Decoding Financial Statements
Strictly Financials
Friday
January 4, 2013
Donald W. Reynolds National Center for Business Journalism at Arizona State University
Strictly Financials
Gary Trennepohl, Ph.D.
n n n n
ONEOK Chair and Presidents Council Professor of Finance Oklahoma State University Trustee, Oklahoma Teachers Retirement System Member, OSU Foundation Investment Committee
[Link]@[Link]
Strictly Financials
Topics
n
Wednesday:
n
8:30 am to 3:00 pm Decoding Financial Statements and Company Analysis. 3:15 pm to 5:00 pm Investing in a Time of Uncertainty 8:30 am to 11:15 am Financial Markets in 2012: Where are the Stories?
Thursday:
n
Strictly Financials
I. Decoding Financial Statements
1. Financial Ratios what they tell us 2. Profitability Model how the firm generates profits
Strictly Financials
Ratios to Measure Financial Health
n
Liquidity
current ratio =
Current assets Current liabilities Current assets - inventory Current liabilities
quick ratio
Strictly Financials
Another View of Liquidity: Net Working Capital
Total Assets
Current Assets
= Liab.+Net Worth
Current Liabilities Net Working Capital Long Term Debt + Common equity
Fixed Assets
Strictly Financials
Ratios (contd.)
n
Profitability
net profit margin = return on assets = total asset turnover =
net profit after tax sales net profit after tax total assets sales total assets
Strictly Financials
Profitability Ratios (contd.)
n
Factors affecting profitability inventory turnover = accounts receivable collection period =
cost of goods sold inventory
accounts receivable (sales/365 days)
Strictly Financials
Ratios (contd.)
n
How is the firm financed? debt ratio debt/equity ratio equity multiplier = = =
total debt total assets Total debt total equity total assets common equity
Strictly Financials
10
Ratios (contd.)
n
What return is generated for common stockholders? return on equity =
EACS common equity
Strictly Financials
11
The Profitability Model
Evaluating a Company Using The Profitability Model
n
The profitability model is useful because it separates return on equity (ROE) into three components n n n
financial leverage (equity multiplier), operating efficiency (net profit margin) asset utilization (total asset turnover).
ROE is a function of all three factors
Strictly Financials
13
The Profitability Model (contd.)
n
Return on equity = NPM X total asset turnover X equity multiplier
ROE =
net profit sales
sales total assets
total assets X common equity
Strictly Financials
14
Understanding Basic Principles of Financial Markets and Investing
1. 2. 3. 4. 5.
Drivers of Stock and Bond Prices The Historical Perspective Market Efficiency Diversification Is Critical Market Risk the VIX
Economics of Stock and Bond Prices
n
Stock Prices over the long term are driven by the earnings they provide to shareholders
n n n
Dividends Growth in earnings and dividends P/E ratio is a measure of relative value
Bond Prices and yield are driven by interest rates and credit quality
n n
Bond prices move inversely to interest rates. Bond investors must predict future interest rates and economic activity to determine proper price.
Strictly Financials 16
History of U.S. Stock and Bond Returns Provides a Perspective for the Future
Strictly Financials
17
Strictly Financials
18
Strictly Financials
19
Strictly Financials
20
Bonds as an Investment
Strictly Financials
21
Strictly Financials
22
The Bond Buyers Dilemma
By Burton Malkiel in the WSJ, Dec 7, 2011
n
The yields on long-term U.S. Treasuries will likely fall below inflation for the next several years. Long-term Treasuries are likely to be sure losers. Investors should consider as alternatives:
n
Bonds with moderate credit risk where the spreads over Treasuries are generous. n Tax-exempt municipal bonds are especially attractive. n Foreign bonds in fiscally secure countries, e.g., Australia
High-quality U.S. stocks with generous dividend yields
n
Abbott Labs, ATT, Exxon, J&J, P&G.
Strictly Financials 23
If Markets are Efficient .
Market efficiency refers to how quickly security prices reflect new information. If markets are efficient, it isnt possible to beat the market.
24
Implications of Market Efficiency for Investors
n
n n
Stock experts dont have an advantage over amateurs because the competition is so severe. Investment return will be a function of risk. The key factor in market efficiency is information. Most SEC regulation is designed to promote the flow of information to investors. Technical analysis is valueless because market participants already have incorporated any information contained in past price sequences into stock prices.
Strictly Financials 25
N STRATEGIST HOTLINE
800-724-1817 Email: info@[Link]
McMillan Analysis Corporation
J 079621323
012
t version of this report, click on the following link to 1 the charts: see om/weekly-charts
A Technicians Chart
by the oversold oupled with the over the fiscal xed signals for quite powerful ator is price and we will most
asured by the PX) has been in tober. From its ws last week, it zeable decline, earful one. As Figure 1 end, and that is 1 From Larry McMillans The Option Strategists Hotline Nov. 22, 2012 d resistance at day moving average is at 1395, and the trend line (see Figure 1) is at Strictly Financials area of 1395 to 1410, which was support on the way down, is now pport to become resistance. Now, the onus is on the bulls to try to
26
Implications (contd.)
n
n n
Fundamental analysis and brokerage-firm recommendations will not enable you to identify firms which will outperform the market. Information contained in accounting statements and other public information already is reflected in security prices. It makes no sense to try and time the market. If theres a way to beat the market, its not obvious.
Strictly Financials
27
How Then Should We Invest?
1.
Buy and hold a well-diversified portfolio through time and make sure you have exposure to international stocks and bonds in developed and emerging markets. Minimize fees, trading costs and expense ratios. Minimize tax impacts of buying and selling. Rebalance periodically to your risk/reward target.
Strictly Financials 28
2.
3.
4.
Diversification in an Institutional Investor Portfolio
1)
2)
3) 4) 5) 6) 7) 8)
Stocks Large-cap, small-cap, growth, value, international, including emerging markets Fixed income Treasuries, high-yield, corporate, municipal Real estate REITs, direct-investment funds MLPs Transportation, E&P, Liquids, Storage Commodities Ags, metals, oil and gas, Precious metals Gold, silver Hedge funds Various types Risk-management tools Options, futures
Strictly Financials 29
So, What Will the Next Decade Bring?
30
One Thing that is Really Changing - Demographics of Major Countries
1.
2.
Countries with larger numbers of younger workers will enjoy higher growth rates than older countries. Demand for housing, autos and consumer goods is driven by the 25- to 45-year-old age cohort.
31
Italy
32
Germany
33
United States
34
Brazil
35
India
36
China
37
Demographic Changes Are Driving the Way Investments Will Be Made in The Future.
Strictly Financials
38
Strictly Financials
39
Strictly Financials
40
THE VIX A MEASURE OF EXPECTED MARKET VOLATILITY (RISK).
Strictly Financials
41
Strictly Financials
42
You Can Keep Track of Current Market Volatility with the VIX
n
The VIX is a measure of the markets perception about market uncertainty over the next 30 days. Its derived from the Black-Scholes option-pricing model, of which one input value is expected volatility (i.e., future standard deviation) of the S&P 500. You make the calculation by solving the model backwards that is given the observed price, what volatility is needed to produce that price by the model.
Strictly Financials
43
So, What Does All of This Data Tell Us?
n
Remember when people say this time is different, it is never different. Markets over and under correct, but they ultimately revert to the mean of their longterm values. Periods of over performance will be followed by periods of under performance, etc. Diversification is a key strategy for investing.
Strictly Financials 44
Story Ideas
1.
2.
3.
What do investors and investment advisers say about market volatility? Are investors/advisers investing in international markets? If so, where and why? What will happen to bond prices and interest rates in 2012-2014?