of earnings growth. • Past profitability does not guarantee future profitability. • Security values are based on future profits. • Expectations of future dividends determine today’s stock value. 9  19-10 32'0% • ROE can differ from ROA because of leverage. • Leverage makes ROE more volatile. • Let t=tax rate and r=interest rate, then: 10 ( ) ( )       −+−= Equity Debt ROAROA1ROE rt [...]... 19-19 Table 19.9 Summary of Key Financial Ratios INVESTMENTS | BODIE, KANE, MARCUS 19 19-20 Table 19.9 Summary of Key Financial Ratios INVESTMENTS | BODIE, KANE, MARCUS 20 19-21 Table 19.9 Summary of Key Financial Ratios INVESTMENTS | BODIE, KANE, MARCUS 21 19-22 Table 19.9 Summary of Key Financial Ratios INVESTMENTS | BODIE, KANE, MARCUS 22 19-23 Table 19.9 Summary of Key Financial Ratios INVESTMENTS...19-11 Financial Leverage and ROE  Debt  ROE = (1 − t ) ROA + ( ROA − r ) Equity    • If there is no debt or ROA = r, ROE will simply equal ROA(1 - t) • If ROA > r, the firm earns more than it pays out to creditors and ROE increases • If ROA < r, ROE will decline as a function of the debt-to-equity ratio INVESTMENTS | BODIE, KANE, MARCUS 11 19-12 Table 19.5 Impact of Financial Leverage... ROA X Compound leverage factor • Tax burden is not affected by leverage • Compound leverage factor= Interest burden X Leverage INVESTMENTS | BODIE, KANE, MARCUS 15 19-16 Table 19.6 Ratio Decomposition Analysis for Nodett and Somdett INVESTMENTS | BODIE, KANE, MARCUS 16 19-17 Choosing a Benchmark • Compare the company’s ratios across time • Compare ratios of firms in the same industry • Cross-industry . reserved. McGraw-Hill/Irwin  Financial Statement Analysis 1  19-2 • Financial statement analysis can be used to discover mispriced securities. • Financial accounting. !! 2  19-3 • Income Statement: – Profitability over time • Balance Sheet: – Financial condition at a point in time • Statement of Cash Flows: – Tracks the cash implications