Company analysis Ratio

Sabuj ghoshSabuj ghosh

Company Analysis Company Analysis Indicators.Indicators.

Two indicators, Two indicators, – Financial Indicator, Financial Indicator, – Non Financial Indicators.Non Financial Indicators.

FINANCIAL INDICATORS:FINANCIAL INDICATORS:

AgendaAgenda

Financials & ProjectionsFinancials & Projections1. Profit & Loss Account1. Profit & Loss Account

2. Balance Sheet2. Balance Sheet

3. Cash Flow Statement3. Cash Flow Statement

4. Financial Ratios4. Financial Ratios

i) Profitabilityi) Profitability

ii) Liquidityii) Liquidity

iii) Efficiencyiii) Efficiency

iv) Valuationiv) Valuation

5. Key Assumptions5. Key Assumptions

Financial RatiosFinancial Ratios

i) Profitability

ii)Liquidity

iii)Efficiency

iv)Valuation

Profitability Ratio:Profitability Ratio:

Return on Investment: Return on Investment: Net Profit Margin:Net Profit Margin: Return On Equity:Return On Equity: Earning Per Share: Earning Per Share: Dividend Cover:Dividend Cover:

i) Profitability Ratiosi) Profitability RatiosROAROA EBIT / Total AssetEBIT / Total Asset

ROEROE PAT (after Pref. Div.) / Net PAT (after Pref. Div.) / Net WorthWorth

ROCEROCE EBIT / Capital Employed EBIT / Capital Employed

DuPont Analysis-ROE DecompositionDuPont Analysis-ROE Decomposition (1*2*3*4*5)(1*2*3*4*5)

1. PAT/PBT (Tax Efficiency)1. PAT/PBT (Tax Efficiency)

2. PBT/EBIT (Interest Burden)2. PBT/EBIT (Interest Burden)

3. EBIT/Sales (Operating Profit Margin)3. EBIT/Sales (Operating Profit Margin)

4. Sales/Total Assets (Asset Turnover)4. Sales/Total Assets (Asset Turnover)

5. TA/NW (Financial Leverage)5. TA/NW (Financial Leverage)

ii) Liquidity Ratiosii) Liquidity Ratios

Current Current RatioRatio

Current Assets / Current Current Assets / Current LiabilitiesLiabilities

Acid Test Acid Test RatioRatio

Quick Assets / Current Quick Assets / Current LiabilitiesLiabilities(Quick Asset= Current Asset-(Quick Asset= Current Asset-InventoryInventory))

Debt Equity Debt Equity RatioRatio

Total Debt / Owners’ fundTotal Debt / Owners’ fund

iii) Efficiency Ratiosiii) Efficiency Ratios

Activity RatiosActivity Ratios

Asset Turnover Asset Turnover RatioRatio

Turnover / Total AssetsTurnover / Total Assets

Working capital Working capital Turnover RatioTurnover Ratio

Turnover / Net working Turnover / Net working capitalcapital

FA Turnover FA Turnover RatioRatio

Turnover / Total Fixed Turnover / Total Fixed AssetsAssets

CA Turnover CA Turnover RatioRatio

Turnover / Total Turnover / Total Current AssetsCurrent Assets

Debtor VelocityDebtor Velocity Credit Sales / Avg. A/c Credit Sales / Avg. A/c ReceivableReceivable

Margin RatiosMargin Ratios

EBITDA EBITDA MarginMargin

EBITDA / SalesEBITDA / Sales

Pre-Tax Pre-Tax MarginMargin

PBT / SalesPBT / Sales

Net Profit Net Profit MarginMargin

PAT / SalesPAT / Sales

iii) Efficiency Ratiosiii) Efficiency Ratios

iv) Valuation Ratiosiv) Valuation Ratios

Adj. EPSAdj. EPS PAT (excluding minority PAT (excluding minority interest) / Total Number interest) / Total Number of outstanding shares of outstanding shares

Cash EPSCash EPS (PAT+ Depreciation) / (PAT+ Depreciation) / Total Number of Total Number of Outstanding sharesOutstanding shares

Dividend Per ShareDividend Per Share Total Dividend declared / Total Dividend declared / Total Number of Total Number of Outstanding sharesOutstanding shares

Book Value Per Book Value Per ShareShare

Net Worth / Total Net Worth / Total Number of Outstanding Number of Outstanding sharesshares

Secondary Market Related Secondary Market Related Ratio:Ratio:

The Equity Investors The Equity Investors contemplating investment contemplating investment through the secondary market through the secondary market consider the following Market consider the following Market Related Ratio: Related Ratio: – Earning-Price Ratio = EPS / Market Earning-Price Ratio = EPS / Market

price per share.price per share.– Market yield =Market yield =

[Dividend + Price Change]/ Initial [Dividend + Price Change]/ Initial Price.Price.

= [D= [D11 +(P +(P22 + P + P11)] / P)] / P11

Case 1Case 1 A company with high Debt-Equity A company with high Debt-Equity

ratio but low Interest Coverage ratio but low Interest Coverage Ratio is perceived to have a high Ratio is perceived to have a high degree of financial risk.degree of financial risk.

Effect – Equity Share Holders Effect – Equity Share Holders may demand a high rate of may demand a high rate of return on their investment to return on their investment to compensate the high degree of compensate the high degree of Business and Financial Risk. Business and Financial Risk.

EPS Vs. CEPSEPS Vs. CEPS

Why are CEPS considered Why are CEPS considered more efficient signals?more efficient signals?

Depreciation policy defers widely among Depreciation policy defers widely among companies even with in a company from companies even with in a company from one year to another and hence makes one year to another and hence makes comparison difficult. comparison difficult.

Another advantage is that they give a Another advantage is that they give a better idea of the cash available for use better idea of the cash available for use with in a company, since depreciation is a with in a company, since depreciation is a non cash charge. non cash charge.

A third factor of preference is that EPS A third factor of preference is that EPS discriminates against growing companies discriminates against growing companies which have been building their gross block which have been building their gross block of assets compared with companies which of assets compared with companies which are growing slowly and therefore are not are growing slowly and therefore are not investing in fixed assets. If company’s investing in fixed assets. If company’s profit figure is low due to high profit figure is low due to high depreciation it does not indicate less-depreciation it does not indicate less-efficiency. efficiency.

ROE Analysis:ROE Analysis: Profitability, turnover and leverage can Profitability, turnover and leverage can

be measured by ROE. be measured by ROE. ROE = (PAT/NS) x (NS/TA) x (TA/NW)ROE = (PAT/NS) x (NS/TA) x (TA/NW)

PAT/NS = [PBT/NS] x [1 – TAXES/PBT ]PAT/NS = [PBT/NS] x [1 – TAXES/PBT ] = Pre tax margin x Post tax = Pre tax margin x Post tax

retention ratio. retention ratio. ROE = (PBT/NS) x (PAT/PBT) x (NS/TA) xROE = (PBT/NS) x (PAT/PBT) x (NS/TA) x

(TA/NW)(TA/NW)

Part Wise Analysis of Part Wise Analysis of ROE.ROE. PAT/NS :- Measurement of Profitability.PAT/NS :- Measurement of Profitability.

NS/TA :- Measure Efficiency with which NS/TA :- Measure Efficiency with which total assets are employed. total assets are employed.

TA/NW :- measure Leverage.TA/NW :- measure Leverage. A trend analysis of PAT/NS and TA/NW A trend analysis of PAT/NS and TA/NW

provides an idea of the business and provides an idea of the business and Financial Risk assumed by a company. Financial Risk assumed by a company.

The higher post tax margin and total The higher post tax margin and total asset turnover ratio, the profitable the asset turnover ratio, the profitable the Firm. Firm.

Part Wise Analysis of Part Wise Analysis of ROE.ROE.

An extremely high turnover ratio An extremely high turnover ratio may indicate that the firm is up may indicate that the firm is up against the capacity limit of its plant against the capacity limit of its plant and equipment and therefore and equipment and therefore provides a worming signal that the provides a worming signal that the firm may have to expand its firm may have to expand its capacity. capacity.

Part-III: Company Part-III: Company ValuationValuation

AgendaAgenda1. Valuation1. Valuation

– Valuation MethodologyValuation Methodology– DCFDCF– Relative ValuationRelative Valuation

2. Key Risks2. Key Risks

3. Valuation Perspectives3. Valuation Perspectives

i) Valuation Methodologyi) Valuation Methodology

ii) Discounted Cash Flowii) Discounted Cash Flow

iii) Relative Valuationiii) Relative Valuation

1. Company Valuation1. Company Valuation

i) Valuation i) Valuation MethodologiesMethodologies

VALUATION METHODOLOGI

ES

MARKET CAPITALIZATION

APPROACH

DISCOUNTED CASH FLOW APPROACH

ADJUSTED BOOK VALUE APPROACH

MULTIPLES

LEVERED

UN-LEVERED

P/EP/CFP/BV

EV/EBITDAEV/EBITEV/REVENUE

ii) Discounted Cash Flow ii) Discounted Cash Flow (DCF)(DCF)Discounts the anticipated future cash flowDiscounts the anticipated future cash flow

DPV= FV/ (1+K)DPV= FV/ (1+K)nn

Where,Where,DPV= Discounted Present ValueDPV= Discounted Present ValueFV= Future ValueFV= Future Valuen= Number of yearsn= Number of yearsK= Cost of CapitalK= Cost of Capital

WACCWACCCost of Capital Cost of Capital -- From which point of view?From which point of view?- What model?What model?- Normalization of dataNormalization of data

ii) Discounted Cash ii) Discounted Cash Flow (DCF)Flow (DCF)

Where,Where, E= equityE= equity V= Value of the firm V= Value of the firm (i.e. total market value of equity + total market (i.e. total market value of equity + total market

value of debt)value of debt)D= total debt componentD= total debt component

Ke= cost of equityKe= cost of equity Kd= cost of debtKd= cost of debt t= corporate tax ratet= corporate tax rate

Cost of Capital

WACC=(E/V)*Ke+ (D/V)*Kd*(1-t)

ii) Discounted Cash Flow ii) Discounted Cash Flow (DCF)(DCF)

Different type ofDifferent type of Dividend Discount ModelZero Growth ModelZero Growth ModelConstant Growth ModelConstant Growth ModelTwo-stage ModelTwo-stage ModelH-Model H-Model (n.b. For detail refer (n.b. For detail refer Annexure-VAnnexure-V attached to the Report) attached to the Report)

Dividend Discount Model

ii) Discounted Cash Flow ii) Discounted Cash Flow (DCF)(DCF)

FCFF= FCFF=

NOPLATNOPLAT

+ Amortization/ Depreciation+ Amortization/ Depreciation

- Inc /(Dec) in working capital- Inc /(Dec) in working capital

- Capital Expenditure- Capital Expenditure

+Inc /(Dec) Deferred Taxes+Inc /(Dec) Deferred Taxes

Free Cash Flow to Firm

ii) Discounted Cash Flow ii) Discounted Cash Flow (DCF)(DCF)

FCFE =FCFE =

FCFFFCFF

- Interest (1-t)- Interest (1-t)

+ Net Borrowing (from long term + Net Borrowing (from long term perspective)perspective)

Free Cash Flow to Equity holder

iii) Relative Valuationiii) Relative Valuation The value of an asset is arrived byThe value of an asset is arrived by

– Compared to the values of similar asset in the Compared to the values of similar asset in the marketmarket

StepsSteps

1. Identify comparable assets and obtain 1. Identify comparable assets and obtain market values of these market values of these

2. Convert these market values into 2. Convert these market values into standardized valuesstandardized values since the absolute prices cannot be compared. since the absolute prices cannot be compared.

3. Compare the subject asset with standardized 3. Compare the subject asset with standardized value or multiple value or multiple

4. Take suitable multiples for the differences4. Take suitable multiples for the differences

5. Mention clearly the assumptions used5. Mention clearly the assumptions used

2. Key Risks of Maruti 2. Key Risks of Maruti

a. Nature & typesa. Nature & types

b. Gravityb. Gravity

a. Nature & typesa. Nature & types Over dependence on domestic marketOver dependence on domestic market Competition hotting up in the growth Competition hotting up in the growth

engine of compact carsengine of compact cars Maruti does not own diesel engine Maruti does not own diesel engine

technology technology Soaring metal Market may cast its Soaring metal Market may cast its

spell on marginsspell on margins Rising Bank interest rates will impact Rising Bank interest rates will impact

the demand and operational costthe demand and operational cost

b. Gravityb. Gravity Launch of newer models on a Launch of newer models on a

continuous basis is a big continuous basis is a big challengechallenge

Fuel efficiency, Maintenance Fuel efficiency, Maintenance and Safety rank very high in the and Safety rank very high in the buyers’ decision-making matrix.buyers’ decision-making matrix.

Vendor development is crucialVendor development is crucial

3. Valuation 3. Valuation PerspectivesPerspectives

a. Challengesa. Challenges

b. Applicability to different b. Applicability to different industriesindustries

c. Preparing a valuation Reportc. Preparing a valuation Report

d. Case Discussionsd. Case Discussions

a. Challengesa. Challenges

DCF model is very sensitive to DCF model is very sensitive to – Growth rate projection and Growth rate projection and – Weighted average cost of capital Weighted average cost of capital

(WACC).(WACC). Comparative Multiple: Comparative Multiple:

No two companies have No two companies have – Same product profile and target Same product profile and target

segment. segment. – Same capital structure Same capital structure – Similar management practicesSimilar management practices

a. Challenges a. Challenges ...contd...contd

Cyclical BusinessCyclical Business Private CompanyPrivate Company Spin offs/ Selling of a divisionSpin offs/ Selling of a division Firm with Negative EarningsFirm with Negative Earnings Young & Start-up firmYoung & Start-up firm Financial Services CompaniesFinancial Services Companies

b. Applicability to different b. Applicability to different industriesindustries

i) Pharmaceutical Industryi) Pharmaceutical Industry

ii) Sugar Industryii) Sugar Industry

iii) Information & Technologyiii) Information & Technology

iv) Logisticsiv) Logistics

i) Pharmaceutical i) Pharmaceutical IndustryIndustry

Product Pipe line and patentsProduct Pipe line and patents R&D cost as a % of SalesR&D cost as a % of Sales Size and growth of therapeutic Size and growth of therapeutic

segmentsegment Contract manufacturing Contract manufacturing

opportunityopportunity Generics opportunityGenerics opportunity Access to distribution networksAccess to distribution networks

ii) Sugar Industryii) Sugar Industry Production capacityProduction capacity Cogen unitCogen unit Flexible manufacturing system to Flexible manufacturing system to

produce ethanol, alcoholproduce ethanol, alcohol Availability of raw materialAvailability of raw material Governmental policies about levy Governmental policies about levy

sugar, subsidies, minimum prices sugar, subsidies, minimum prices for farmersfor farmers

World scenario of sugar supply, World scenario of sugar supply, consumption and balance.consumption and balance.

iii) Information & iii) Information & TechnologyTechnology

Revenue by geographyRevenue by geography Customer’s Industry Vertical/ Domain Customer’s Industry Vertical/ Domain Revenue generated from various contract Revenue generated from various contract

like fixed price contract type or fixed time like fixed price contract type or fixed time contract contract

Services offering like application Services offering like application development maintenance, enterprise development maintenance, enterprise solution & others.solution & others.

Revenue from repeat business & new Revenue from repeat business & new businessbusiness

Business generation from off shore and Business generation from off shore and onsiteonsite

iv) Logisticsiv) Logistics

Occupancy RateOccupancy Rate Frequency of congestion free air traffic Frequency of congestion free air traffic Income generated per passenger per Income generated per passenger per

seatseat ATF as a % of total sale (prime operating ATF as a % of total sale (prime operating

expense)expense) Size & growth of the sectorSize & growth of the sector Competition among playersCompetition among players Government regulation towards civil Government regulation towards civil

aviationaviation

- Airways

Load factor (cargo handling)Load factor (cargo handling) Bunker cost as a % of total sales Bunker cost as a % of total sales

(prime operating expense)(prime operating expense) Cargo handling expenses as a % total Cargo handling expenses as a % total

salessales Size & growth of the sectorSize & growth of the sector Government regulation towards the Government regulation towards the

sectorsector Export/ Import Factor of the countryExport/ Import Factor of the country Aging factor of shipsAging factor of ships

- Shipping

LogisticsLogistics

How to Write a Valuation How to Write a Valuation Report?Report?

Don’tsDon’ts– Never start Valuation before understanding Never start Valuation before understanding

the businessthe business– Never Start with FinancialsNever Start with Financials– Don’t give too much focus on the past – Don’t give too much focus on the past –

leave that to the historiansleave that to the historiansDo’sDo’s

– Be Brief and ConciseBe Brief and Concise– Put Relevant Information form the point of Put Relevant Information form the point of

view of Investmentview of Investment– Should contain Graphs/Tables/ChartsShould contain Graphs/Tables/Charts– The Graphs/Tables/Charts should be The Graphs/Tables/Charts should be

analyzed and not described in textanalyzed and not described in text– Analyses should facilitate/enable in Analyses should facilitate/enable in

investment decision makinginvestment decision making– Assumptions should be stated after being Assumptions should be stated after being

validatedvalidated

Process for Valuation Process for Valuation ReportsReports

Follow the Deductive Logic Path to Follow the Deductive Logic Path to Understand the Business of the company Understand the Business of the company by going throughby going through– Industry ReportsIndustry Reports– Company WebsiteCompany Website– Equity Research ReportsEquity Research Reports

Prepare a Plan on the Research Prepare a Plan on the Research Objective and ApproachObjective and Approach

Identify Time Schedules and Milestones Identify Time Schedules and Milestones

Process for Valuation Process for Valuation ReportsReports

…Contd…Contd Identify the parameters to be takenIdentify the parameters to be taken Segmental AnalysisSegmental Analysis Competitive EvaluationCompetitive Evaluation Future ProspectsFuture Prospects Earnings OutlookEarnings Outlook

Decide the Valuation Methodology taking into Decide the Valuation Methodology taking into account the Industry in which the company is account the Industry in which the company is operatingoperating

Study the Capital Structure of the Firm and Study the Capital Structure of the Firm and Notes to AccountsNotes to Accounts

Arrive at the Growth Rates and Discount RatesArrive at the Growth Rates and Discount Rates Calculate the Value of the companyCalculate the Value of the company Validate the Values Validate the Values Prepare the reportPrepare the report

Data Sources for Equity Data Sources for Equity ResearchResearch SEC Filings – 10K, 10Q, 8 KSEC Filings – 10K, 10Q, 8 K

News ItemsNews Items Company WebsiteCompany Website Annual Reports Annual Reports

– Chairman’s SpeechChairman’s Speech– MD&AMD&A– Balance Sheet Balance Sheet – P/l AccountP/l Account– Cash Flow StatementCash Flow Statement– Notes to AccountsNotes to Accounts

Research ReportsResearch Reports Company Press ReleasesCompany Press Releases Industry Associations/ForumsIndustry Associations/Forums Government SourcesGovernment Sources

Process for ReportsProcess for Reports

Understanding Business

Identifying Time schedule & Milestones

Plan of ActionDeciding on

Valuation Model

Predicting Growth Rates

Identifying Key Parameters

PROCESS CYCLE

Content & Quality Check (Levels 3)

Report Preparati

on

Delivery

3(iv) Case Discussions on3(iv) Case Discussions on Sell side: Maruti UdyogSell side: Maruti Udyog

Buy side : Valuation Attractive Buy side : Valuation Attractive ( Gammon India)( Gammon India)

Changing Gear in AutoChanging Gear in Auto

ICRA valuationICRA valuation

Thank YouThank You