1. Credit Analysis Equity Analysis
Financial Analysis
Credit Analysis
Equity Analysis

2. Creditors What is the borrowing cause?
What is the firm’s capital structure?
What will be the source of debt repayment?

3. Credit Rating Business Risk Financial Risk Industry characteristics
Company position
Management
Financial Risk
Financial characteristics
Financial Policy
Profitability
Capital Structure
Cash Flow Protection
Financial flexibility

4. Standard & Poor’s rating method
EBIT interest coverage
EBITDA interest coverage
Funds from operations/Total debt %
Free operating cash flow/Total debt %
Return on capital %
Operating income/Sales
Long-term debt/Capital
Total debt/Capital

5. Standard and Poors Corporate Ratings

6. Financial distress
The deterioration in a company’s financial condition such that its ability to repay debt is impaired

7. Prediction of financial distress Univariate models
Beaver (1966) relied on
Cash flow to total debt
Net income to total assets
Total debt to total assets
Working capital to total assets
Current ratio
No-credit (defensive) interval

8. Prediction of financial distress Multivariate models
Altman Z-score
(Current assets – current liabilities)/total assets (weight-1,2)
Retained earnings/Total assets (weight-1,4)
EBIT/Total assets (weight-3,3)
Preferred and common stock market value/Book value of liabilities (weight-0,6)
Sales/Total assets (weight-1,0)

9. Altman Z-score Z> 2,99  Not in financial distress
Z< 1,81  In financial stress
2,99>Z>1,81 Uncertain

10. Altman Z score Anadolu Cam

11. Additional considerations
Mezzanine items
Could be debt or equity
Off-balance-sheet liabilities
Operating leases
Contingent liabilities
Environmental liabilities

12. Equity Analysis Buy-side Sell-side
Work for an institutional investors (mutual fund)
Make internal recommendations regarding the purchase of equity securities
Might review reports of sell-side analysts
Sell-side
Work for brokerage firms
Issue reports for retail and institutional customers

13. Valuation Current value V0 is a function of
Present value of next year’s cash flow, CF1
Required rate of return, r
Expected constant growth rate, g

14. Provides information regarding
Equity Analysis
Provides information regarding
The future cash flow generating ability of the firm
The growth (or lack thereof) of those cash flows
The risk of those cash flows, and
The risk-free rate commanded by the market

15. Top-Down Analysis Begin at highest (economy) level Market sectors
Allocation between domestic and international equities
Market sectors
Industries (within a sector)
End with evaluation of specific companies

16. Bottom-Up Analysis Begin with individual companies
Look for key strengths
Screen large data bases for attractive characteristics
Compustat, Bloomberg, Baseline
Search for a combination of characteristics

17. Macroeconomic Analysis
Gross Domestic Product (GDP): total value of all final goods and services produced within a country.
Nominal, measured in current dollars
Real, adjusted for changing prices
Gross National Product (GNP): total value of all final goods and services produced by factors of production owned by citizens of a country regardless of production location
Growth rates of both can be used as an initial estimate of a firm’s growth rate

18. Business Cycle Expansion Peak – high point following expansion
Period of economic growth
Increased need for PP&E, labor, inventory
Peak – high point following expansion
Recession
Contraction following a peak
Rising unemployment, decreased need for factors of production
Two quarters of falling real GDP

19. Business Cycle Trough – low point following recession Depression
Prolonged and severe recession
Some sectors and industries will perform better in some stages of the cycle than in others.
Cyclical firms are sensitive to stages of the economic cycle.

20. Inflation
Consumer Price Index (CPI) measures inflation of a market basket of consumer goods
Producer Price Index (PPI) measures inflation at the wholesale level
Higher inflation, higher required risk-free rate of interest
Impacts all companies and all industries (to varying degrees)

21. Economic Indicators Leading indicators Lagging indicators
Move in advance of the business cycle
Unemployment claims, new orders
Lagging indicators
Follow behind the business cycle
Average duration of unemployment, average prime rate
Coincident indicators
Move with the business cycle
Industrial production

22. Sector/Industry Analysis
Assess the ability of companies within the industry to generate cash flow
Assess the potential growth of that cash flow
Assess the risks related to receipt of those cash flows
Assess the industry’s ability to grow relative to the overall economy

23. Porter’s 5 Competitive Forces that determine industry profitability
Threat of New Entrants
- Capital requirements, government policy, access to distribution
Bargaining Power of Suppliers
- Supplier concentration, switching costs, differentiation of inputs
3. Bargaining Power of Buyers
- Buyer concentration, price sensitivity, brand identity
4. Threat of Substitute Products or Services
5. Rivalry Among Existing Firms
- Industry growth, barriers to exit, current industry concentration

24. Company Analysis Understand the business Evaluate past performance
Forecast performance
Value the company
Make an investment recommendation

25. Understanding the Business
Gain an understanding of the products and services provided by the company and the market for those products and services
Talk to employees, suppliers, competitors
Interview customers
Utilize the company’s products or services

26. Evaluating Past Performance
Understand reported financial information
Common size and ratio analysis
Consider efficiency, liquidity, solvency, cash flow and relative valuation
Understand US GAAP and IAS
Financial reporting quality and conservatism

27. Forecasting Performance
Based on evaluation of past performance, economic/industry conditions and expected changes
Pro-forma (projected) financial statements
Projection of future earnings
Use earnings model or statistical projection

28. Valuing the Company
Determine the appropriate price for making an equity investment
Is the intrinsic value higher or lower than the current market price?
Specific methods
Discounted cash flow
Market-multiple
Residual income

29. Making an Investment Recommendation
Current price of subject company’s securities
Results of valuation
Risks of investment
Investor’s risk tolerance, objectives and time horizon
Buy/Attractive
Hold/Market Perform
Sell/Market Under perform

30. Five Steps of a Financial Statement Analysis
Establish objectives of the analysis
Who are you and why are you interested in this company?
What questions would you like to have answered?
What info is vital to the decision at hand?

31. Five Steps of a Financial Statement Analysis (cont.)
Study the industry in which the firm operates and relate industry climate to current and projected economic developments

32. Five Steps of a Financial Statement Analysis (cont.)
Develop knowledge of the firm and the quality of management
How well does this firm appear to be run?
Are they taking advantage of opportunities?
Are they innovative, forward-looking, etc?

33. Five Steps of a Financial Statement Analysis (cont.)
Evaluate financial statements–tools include:
Common-size financial statements
Key financial ratios
Trend analysis
Structural analysis
Comparison with industry competitors

34. Five Steps of a Financial Statement Analysis (cont.)
Evaluate financial statements–areas include:
Short-term liquidity
Operating efficiency
Capital structure and long-term solvency
Profitability
Market ratios
Segmental analysis (when relevant)
Quality of financial reporting

35. Five Steps of a Financial Statement Analysis (cont.)
Summarize findings based on analysis
Reach conclusions about the firm relevant to your established objectives

36. What we have accomplished
Turned
Maze
Auditor’s Report
MD&A
Notes
Statement of Cash Flows
Income Statement
Statement of Shareholders’ Equity
Balance Sheet

37. Financial Statements An Overview
Map