Financial Ratio analysis view_important topic

INTRODUCTIONFinancial ratio analysis is an important topic and is covered in all mainstream corporate finance textbooks. It is also a popular agenda item in investment club meetings. It is widely used to summarize the information in a company's financial statements in assessing its financial health. In today's information technology world, real time financial data are readily available via the Internet. Performing financial ratio analysis using publications, such as Robert Morris Associates’ Annual Statement Studies, Dun & Bradstreet’s Key Business Ratios, Moody’s Manuals, Standard & Poor’s Corporation Records, Value Line Investment Survey, etc., is no longer efficient. Since students and investors now have easy access to on-line databases, the assignments on financial ratio analysis can be modified accordingly to enhance learning. Based upon my experience as a finance professor and as a member of a local investment club, I have prepared this teaching note to help students and investors in performing financial ratio analysis via an on-line database, Dow Jones Interactive. This database is a Web based, enterprise wide business news and research solution supported by Dow Jones & Company, the parent company of The Wall Street Journal. The class assignment presented herein is designed to demonstrate how to assess a company's overall operations over time and its current financial standing in the industry. THE FINANCIAL RATIO ANALYSIS ASSIGNMENTStudents will work on the assignment collaboratively in groups of three or four students. Each group will select an industry of interest to the group, and each student will select a company within that industry. Students will download the relevant financial data from the Internet and perform ratio analysis for the selected companies. Since successful financial ratio analysis is as much an art as it is a science, students must use common sense and sound judgment throughout the analysis. The purpose of this assignment is to provide students with the opportunity to: • retrieve real time financial data via the Web; • analyze the financial performance of selected companies; • practice communication skills, both in writing (through word processing) and in speaking (through giving a Power Point presentation); • enhance teamwork skills.Trend analysis provides signals as to whether the company's financial health is likely to improve or deteriorate. Each student will perform the trend analysis based upon the following financial ratios: • Leverage Ratios: to measure the extent to which the company's assets are financed with debt; • Liquidity Ratios: to measure the company's ability to pay its bills; • Profitability Ratios: to measure the company's ability to generate earnings; • Efficiency Ratios: to measure the company's ability to utilize its assets; • Market Value Ratios: to measure the market perception about the company's future prospects.The downloaded four years' balance sheets and income statements are to be used to calculate the financial ratios not reported in the DJI. For example, four leverage ratios (Debt/Equity, LT Debt/ Cap, LT Debt/Tot Debt, and LT Debt/Tot Assets) are reported, but the interest coverage ratio (= earnings available for interest/interest expenses) is missing in the DJI. Students are required to obtain the earnings and interest expenses information from the income statements and calculate this ratio to measure the company's ability to service the debt. In the area of liquidity, current ratio (= current assets/current liabilities) and quick ratio (= quick assets/ current liabilities) are reported, but the interval measure (= quick assets/daily operating expenditures) is not. Students are required to obtain quick assets (= cash & equivalent + receivables) from the balance sheets and operating expenditures from the income statements, and calculate this ratio to measure how long the company can keep up with its bills using only existing quick assets. As the financial ratios in each of the five performance areas are compiled, they are analyzed across time. A sample trend analysis for Intel is presented (below) in Table 1. Table 1. Intel Trend AnalysisPERFORMANCE AREA 1998 1997 1996 1995 TRENDLeverage: Debt % Tot Assets 25.7 33.2 28.9 30.6 Drop in leverage during 1998Interest Coverage 269.7 395.8 318.4 195.4 Lower coverage during 1998Liquidity: Current Ratio 2.3 2.6 2.8 2.2 Lower liquidity since 1996Quick Ratio 1.0 1.3 1.6 1.3 Lower liquidity since 1996Interval Measure (days) 63.8 90.8 115.3 86.4 Lower liquidity since 1996Profitability: Profit Margin (%) 23.1 27.7 24.7 22.0 Lower profitability during 1998Return on Assets (%) 19.3 24.0 21.7 20.4 Lower ROA during 1998Return on Equity (%) 26.0 36.0 30.6 29.4 Lower ROE during 1998Efficiency: Asset Turnover .835 .868 .878 .926 Lower efficiency since 1995Receivables Turnover 7.5 7.0 6.1 6.4 Increased efficiency since 1996Inventory Turnover 5.7 5.2 4.4 4.1 Increased efficiency since 1995Market Value: Price/Book Value 8.41 5.92 6.37 3.83 Good market perceptions Du Pont AnalysisSince it is important to understand how the company's profitability, efficiency, and leverage are linked in its financial performance, students are required to demonstrate and evaluate its Du Pont system over time. The company's return on assets, ROA (=net income/assets), can be expressed as:ROA = (Net Income/Revenue) * (Revenue/Assets) = Profit Margin * Asset TurnoverAnd the company's return on equity, ROE (=net income/equity), can be expressed asROE = (Net Income/Revenue) * (Revenue/Assets) * (Assets/Equity) = ROA * Equity MultiplierBoth the company's profitability (as measured in terms of profit margin) and efficiency (as measured in terms of asset turnover) determine its ROA. This ROA, along with the company's financial leverage (as measured in terms of its equity multiplier), contributes to its ROE. As the company's use of leverage magnifies its ROE, students are required to examine ROE carefully. The changes in the company's ROE are to be noted and explained through its profit margin, asset turnover, and equity multiplier over time. The objective is to identify the company's strong area that can be capitalized upon and/or its weak area that must be improved upon. See Table 2 (below) for a sample Du Pont analysis for Intel. Table 2. Intel Du Pont Analysis Item / Ratio 1998 1997 1996 1995 EvaluationNet Income, $million (from Income statements) 6068 6945 5157 3566 Revenue, $million (from Income statements) 26273 25070 20847 16202 Assets, $million (from balance sheets) 31471 28880 23735 17504 Equity, $million (from balance sheets) 23377 19295 16872 12140 Profit Margin % (Net Income/Revenue) 23.1 27.7 24.70 22.0 Drop in profitability during 1998Asset Turnover (Revenue/Assets) .835 .868 .878 .926 Lower efficiency since 1995Return on Assets % (Profit Margin* Asset Turnover) 19.3 24 21.7 20.4 Drop in ROA during 1998Equity Multiplier (Assets/Equity) 1.35 1.50 1.41 1.44 Decrease in leverage during 1998Return on Equity % (ROA* Equity Multiplier) 26.0 36.0 30.6 29.4 Sharp decline in ROE during 1998 how the company performs as compared to the industry norms and where the company stands relative to its competitors in the industry. The company's weak and/or strong areas of performance must be identified and recommendations for improvement presented. See Table 3 (below) for a sample industry comparative analysis for Intel.Table 3. Intel Industry Comparative Analysis Performance Area Intel AMD* Semiconductors EvaluationLeverage: ExcellentDebt/Equity (%) 3 73 19 Low leverageInterest Coverage 269.7 - 20.8 High coverageLiquidity: GoodCurrent Ratio 3.2 1.7 2.8 Above average liquidityProfitability: ExcellentProfit Margin (%) 26.1 -0.9 11.1 High profitabilityReturn on Assets (%) 19.3 -2.4 7.2 High ROAReturn on Equity (%) 28.9 - 14.1 High ROEEfficiency: GoodRevenue/Assets .86 .64 .82 Above average Market Value: Good Price/Book Value 8.41 2.10 6.04 High price to bookPrice/Earnings 36.3 - 67.3 Below average PEDividend Yield (%) 0.2 0.0 0.1 Average * AMD, Advanced Micro Devices, is one of Intel's key competitors in semiconductors industry. SUMMARYThe incorporation of computer technology in finance classes has become more popular than ever in this information technology rich environment. Mediated classrooms have grown rapidly in numbers throughout universities worldwide. This teaching note demonstrates how finance professors, business students, and investment club members can take advantage of the changing environment to enhance learning. Students can easily retrieve a company's real time financial data via the Internet and analyze its financial performance over time. The assignment presented herein is designed to help students/investors learn how to assess the company's overall operations and its current financial standing in the industry through teamwork and state of the art computer technology. It can be used in any corporate finance classes and/or investment clubs.REFERENCESBodie, Z. and R.C. Merton. Finance (2000), Prentice-Hall, Inc. Brealey, R.A. and S.C. Myers. Principles of Corporate Finance (2000), 6th Edition, The McGraw-Hill Companies, Inc. Brealey, R.A., S.C. Myers and A.J. Marcus. Fundamentals of Corporate Finance (1999), 2nd Edition, The McGraw-Hill Companies, Inc. Brigham, E.F. and J.F. Houston. Fundamentals of Financial Management (1999), Concise 2nd Edition, The Dryden Press. Brigham, E.F., L.C. Gapenski and M.C. Ehrhardt. Financial Management: Theory and Practice (1999), 9th Edition, The Dryden Press. Gitman, L.J. Principles of Managerial Finance (2000), 9th Edition, Addison Wesley Longman, Inc. Keown, A., J.W. Petty, D.F. Scott and J.D. Martin. Foundations of Finance (1998), 2nd Edition, Prentice-Hall, Inc. Ross, S.A., R.W. Westerfield and B.D. Jordan. Essentials of Corporate Finance (1999), 2nd Edition, Irwin/McGraw-Hill. Ross, S.A., R.W. Westerfield and J. Jaffe. Corporate Finance (1999), 5th Edition, Irwin/McGraw-Hill. Scott, D.F., J.D. Martin, J.W. Petty and A. Keown. Basic Financial Management (1999), 8th Edition, Prentice-Hall, Inc. APPENDIX 1. FINANCIAL PROFILE Data current through 10/06/1999 INTEL CORP 2200 Mission College Blvd. Santa Clara, California 95052-8119 Telephone: (408) 765-8080 Fax: (408) 765-1596 Dow Jones Industry Group: Semiconductors Business Description: Designs, develops, manufactures and markets microcomputer components and related products at various levels of integration. Its principal components consist of silicon based semiconductors etched with complex patterns of transistors. Primary SIC: 3674 Stock Symbol: INTC Exchange: NASDAQ CEO: Craig R. Barrett Employees: 64,500 Auditors: Ernst & Young LLP Latest Report: Unqualified Balance Sheet Statement ($ Mil) Fiscal Year End Assets 12/1998 12/1997 12/1996 12/1995Cash & Equivalent 2,038.0 4,102.0 4,165.0 1,463.0Receivables 3,527.0 3,438.0 3,723.0 3,116.0Inventories 1,582.0 1,697.0 1,293.0 2,004.0Other Cur Assets 6,328.0 6,630.0 4,503.0 1,514.0Total Cur Assets 13,475.0 15,867.0 13,684.0 8,097.0Gr Fixed Assets 21,068.0 18,127.0 14,262.0 11,792.0Accum Depr 9,459.0 7,461.0 5,775.0 4,321.0Net Fixed Assets 11,609.0 10,666.0 8,487.0 7,471.0Oth Non-Cur Asset 6,387.0 2,347.0 1,564.0 1,936.0Tot Non-Cur Asset 17,996.0 13,013.0 10,051.0 9,407.0Total Assets 31,471.0 28,880.0 23,735.0 17,504.0Liabilities Accounts Payable 1,244.0 1,407.0 969.0 864.0Short-Term Debt 159.0 322.0 389.0 346.0Other Cur Liab 4,401.0 4,291.0 3,505.0 2,409.0Total Cur Liab 5,804.0 6,020.0 4,863.0 3,619.0Long-Term Debt 702.0 448.0 728.0 400.0Defer Inc Taxes 1,387.0 1,076.0 997.0 620.0Oth Non-Cur Liab 201.0 2,041.0 275.0 725.0Tot Non-Cur Liab 2,290.0 3,565.0 2,000.0 1,745.0Total Liabilities 8,094.0 9,585.0 6,863.0 5,364.0Preferred Equity 0.0 0.0 0.0 0.0Common Equity 23,377.0 19,295.0 16,872.0 12,140.0Retained Earnings 17,952.0 15,984.0 13,975.0 9,557.0Total Equity 23,377.0 19,295.0 16,872.0 12,140.0Tot Liab & Stk Eq 31,471.0 28,880.0 23,735.0 17,504.0Income Statement ($ Mil) Fiscal Year End 12/1998 12/1997 12/1996 12/1995Revenues/Sales 26,273.0 25,070.0 20,847.0 16,202.0Cost of Sales 9,337.0 7,753.0 7,276.0 6,432.0Gr Oper Profit 16,936.0 17,317.0 13,571.0 9,770.0S, G & A Expenses 5,585.0 5,238.0 4,130.0 3,139.0Op Prof bef Depr 11,351.0 12,079.0 9,441.0 6,631.0Deprec & Amort 2,807.0 2,192.0 1,888.0 1,379.0Oper Inc aft Depr 8,544.0 9,887.0 7,553.0 5,252.0Other Income, Net 792.0 799.0 406.0 415.0Inc Avail for Int 9,171.0 10,686.0 7,959.0 5,667.0Interest Expense 34.0 27.0 25.0 29.0Pretax Income 9,137.0 10,659.0 7,934.0 5,638.0Income Taxes 3,069.0 3,714.0 2,777.0 2,072.0Net Inc Tot Ops 6,068.0 6,945.0 5,157.0 3,566.0Special Inc/Chrg -165.0 0.0 0.0 0.0Normalized Income 6,233.0 6,945.0 5,157.0 3,566.0Total Net Income 6,068.0 6,945.0 5,157.0 3,566.0Preferred Div 0.0 0.0 0.0 0.0Net Inc Avail Com 6,068.0 6,945.0 5,157.0 3,566.0 Key Financial Ratios Fiscal Year End 12/1998 12/1997 12/1996 12/1995Book Value P/S 7.05 5.93 5.14 3.70Price/Book Val (%) 841 592 637 383Debt/Equity (%) 3 2 4 3LT Debt % Inv Cap 2.9 2.3 4.1 3.2LT Debt % Tot Dbt 8.7 4.7 10.6 7.5Debt % Tot Assets 25.7 33.2 28.9 30.6Quick Ratio 1.0 1.3 1.6 1.3Current Ratio 2.3 2.6 2.8 2.2Revenue/Assets (%) 80.0 90.0 90.0 90.0Price/Revenue (%) 748 456 516 288Cash % Revenue 7.8 16.4 20.0 9.0Pre-Tax Mgn (%) 34.8 42.5 38.1 34.8Post-Tax Mgn (%) 23.1 27.7 24.7 22.0Eff Tax Rate (%) 33.6 34.8 35.0 36.8Receivable Turn 7.5 7.0 6.1 6.4Inventory Turn 5.7 5.2 4.4 4.1Ret on Equity (%) 26.0 36.0 30.6 29.4Ret Invest Cap (%) 25.2 35.2 29.3 28.4Ret on Assets (%) 19.3 24.0 21.7 20.4Key Competitors: 3Com Acer AMD Atmel Cisco Systems EDS Fujitsu Harris Corporation Hitachi IBM Integrated Device Technology Lucent Macronix International Mitsubishi Electric Motorola National Semiconductor NEC Nortel Networks Philips Electronics Samsung Electronics STMicroelectronics Sun Microsystems Texas Instruments Toshiba APPENDIX 2. COMPANY TO COMPANY COMPARISON REPORT Data current through 10/06/1999 INTEL CORP ADVANCED MICRO DEVICES Price Change Latest Week 2.7 % 12.7 % Last 4 Weeks -11.9 % -10.4 % Last 13 Weeks 16.1 % 14.4 % Last 52 Weeks 83.6 % 28.0 % YTD 29.8 % -33.0 % Change vs S&P 500 Latest Week 99 % 109 % Last 4 Weeks 90 % 91 % Last 13 Weeks 123 % 121 % Last 52 Weeks 136 % 95 % YTD 120 % 62 % Price Range ($) Latest Close 76.94 19.44 52-Week High 89.50 33.00 52-Week Low 40.75 14.56 5-Year High 89.50 48.50 5-Year Low 6.34 10.25 Relative Price P/E Ratio 36.3 NE P/E, 5-Yr Avg High 24.1 NC P/E, 5-Yr Avg Low 12.2 NC Price/Book Value 841 % 210 % Price/Revenue 903 % 106 % Price Action Beta 1.25 1.64 Volume Shares Latest Week 58,668,800 8,122,000 $ Latest Week 4,500,263,000 152,453,000 % of Shares Out 1.77 % 5.52 % Liquidity Ratio 906,964,100 14,871,200 On-Balance Index 50 % 95 % Revenue 12 Months ($Mil) 28,194.0 2,701.4 Fiscal Year ($Mil) 26,273.0 2,542.1 Change Last Qtr 13.8 % 13.0 % Change YTD 16.1 % 14.9 % Earnings 12 Months ($Mil) 7,371.0 -25.2 EPS 12 Months($) 2.12 -0.18 EPS Fiscal Year($) 1.73 -0.72 Change EPS Qtr 54.5 % NE Change EPS YTD 56.5 % NE Change EPS 12 Mos 30.9 % NE 5-Yr Ann EPS Growth 24.9 % NC Dividends Indicated Rate($) 0.12 0.00 Dividend Yield 0.2 % 0.0 % 5-Yr Annual Growth 19.06 % NC Payout Ratio 4 % NC Payout Last 5 Years 4 % NC Last Ex-Dividend 11/03/1999 04/27/1995 Ratios Profit Margin 26.1 % -0.9 % Return on Equity 28.9 % NE Return on Assets 19.3 % -2.4 % Revenue/Assets 86 % 64 % Debt/Equity 3 % 73 % Interest Coverage 269.7 NC Current Ratio 3.2 1.7 Shareholdings Market Value ($Mil) 254,509 2,861 Latest Shares Out 3,308,000,000 147,211,000 Insider Net Trading -60,000 -18,667 Short Int Ratio 1.8 Days 5.5 Days Fiscal Year Ends 12/1998 12/1998 APPENDIX 3. COMPANY TO PRIMARY INDUSTRY COMPARISON REPORT Data current through 10/06/1999 INTEL CORP SEMICONDUCTORS Price Change Latest Week 2.7 % 6.0 % Last 4 Weeks -11.9 % -9.5 % Last 13 Weeks 16.1 % 4.9 % Last 52 Weeks 83.6 % 106.4 % YTD 29.8 % 29.2 % Change vs S&P 500 Latest Week 99 % 103 % Last 4 Weeks 90 % 92 % Last 13 Weeks 123 % 111 % Last 52 Weeks 136 % 153 % YTD 120 % 120 % Price Range ($) Latest Close 76.94 58.58 52-Week High 89.50 65.91 52-Week Low 40.75 28.29 5-Year High 89.50 65.91 5-Year Low 6.34 10.38 Relative Price P/E Ratio 36.3 67.3 P/E, 5-Yr Avg High 24.1 32.4 P/E, 5-Yr Avg Low 12.2 17.3 Price/Book Value 841 % 673 % Price/Revenue 903 % 687 % Price Action Beta 1.25 1.53 Volume Shares Latest Week 58,668,800 323,557,900 $ Latest Week 4,500,263,000 18,770,692,000 % of Shares Out 1.77 % 2.80 % Liquidity Ratio 906,964,100 3,175,400,000 On-Balance Index 50 % 61 % Revenue 12 Months ($Mil) 28,194.0 97,374.4 Fiscal Year ($Mil) 26,273.0 90,467.4 Change Last Qtr 13.8 % 22.9 % Change YTD 16.1 % 17.5 % Earnings 12 Months ($Mil) 7,371.0 10,808.0 EPS 12 Months($) 2.12 0.87 EPS Fiscal Year($) 1.73 0.71 Change EPS Qtr 54.5 % 150.0 % Change EPS YTD 56.5 % 59.3 % Change EPS 12 Mos 30.9 % 22.5 % 5-Yr Ann EPS Growth 24.9 % -9.8 % Dividends Indicated Rate($) 0.12 0.06 Dividend Yield 0.2 % 0.1 % 5-Yr Annual Growth 19.06 % 0.92 % Payout Ratio 4 % 6 % Payout Last 5 Years 4 % 3 % Last Ex-Dividend 11/03/1999 Ratios Profit Margin 26.1 % 11.1 % Return on Equity 28.9 % 14.1 % Return on Assets 19.3 % 7.2 % Revenue/Assets 86 % 82 % Debt/Equity 3 % 19 % Interest Coverage 269.7 20.8 Current Ratio 3.2 2.8 Shareholdings Market Value ($Mil) 254,509 677 Latest Shares Out 3,308,000,000 11,557,097,000 Insider Net Trading -60,000 -2,525,608 Short Int Ratio 1.8 Days 2.0 Days Fiscal Year Ends 12/1998 12/1998 Data Source: Media General Financial Services