Topic 6: Financial Statement Analysis & Equity Valuation Flashcards
1
Q
What are economic earnings?
A
- sustainable cash flow that can be paid out to stock holders without impairing the productive capacity of the firm
2
Q
What are accounting earnings?
A
- affected by some conventions (inventories, depreciation); business cycles
3
Q
What does total asset turnover measure?
A
- measures how efficient a firm uses its assets (for every dollar of assets, how many sales the firm generates)
4
Q
What does a high interest coverage ratio indicate?
A
- shows the likelihood of bankruptcy is low because annual earnings are significantly greater than annual interest obligations
5
Q
What determines the intrinsic value of a firm’s stock?
A
- Expectations of future dividends and earnings
6
Q
What happens if ROA is greater than borrowing rate?
A
- a firm earns more on its money than it pays out to creditors the surplus earnings are available to the firm’s owners (shareholders), which increases ROE
7
Q
What happens if ROA is less than borrowing rate?
A
- ROE will decline
by an amount that depends on the debt-to equity ratio
8
Q
What is the compound leverage factor made of?
A
= Interest burden * Leverage
9
Q
What does a low P/B ratio mean?
A
- A low P/B ratio stock can be a safer investment, since the book value can be a floor supporting the market price
10
Q
What does a high P/B ratio indicate?
A
- A high P/B ratio is an indication that investors think a firm has chance of earning a return on investment > market capitalization rate (K)
11
Q
What does a low P/E ratio indicate?
A
- Low P/E ratio stocks may be good bargains since you can acquire a claim on a dollar of earnings more cheaply if the P/E ratio is low
12
Q
What does a high P/E ratio indicate?
A
- Current earnings may differ from future earnings, so high P/E stocks may still be bargain if their earnings and dividends are expected to grow faster
13
Q
What is the difference between LIFO & FIFO?
A
- LIFO- assumes goods are valued at todays cost
- FIFO- assumes goods are valued at original cost
14
Q
- LIFO: cost of goods sold (COGS) of $1.1 million,
the end-of-year balance sheet value of the 1
million units in inventory remains $1 million - FIFO: COGS of $1 million, the end-of-year
balance sheet value of the inventory would be
$1.1 million
Which is the preferred way of presenting inventory and why?
A
- LIFO firm has both a lower reported profit and a lower balance sheet value of inventories than the FIFO firm
- LIFO is preferred in computing economic earnings since it uses up-to-date prices to evaluate the COGS
15
Q
Trading Signal
- IV (Intrinsic value) > MP (Market Price)
A
- Buy or long
