Investment Analysis

CHAPTER 14: Company Analysis

CSI Global Education Inc.

Company Analysis
Analysing a company to determine whether or not it is a good
investment by closely examining the Financial statements.
Other factors used in company analysis are:
Qualitative Analysis – management effectiveness and other
intangibles.
Liquidity of common shares
Continuous monitoring of the company.

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Trend Analysis
Ratios from a company’s financial statements are used when
analyzing a company. However, a ratio for just one year has little
value. These ratios have more meaning when they are compared
from one year to the next.
Ratios are compared with one another over a period of time by
using a base year. For example: Year 1 is the base year
Year Year 1 Year 2 Year 3 Year 4
EPS $1.18 $1.32 $1.73 $1.76
1.18 1.32 1.73 1.76
1.18 1.18 1.18 1.18
Trend 100 112 147 149

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Ratio Analysis
A ratio shows the relationship between two numbers, in which a
number is usually related to 1, e.g., 2.2 to 1 or 2.2:1. The four
general categories of ratios are:
Liquidity Ratios: used to judge a company’s ability to meet its
short-term commitments.
Risk Analysis Ratios: show how well a company can deal with its
debt obligations.
Operating Performance Ratios: illustrates how well management
has made use of the company’s resources.
Value Ratios: shows the market worth of the company’s shares or
the return on owning them.

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Current Ratio (or Working Capital)
Purpose:
Assess liquidity (the ability to meet short-term financial obligations)

Current Assets
Formula:
Current Liabilities

2:1 is a suggested or recommended level. But depends on type of

business and industry.

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Quick Ratio or Acid Test
Purpose:
More stringent test of liquidity

Formula: Current Assets – Inventory

Current Liabilities

1:1 is the suggested or industry recommended level. But depends

on type of business and industry.

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Risk Analysis Ratios
Focus: analyze the riskiness of a company.
1. Is the debt level reasonable?
2. What is the company’s ability to pay interest, as measured
through the interest coverage ratio
3. What is the company’s ability to repay its debt, as measured
through asset coverage & cash flow to total debt ratios

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Asset Coverage Ratio
Purpose:
Assess debt holder protection provided by the company’s tangible
assets after removing all liabilities

Formula:
Total Assets – Def. Charges – Intangible Assets – (Current Liabilities Less Short Term Debt)
Total Debt (i.e. LTD + STD)/1000

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Asset Coverage
• Industry standards for this ratio vary due, in part, to the stability
of income provided by the company.
• Utilities, for example, have a fairly stable source of income as
they are characterized by heavy investment in permanent
property, which accounts for a large part of their total assets.
• They are also subject to regulation, which ensures the utility a
fair return on its investment.

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Debt/Equity Ratio
Purpose:
Shows the proportion of borrowed funds used relative to the
investments made by shareholders in the company.
Total Debt (STD + LTD)
Formula:
Book Value of Equity

If the debt burden is too large, it reduces the margin of safety

protecting debt holders capital. Financial risk also increases.

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Cash Flow/Total Debt
Purpose:
Measure of ability to repay borrowed funds

Formula:
Cash flow from operations
Total debt outstanding
Where cash flow =
earnings before extraordinary items – equity income + non-controlling
interest in subsidiaries + deferred taxes + amortization + other non-
cash expenses + net change in working capital requirements

Or, simply use cash flows from operating activities (CFO) from the cash
flow statement.

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Interest Coverage
Purpose:
Measure of ability to pay interest on debt

Formula:
Profit before interest charges and taxes
Interest Charges

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Operating Performance Ratios
Purpose:
• Measure of the profit left after various expenses.
• Shows how well management used the company’s resources.
• Used to compare to others in industry and historic performance.

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Operating Performance Ratios (continued)
Gross Profit Margin:

Revenue – Cost of Sales

Revenue

Net Profit Margin:

Profit - Share of Profit of Associates
Revenue

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After-tax return on common equity
Purpose:
Shows the dollar amount of earnings that were produced for each
dollar invested by the company’s common share holders.

Formula:
Profit X 100
Total Equity

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Inventory Turnover
Purpose:
Measures amount of inventory in relation to sales.

Formula:
Cost of Sales
Inventory
Eg $28,250,000 = 3.13 times
$9,035,000
To calculate ratio into days
365 = 116.61 days
3.13

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Value Ratios
Ratios used to assess the value of a stock in relation to its price.
Used to relate a stock’s price to dividends and earnings.

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Percentage Dividend Payout Ratios
Purpose:
Measures extent that profits were paid to shareholders.

Formulas:
Common Share Dividends X 100
Profit

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Earnings Per Common Share
Purpose:
Measures earnings available to each common share.

Formula:
Profit
Number of common shares outstanding

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Dividend Yield
Purpose:
Measures investors % return on investment from dividends.

Formula:

Annual Dividend per share X 100

Current market per share

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Price-Earnings Ratio
Purpose:
• Used to show how much an investor is paying for a company’s
earnings.
• Allows a common comparison between others in the same
industry.

Formula:
Current Market Price of Common
Earnings Per Share O ver Last 12 Months

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Price-Earnings Ratio
Purpose:
• Helps to evaluate stock value over market cycle.
• P/Es  in increasing stock market.
• P/Es  in decreasing stock market.
• High growth companies tend to have higher P/Es than low
growth companies.
• P/Es tend to move in the opposite direction to inflation.

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Equity (Book Value) per Common Shares

Purpose:
Assess the asset coverage for each common share.
Formula:
Equity
Number of common shares outstanding

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Investment Quality of Preferreds
There are four tests to consider:
1. Preferred Dividend Coverage
– Is income sufficient to pay the dividend
– Is it stable and rising

2. Record of Continuous Dividend Payments

3. Equity Per Preferred Share

– Is equity adequate to repay the par value of the preferred

4. Independent Credit Assessment

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