8.2 Financial Statement Analysis

Question 1

What are investor ratios?

Answer 1

ratios that are of interest to investors

Question 2

How do we calculate EPS?

Answer 2

profit available to ordinary shareholders/number of ordinary shares

Question 3

how do we find profit attributable to ord. shareholders

Answer 3

Start w net profit

subtract:
pref shares
minority interest

Question 4

What are the features of EPS ratio?

Answer 4

• higher is better
• look for steady growth of EPS figure
• it is relative (depends how many shares, sector etc)

Question 5

How do we calculate diluted EPS?

Answer 5

add back:

warrants
convertible pref. shares/loan stock

to number of shares

Question 6

What is the P/E ratio?

Answer 6

market price per share/ EPS

expressed as multiple

Question 7

How do we interpret P/E ratio?

Answer 7

High (higher compared to comps) P/E ratio may indicate high growth prospects

Low - indicates a value company, bargain (market has missed smt)
- or a company in trouble - had good earnings but market expects earnings to decrease

it is a relative valuation multiple (should compare to peer/sector avg)

gives relative market value (market value relative to earnings)

Question 8

Is there a correlation between share price and EPS ratio?

Answer 8

usually a positive correlation (higher EPS, higher share price)

Question 9

Why is higher PE multiple indicative of future growth prospects?

Answer 9

Because the Market price of the share is driven by smt more than just earnings which means the market is factoring in an increase in future earnings into the value (or market has miscalculated)

Question 10

What is trailing PE ratio?

Answer 10

Ignore one-off events (non-recurring items), such as windfalls or exceptional items

Question 11

What is a prospective PE ratio?

Answer 11

Instead of using the historic EPS of the company, the prospective P/E ratio uses the current financial year’s forecas

Question 12

How is EV/EBITDA diff to PE multiple?

Answer 12

Valuation multiple that doesn’t factor in capital structure - takes full value of whole company (EV)

Question 13

Hoe do we interpret EV/EBITDA multiple?

Answer 13

Same as P/E multiple

Question 14

How to calculate dividend yield?

Answer 14

(Dividend per share/market price per share)x100%

Question 15

How do we interpret dividend yield?

Answer 15

Low: may indicate high future growth
- company reinvesting profits
- market factroing in smt else into market price

• could also be overvalued

High: share is performing well (value company)

• could be risky (company in trouble)

Question 16

What is dividend cover?

Answer 16

Tells us how many times a dividend could be paid from this years earnings

• gives idea of sustainability of the dividend
• is a multiple

Question 17

How do we calculate Dividend cover?

Answer 17

EPS/Dividends per share

Question 18

What is an uncovered dividend?

Answer 18

• dividend cover <1
• paying out more in dividends than revenue generated that year
• where profits other than this years are being used to pay out a dividend (eg. retained earnings reserve)

Question 19

What is the gearing ratio?

Answer 19

Debt to equity ratio

= interest bearing debt (incl. pref shares and overdrafts)/equity shareholders funds x 100%

Question 20

How do we interpret gearing ratio

Answer 20

Higher = more highly geared and vv

• more volatile profits (good years more good, bad years more bad)

risk to dividends: One interpretation of this ratio is the risk to shareholder dividends. As dividends are discretionary, and interest on debt is obligatory.

ability to borrow: ability of the company to borrow more. The more
highly geared the company is, the less likely it will be able to borrow more.

Question 21

How do we calculate interest cover ratio?

Answer 21

profit before interest and tax/interest expense

its a multiple

Question 22

What does interest cover ratio show us?

Answer 22

How easily a company can pay interest expenses on outstanding debt

• The lower the ratio, the more the company is burdened by debt expense.

Question 23

What if interest cover multiple is less than 1?

Answer 23

problem - wont be able to cover interest expenses

Question 24

What do liquidity ratios show us?

Answer 24

how able a company is to meet liabilities in the next 12 months

Question 25

Who are interested in liquidity ratios?

Answer 25

creditors

Question 26

What is the current ratio?

Answer 26

current assets/current liabilities

Question 27

what is the ideal current ratio level?

Answer 27

greater than 1 - means can meet current liabilities with liquid assets

Question 28

What is the quick ratio?

Answer 28

current assets - inventory / current liabilities

higher than 1 is highly liquid

Question 29

What is another name for the quick ratio?

Answer 29

acid test

ultimate test of liquidity because you take out inventory which is not so liquid

Question 30

What is return on capital employed? (ROCE)

Answer 30

operating profits/capital employed x 100%

how much capital was employed to generate level of return

Question 31

What is capital employed and the 2 ways to calculate it?

Answer 31

total assets - current liabilities

(subtract current lib to acknowledge that a portion of assets cant be used this year as they have to pay off current lib)

can also be shown as equities + non-current liabilities (other side of equation)

Question 32

What does ROCE show us?

Answer 32

Higher = more profitable compared to size

Question 33

What is ROE?

Answer 33

net income/shareholders equity x 100%

• use net income as shareholders are only entitled to profit after tax

Question 34

What does ROE show us?

Answer 34

Higher = better return for shareholders

Question 35

What does profit show us?

Answer 35

What % of revenue becomes profit

• efficiency of business

Question 36

what is another term for return on capital employed?

Answer 36

return on assets