Fundamental Analysis Overview

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Agenda

What is Fundamental Analysis?

Financial Statement Overview

Key Financial Ratios

Applying Fundamental Analysis

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What is Fundamental Analysis?

Utilizing a company’s financial data to:

• Determine financial health

• Discover intrinsic value

• Compare to industry

• Invest accordingly

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Financial Statement Overview

How to find the financial information?

• Public companies are required to publish their financials• Financial earnings reports

10-Q• Reports the company’s performance after each fiscal quarter• Not required to be audited

10-K• Reports the company’s performance after each fiscal year• More detailed than the 10-Q

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Financial Statement Overview

The Balance Sheet

Assets• Resources that a business owns at a given point of time• Cash, Inventory, Accounts Receivable, P.P.E.• Provide future probable benefit

Liabilities• Represents the company’s debt

Equity• Value that owners have contributed to the business• Profit reserved (not paid out as a dividend)

represents retained earnings

• Presents information about a company’s assets, liabilities and equity at a given point in time

Fundamental Accounting Equation: Assets = Liabilities + Equity

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Financial Statement Overview

The Income Statement

• Presents periodic information about revenues, expenses, and profits

Revenues• The money a company brings in; growth is key

Expenses• Cost of Goods Sold (COGS)

• Cost of purchasing the goods and services sold by the company• Selling, General and Administrative (SG&A)

• Costs of operating the business• Includes depreciation and amortization

Net Income• The “bottom line” or earnings• Net Income = Revenues - Expenses

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Financial Statement Overview

Statement of Cash Flows

• Represents a record of the business’ cash inflows and outflows over a period

3- Types of Cash Flow

Operating Cash Flow• Cash generated from day-to-day business operations

Cash from Investing• Cash used for sale and purchase of assets

Cash from Financing• Cash paid or received from the issuing and borrowing of funds

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REMEMBER

• Ratios alone have no value

• Need to compare ratios to other companies and industry averages (benchmarks)

• Only compare ratios to similar companies (in the same industry)

• Fundamental analysis is just one tool to investing, it does not paint the entire picture

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Financial Ratios

Key Ratios

• Liquidity Ratios

• Profitability Ratios

• Solvency Ratios

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Financial Ratios

• Measure ability to pay debts as they come due

1. Current Ratio = Current Assets ÷ Current Liabilities• measures company’s ability to pay current liabilities with

it’s current assets

2. Quick Ratio• doesn’t include inventory (like current ratio using only

highly liquid assets)

3. Inventory Turnover = Cost of Goods Sold ÷ Average Inventory• the higher the ratio, the faster the company is selling it’s

inventory

Liquidity Ratios

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Financial Ratios

1. Gross Margin = Gross Profit ÷ Net Sales Revenue• how much profit realized per unit sold

2. Profit Margin Ratio = Net Income ÷ Net Sales Revenue• percent of sales revenue that becomes net income

3. Return on Assets = Net Income ÷ Average Assets• how the company uses it’s assets to generate income

4. Return on Equity = Net Income ÷ Average Total Equity• how the company generates income through stockholder’s

investments

Profitability Ratios

• Rate of return

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Financial Ratios

5. Earnings per share (EPS) = Net Income ÷ Number of Shares Outstanding• net income associated with each share of common stock

6. Price per Earnings (P/E) = Price per Share ÷ Earnings per Share• measures how much investors are willing to pay per dollar of earnings

7. Price/Earnings to Growth (PEG Ratio) = P/E Ratio ÷ EPS Growth• Determine a stock’s value while taking the company’s earnings growth

into account

Profitability Ratios

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Additional Investment Considerations

Dividends• Money a company gives it’s shareholders as an additional

incentive to own the stock • Not all companies provide a dividend

Share Repurchases• When a company buys its own shares in the market• Utilized when a company believes it’s stock is undervalued

Stock Splits• Essentially a meaningless stunt by company’s to make their

stock seem like a better value for investors

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Financial Ratios

• Consumer

Same Store Sales• Compares the year over year sales of similar stores• Excludes any new stores built in a given year• Usually a figure presented by companies, doesn’t need to be calculatedSales Per Square Foot

Sales Per Sq Ft = sales ÷ total sq ft• Measures how efficiently locations run their stores• Important for retail and grocery stores, not important for Amazon• Have to measure very comparable stores (i.e. Nike and Under Armour)

Things to consider• Promotions/Discounts• Price Changes• Inventory levels• Traffic (both foot and online)• Profit margin trends• Seasonality

Industry Specific Ratios

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Financial Ratios

Industry Specific Ratios

• Healthcare

Biotechnology

• Product portfolio and research pipeline• Patents to protect products• Drug phases 1-3• R&D as a percent of sales• PEG ratio

Pharmaceuticals• Similar to Biotech but typically larger• Make drugs from chemicals as opposed to biological

substances• Make drugs themselves or license drugs from outside

sources• Revenue growth provides insight to market share and

competition• R&D as a percent of sales• Profit margin shows success of drugs

Healthcare Providers and Services• Hospitals or insurance companies• Enrollment numbers• Operating margin• Sales• Net income

Medical Equipment• Manufacture medical and surgical devices• Operating margin• Cost of goods sold percentage• Inventory turnover (COGS/Avg. Inventory)

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Financial Ratios

• Industrials

Industry Specific Ratios

TurnoverInventory Turnover = Sales ÷ Inventory• Rate at which a company sells and replaces its inventory

Fixed Asset Turnover = Sales ÷ Property, Plant & Equipment (PP&E)• A company’s ability to generate sales from fixed assets (PP&E)• Measure of effectiveness of investments made to increase output

Average Collection Period• Amount of time it takes to receive payment for goods• Important for companies selling large/expensive goods like heavy machinery, aircraft, etc.

Valuation RatiosPrice to Tangible Book Value (P/TBV) = Share Price ÷ Tangible Book Value per Share• Ratio of share price to the value of the tangible assets each share represents• Important metric in an asset-heavy sector such as industrials

Other FactorsRelevant Commodity Prices• Fluctuating commodity prices affect net profit margins. Many industrial companies are reliant on raw and

refined materials.

Backlog/Contracts• Measure of committed future demand for products

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Financial Ratios

• Tech, Media, Telecommunications

Industry Specific Ratios

Technology Sector (Valuation Ratios):• EV/Sales = (Market Cap + Debt – Cash)/Annual Sales

- Gives investors an idea of how much it costs to buy the company’s sales - Will be used if you’re investing in growth companies- Lower is better

 • EV/EBITDA = (Market Cap + Debt – Cash)/EBITDA

- Enterprise Value/Earnings Before Interest, Tax, Depreciation & Amortization - Measures the price an investor pays for the benefit of the company’s cash flow- Will be used if you’re investing in large tech- Lower is better

 Telecommunications Sector (Key Metrics):• Average Return per User (ARPU)

- Illustrates the company’s operational performance (ability to maximize profits and minimize costs)

• Churn Rate- Measures the number of subscribers who leave (low churn rate is ideal)

 • Subscriber Growth

- Measures the company’s future revenue growth and its ability to grow its customer base and add new subscribers

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Financial Ratios

• Energy

Industry Specific Ratios

Price/CF• Oil industry generally carries larger levels of debt so it allows for increased

certainty in meeting debt obligations• The higher the ratio, the risker the stock

Production/Reserves• Production/Reserves shows how long reserves will last at current production rate

with no additions to reserves• 1/Production to Reserves Ratio finds the Reserve Life Index in years• Reserve-Replacement Ratio (%) = (Increase in Reserves +

Production)/Production is to see if a company is increasing or depleting reserves

Things to consider• Price of oil, natural gas, and other resources• Sensitivity to regulation and political events• Reserve rules creating additional costs • Wide variety of ratios are used depending on type of business segments

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Financial Ratios

• Financial Institutions Group (FIG)Industry Specific Ratios

Key Profitability Ratios:Net Interest Margin (NIM) = Net Interest Income ÷ Avg. Earning Assets• Determines how effectively the bank is using assets to generate income (higher is better)

Return on Average Common Equity (ROAE) = Net Income ÷ Avg. Common Equity• Determines a bank's ability to generate returns to investors in its common stock (higher is better)

Capital Adequacy Ratio Tangible Common Equity Ratio (TCE) = (Total Equity - Intangible Assets) ÷ Tangible Assets • Determines how much loss an institution can take before shareholders' equity is zero

Valuation RatiosPrice to Tangible Book Value (P/TBV) = Share Price ÷ Tangible Book Value Per Share*• *Tangible Book Value Per Share = Tangible Assets ÷ # of Shares Outstanding• A representation of how many income-producing assets an institution has

Dividend Discount Model (DDM) = Dividends Per Share ÷ (Discount Rate - Dividend Growth Rate) • A procedure for valuing the price of a stock by using predicted dividends and discounting them back to

present value • If the value obtained from the DDM is higher than what the shares are currently trading at, then the stock

is undervalued*P/E Ratio is also heavily used but it's not industry specific*

*Insurance companies also use Embedded Value• (EV = Present Value of Future Profits + Adjusted Net Asset Value)

*Asset Managers are able to used EV/EBITDA