Equity Research with Financial Modelling

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Quantitative Analysis

Profitability Ratios

1. Gross Margin - Measures how well each unit of turnover is utilized to cover the cost of goods sold
(COGS).
Gross Margin = Gross Profit/Net Sales

2. EBITDA Margin - Measures the operating efficiency of a firm.

EBITDA Margin = EBITDA/Net Sales

3. Net Profit Margin - Measures the extent to which all of the concerned costs deplete the revenue.
Net Profit Margin = Net Profit/Net Sales

4. Return on Equity (ROE) - Measures how efficiently a firm generates profits for every unit of
shareholders' equity.
ROE = Net Profit/ Average Equity + Average Preferred Stock)

5. Return on Common Equity (ROCE) – Measure return available to equity shareholders.

ROCE = (Net Profit – Preferred Dividend)/ Average Common Equity

6. Return on Total Capital (ROTC) - Measures how efficiently a firm generates profits for every unit
of capital invested.
ROTC =EBIT/Average Total Capital

7. Return on Assets (ROA) - Measures how efficiently a firm generates profits for every unit of
asset.
ROA = Net Profit/Average Assets

Analysis of profitability ratios for a company can be done in two ways:

 Comparing the current health of the company against its own history.
 Comparing the company’s performance against its peers.

DuPont Analysis
DuPont Analysishelps to further analyse the factors that affect Return on Equity (ROE) -
1. Operating performance (Profit margin)
2. Asset management (Asset turnover)
3. Financial leverage (Leverage ratio)

Activity Ratios

1. Accountsreceivable turnover - Quantifies a firm's effectiveness in credit extension to its

customers, and credit recovery
Account Receivables Turnover = Net Sales/Average Receivables

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2. Days Receivables - Indicates how quickly a company can recover cash from its credit sales.
Days Receivables = 365/Account Receivables Turnover

3. InventoryTurnover - Measures the number of times the company used and replaced its inventory,
during afinancial year
Inventory Turnover = COGS/Average Inventory

4. Days Inventory - Indicates the average length of time, a company holds its inventory in a year.
Days Inventory = 365/Inventory turnover

5. Accounts Payable Turnover - Measures the rate at which a firm paysits creditors.
Accounts Payable Turnover = COGS/Average Payables

6. Days Accounts Payable –Indicatesthe average number of days a company takes to pay its
creditors.
Days Accounts Payable = 365/Accounts Payable Turnover

7. Total Asset Turnover - Measures how efficiently a firm uses its assets.
Total Asset Turnover = Sales/Average Total Assets

Solvency Ratios(Also called gearing or leverage ratios)

1. Debt-to-equity ratio - It defines the ratio inwhich debt and equity have been used to meet the
company’s funding requirement.
Debt-to-equity ratio = Total Debt/Total Equity

2. Interest coverage ratio -Indicates how well the EBIT (earnings) of the company cover the
interest costs.
Interest Coverage Ratio = EBIT/Interest Expense

Liquidity Ratios

1. Current Ratio = Total Current Assets/ Total Current Liabilities

2. Quick Ratio = (Total Current Assets - Inventory)/ Total Current Liabilities

3. Cash Ratio = (Cash and its Equivalents + Investments)/ Total Current Liabilities

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 Equity Research with Financial Modelling
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Valuation Ratios

1. Price/Earnings (P/E) Ratio - It tells the price that investors are ready to pay for each unit of profit.

Trailing P/E ratio = Market price per share/ Trailing EPS

Forward P/E ratio = Market price per share/Forward EPS

2. Price to Earnings Growth (PEG) Ratio = (Price/Earnings)/Expected Earnings Growth

3. EV/EBITDA - Enterprise Value (EV) is the takeover price that an acquirer needs to pay, in case of an
acquisition.

EV/EBITDA = (Market value of equity + Market value of debt – Cash)/EBITDA

4. Price/Book Value (P/B) Ratio - Book value is the value at which shareholders’ equity is carried on a balance
sheet. This ratio is generally used in industries with liquid assets like banks and financial institutions.

P/B Ratio = Market price per share/Book value per share

Industry Specific Ratios

There are some valuation ratios that are industry specific such as -
 Enterprise Value/Screen is used to value multiplexes.
 EV/reserves is used to value mining companies.
 Sales/sqft is used in the retail industry.

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