Financial analysis a user approach

FINANCIAL ANALYSIS A USER APPROACH GARY GIROUX Texas A&M University British Council Ethiopia II1IIIIIIIII R 432702338 ~WILEY www.wiley.comJcollegeJgiroux AcquisitionsEditor JayO'Callaghan Marketing Manager Keari Bedford Production Manager LariBishop Designer Shoshanna Threk Illustration Editor Michele Chancellor Copy Editor Leon Unruh Indexer SandySchroeder Cover Design BenjaminReece Cover Images Milan main gallery:Copyright ICCorbis All others: Copyright ©PhotoDisc This book was set in Minion and printed and bound by Malloy, Inc The cover was printed by Phoenix Color Corp This book is printed on acid free paper.w Copyright ©2003 Leyh Publishing LLC This textbook was published by John Wiley & Sons, Inc under exclusive licensefrom Leyh Publishing, LLC No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc 222 Rosewood Drive, Danvers, MA 01923 (508)750-8400,fax (508)750-4470 Requests to the Publisher for permission should be addressed to the PermissionsDepartment, John Wiley & Sons, Inc., III River Street, Hoboken, NJ 07030 (201)748-6011,fax (201)748-6008.E-Mail:PERMREQ@WILEY.COM To order books or for customer service please call1-800-CALLWILEY (225-5945) ISBN0-471-22990-3 This book is dedicated to the memory of Michael, Sunny, and Louis Giroux Contents PREFACE XIV ABOUT THE AUTHOR XX Chapter • WHAT Is FINANCIAL ANALYSIS? Objectives 1 INTRODUCTION PURPOSE CORPORATE OVERVIEW INDUSTRY ANALYSIS BUSINESS STRATEGY DELL'S BUSINESS STRATEGY QUANTITATIVE FINANCIAL ANALYSIS DETAILED ACCOUNTING ANALYSIS COMPREHENSIVE ANALYSIS 10 FINANCIAL ANALYSIS DECISION Summary 11 Key Terms 11 Problems 12 Cases 19 10 Questions 11 Ethics Considerations 19 Internet Projects 20 Chapter • THE FINANCIAL ENVIRONMENT Objectives 21 INTRODUCTION 21 CAPITAL MARKETS 22 v 21 FINANCIAL ANALYSIS: A USER APPROACH CREDIT DECISIONS 23 EQUITY INVESTMENT DECISIONS SEC REGULATION 24 FINANCIAL REPORTING THE FASB 23 24 25 FINANCIAL STATEMENTS 25 MANAGEMENT INCENTIVES FOR DISCLOSURE 26 THEORETICAL PERSPECTIVES FROM FINANCIAL THEORY EFFICIENT MARKETS 27 RANDOM WALK THEORY 29 PORTFOLIO THEORY AND THE CAPITAL ASSET PRICING MODEL BETA (B) ANALYSIS 30 EFFICIENT CONTRACTING AND AGENCY THEORY ECONOMIC RATIONALITY AND BEHAVIOR 31 31 EARNINGS MANAGEMENT AND ACCOUNTING CHOICE ECONOMIC CONSEQUENCES Summary 33 KeyTerms Problems 34 Cases 37 Internet Projects 38 33 33 Questions 34 Ethics Considerations 37 Chapter • THE FINANCIAL STATEMENTS 39 Objectives 39 INTRODUCTION 39 THE BALANCE SHEET 41 ASSETS 41 LIABILITIES 44 STOCKHOLDERS' EQUITY 45 INCOME STATEMENT 46 STATEMENT OF CASH FLOWS 47 STATEMENT OF STOCKHOLDERS) EQUITY Summary 50 Key Terms 50 Problems 51 Cases InternetProjects 54 53 Questions 50 Ethics Considerations 53 50 32 29 27 CONTENTS Chapter • I vii QUANTITATIVE FINANCIAL ANALYSIS USING FINANCIAL STATEMENT INFORMATION Objectives 55 INTRODUCTION 55 56 COMMON-SIZE ANALYSIS 59 FINANCIAL RATIOS LIQUIDITY ACTIVITY 55 60 61 63 LEVERAGE/SOLVENCY PROFITABILITY 65 66 DUPONT MODEL LIMITATIONS OF RATIO ANALYSIS 67 Summary 68 KeyTerms 68 A Summary of Financial Ratios 70 Questions 69 Problems InternetProjects 81 Cases 68 79 ApPENDIX: OTHER FINANCIAL RATIOS AND CONSIDERATIONS 82 Chapter • M ULTIPERIOD QUANTITATIVE FINANCIAL ANALYSIS Objectives 83 INTRODUCTION 83 83 GROWTH ANALYSIS TREND ANALYSIS 86 QUARTERLY ANALYSIS 87 Summary 89 KeyTerms 89 Questions 89 Problems 89 Cases 97 InternetProjects 101 Chapter • QUANTITATIVE FINANCIAL ANALYSIS TECHNIQUES: INCORPORATING MARKET INFORMATION Objectives 102 102 83 vIII I FINANCIALANALYSIS:A USER APPROACH INTRODUCTION STOCK PRICES 102 103 EARNINGS PER SHARE AND ~LYSTS FORECASTS CALCULATING MARKET-RELATED RATIOS PRICE EARNINGS RATIO DIVIDEND YIELD 105 106 107 109 MARKETVALUE AND MARKET-TO-BOOK RATIO MARKET-RELATED RATIOS DEBT TO MARKET EQUITY 109 110 110 SALES TO NET ASSETS AND SALES TO MARKETVALUE 111 PRICE EARNINGS TO EARNINGS GROWTH RATES (PEG) BETA (B) ANALYSIS 111 113 VALUATION MODELS 114 EARNINGS-BASED GROWTH (DIVIDEND DISCOUNT) MODEL INTRINSIC VALUE PER SHARE STOCK SCREENING 114 115 115 Summary 116 Key Terms 117 Questions 117 Problems 118 Ethics Considerations 129 A Summary ofMarket Ratios 117 Cases 126 Internet Projects 130 Chapter • AN ACCOUNTING ANALYSIS PERSPECTIVE Objectives 131 131 INTRODUCTION 131 REVENUE RECOGNITION 132 CONSERVATIVE VERSUS AGGRESSIVE RECOGNITION EXPENSES 133 134 EBIT AND EBITDA 135 NONRECURRING ITEMS 136 NET INCOME VERSUS COMPREHENSIVE INCOME 137 PRO FORMA STATEMENTS AND S&P'S CORE EARNINGS ANALYSIS USING THE CASH FLOW STATEMENT DETAILED ACCOUNTING ANALYSIS 140 139 138 CONTENTS FINANCIAL ACCOUNTING OVERVIEW 141 EVALUATE ACCOUNTING REPORTING COMPLETENESS 141 EVALUATE THE POTENTIALFOR EARNINGS MANAGEMENT CONSIDER POTENTIALRED FLAGS 141 142 REEVALUATE OR RESTATE FINANCIAL INFORMATION 142 UPDATING ANNUAL REpORT INFORMATION 143 Summary 143 Key Terms 144 A Summaryof Financial Ratios 144 Questions 144 Problems 145 Cases 152 Ethics Considerations 156 Internet Projects 156 Chapter • ACCOUNTING ANALYSIS: SPECIFIC ISSUES Objectives 157 157 INTRODUCTION 157 MARKETABLE SECURITIES INVENTORY 158 159 FIXED ASSETS (PROPERTY, PLANT, AND EQUIPMENT) TAX ALLOCATION 162 INTERPERIOD TAX ALLOCATION 163 INCOME INCOME TAX DISCLOSURES AND EFFECTIVE TAX RATES LEASES 160 164 166 SPECIAL PURPOSE ENTITIES 168 Summary 169 Key Terms 169 A Summaryof Financial Ratios 169 Questions 170 Problems 170 Cases 174 Ethics Considerations 177 Internet Projects 178 Chapter • ACCOUNTING ANALYSIS: SPECIFIC ISSUES Objectives 179 INTRODUCTION STOCK OPTIONS 179 180 SEGMENT REpORTING FOREIGN CURRENCY 181 182 179 I Ix Business Index A Alcoa depreciation for, 162 fixed assets for, 161 inventory for, 160 Amazon.com, credit analysis for, 245-47 American Airlines, 134 acquisiton of TWA by, 225 American Electic Power, liabilities of,224 AOL Time Warner, 137, 169,204, 206-7,209-10 Apple Computer, 3, 5, 56 abbreviated financial statements for, 57 abbreviated income statement for, 84 accounting analysis for, 218-20 activity ratios, 63 annual earnings growth rate for, 85 assets of, 43 beta analysis for, 31,113,114 bond ratings for, 230 business strategy for, 260 common-size statements for, 58, 59 corporate debt for, 223 debt to market equity for, III depreciation for, 161, 162 Dupont Model calculations for, 66 earnings per share for, 105 EBITDA for, 135 effective tax rate for, 165, 166 financial statements for, 57 fiscal year for, 84 fixed assets for, 161 forecasts for, 106 geographic segment analysis for, 184 industry segments for, 182 intrinsic value per share, 115 inventory for, 160 leases for, 167 leverage ratios for, 64, 65 liquidity for, 61 marketable securities for, 158 market to book ratio for, 110 performance for, 85, 86 price earnings ratio for, 107, 108 price earnings to earnings growth rates for, 112 quarterly analysis for, 87-88 revenue recognition for, 133 segment reporting for, 181 stock options for, 180, 181 stock prices for, 103 trend analysis for Z-score calculation for, 228 B BellSouth, 239 Boeing, 133 Bristol-Myers Squibb, 136 C Carnegie Steel, 203 Chance Vought, 204 Cisco Systems, 134-35 Citigroup, 30 Coca-Cola, 3, 272 Compaq, 103, 141 acquisition by Hewlett-Packard, 211 acquisition of Digital Equipment Corporation, 211 Conoco, 85, 136, 137 Continental Airlines, 134 ConvergeNet Technologies, acquisition by Dell Computer, 211 285 D DaimlerChrysler, 204 Dell Computer, 3, 5, 24, 26, 56 abbreviated financial statements for, 57-58 abbreviated income statement for, 84 accounting analysis for, 218-20 acquisition of ConvergeNet Technologies, 211 activity ratio for, 62 annual earnings growth rate for, 85 annual report for, 56,143 asset position for, 43-44 balance sheet for, 59 beginning balances for fiscal year in,50 beta analysis for, 30-31, 113, 114 bond ratings for, 230 business strategy, 6-8 cash flow statement for, 139, 140 comprehensive analysis for, 270 corporate debt for, 223 corporate overview for, 8, 260, 270 credit analysis for, 244 current ratio for, 60, 63 debt to market equity for, III deferred taxes for, 165 depreciation for, 161, 162 detailed accounting analysis for, 270 DuPont Model calculations for, 66 earnings per share, 105, 106 EBITDA for, 135 effective tax rate for, 164-165 equity analysis for, 256-57 executive summary for, 270 financial accounting overview for, 141 286 I FINANCIAL ANALYSIS: A USER APPROACH financial analysis for, 261 financial reporting for, 185-86 financial statement analysis for, 270 financial statements for, 40 fiscal year for, 84 fit to the growth fund, 258-59 fixed assets for, 161 income statement for, 9,164 income statements of, 46 industry segment analysis for, 183 industry segments for, 182 intrinsic value per share for, 115 inventory for, 160 investment decision for, 270 investment decisions for, 264 investment purpose for, 270 leases for, 167 leverage ratio for, 64, 65 liabilities of, 44 liquidity ratio for, 61 marketable securities for, 158 market analysis for, 261 market share of,S market to book ratio for, 110 net assets for, 109 operations by geographic region for, 181 options used by, 189-90 price earnings ratio for, 107, 108 price earnings to earning growth rate for, 112 quarterly analysisr, 87-88, 97-99 ratio analysis for, 226-27 reconciled cash for, 48 revenue recognition for for, 133 sales to net assets ratio for, III segment reporting for, 181 shares issued by, 45 stock options for, 179, 180-81 stock prices for, 103 trend analysis for, 86 Z-score caluation for, 228 Delta Airlines, inventory for, 160 Digital Equipment Corporation, acqusition by Compaq, 211 Disney, compensation at, 199-200 Drexel Burnham Lambert, 239 Duke Energy, 161, 162 corporate debt for, 224 depreciation for, 162 fixed assets for, 161 Dun & Bradstreet, 56 DuPont, 44,109,136,142 acquisition and divestment strategyof,216 assets of, 51 business segment information for, 179 cash flows from operations for, 52 corporate overview and business strategy, 12-14 credit analysis for, 244 preferred stock at, 51-52 E Eastman Kodak, 30 Enron,22,24,27,168-69 ExxonMobil, 204 projected growth rate for, 257 F Ford Motor, 6, 109 classifying debt for, 236-38 corporate debt for, 224 corporate overview and business strategy for, 17-19 depreciation for, 162 fixed assets for, 161 marketable securities for, 159 Z-scores in, 235 G Gateway Computer, 3, 5, 56 abbreviated financial statements for, 57 abbreviated income statement for, 84 accounting analysis for, 218-20 acquisition of NECX Direct, 211 activity ratio for, 61, 62, 63 annual earnings growth rate for, 85 annual growth percentage for, 85 assets for, 43 balance sheet for, 59 beta analysis for, 11,31,114 bond ratings for, 230 business strategy for, 260 closing stock prices for, 104 common-size analysis for, 58 corporate debt for, 223 daily trends for, 103 depreciation for, 161, 162 DuPont Model calculations for, 66 earnings per share for, 105, 106,107 EBITDA for, 135 effective tax rate for, 165, 166 financial accounting overview for, 141 financial statements for, 57 fiscal year for, 84 fixed assets for, 161 geographic segment analysis for, 183 industry segment analysis for, 184 industry segments for, 182 intrinsic value per share for, 115 inventory for, 160 investment decisions for, 264 leases for, 167 leverage ratios for, 65 marketable securities for, 158 marketto book ratio for, 110 price earnings to earnings growth rates for, 112 profitbility ratio for, 66 quarterly statements for, 143 quaterly analysis for, 87-88 red flags for, 142 revenue recognition for, 133 segment reporting for, 181 stock options for, 180, 181 trend analysis for, 86 Z-score caluation for, 228 General Electric (GE), 3-4, 272 debt levels at, 236 evaluating stock options and pensions at, 196-97 income statement items for, 53 as old economy company, 109 pension plans for, 188 projected growth rate for, 257 General Motors (GM) corporate debt for, 224 special purpose entities for, 168-69 Z-scores in, 235 Global Crossing, 27,129-30,134,239 BUSINESS INDEX H lfewlett-Packard,3, 103 acquisiton of Compaq by, 211 Hilton Hotels, 52 corporate overview and business strategy, 14-16 revenue and operating expenses for, 52 lfoovers,4,116 I IBM (International Business Machines),3,5,19 Intel, projected growth rate for, 257 International Paper, projected growth rate for, 257 ISM,161 K Kmart, bankruptcy filing by, 225 L Ling Electronic, 204 Ling-Temco-Vought (LTV), 204 Lucent Technologies, 139-40, 142 M Marathon Oil, 4, 204 Merck, projected growth rate for, 257 Merrill Lynch, 22, 269 Microsoft,30, 161, 169 contingencies at, 152-53 financial risks and use of derivatives at, 2OG-201 projected growth rate for, 257, 258 stock option reporting at, 197-99 Moody's, 229, 230 N NCR, NECX Direct, acquisition by Gateway, 211 o ~ensCorning,28,44 p Pepsi,3 PETCO, 138 Philip Morris, projected growth rate for, 257 Piles of Tiles, 241-42, 244 credit analysis for, 242 Pitney Bowes, PPG,44 Procter & Gamble, 30, 115 Q ~uicken,4-5, T Temco,204 Toyota, Trans World Airlines (TWA), 137 bankruptcy filing by, 225 Z-score caluation for 229 Tyco,22 u United Airlines proposed merger with US Air 214-15 US Air proposed merger with United Airlines, 214-15 USX (U.S Steel) 203 204 W WalMart 225 WorldCom.22.27.156.216 106,112,113 X Xerox, 3, 22 134 restatement of revenue, 153-56 Risk Grades, 113-14 S Sears, leases for, 167 Southern Company, 109 Standard Oil, 203 287 Standard & Poor's, 229, 230 bond rating information for related companies, 230 core earnings, 138-39 Sun Microsystems, ~west,239 R I y YahOo, z Zacks 106 112 Subject Index A accelerated depreciation, 166 accounting accrual, 134 for acquisitions, 204-{i cookbook, 167,205 for derivates, 189 for foreign currency, 184-86 accounting analysis, 131-43 cash flow statements in, 139-40 conservative versus aggressive recognition in, 133-34 in credit analysis, 240, 243-44 derivations in, 188-90 detailed, 9-10, 140-42 earnings before interest, taxes, depreciation, and amortization (EBITDA) in, 135 ernings before interest and taxes (EBIT) in, 135 expenses in, 134-35 fixed assets in, 160-62 foreign currency in, 182-86 income tax allocation in, 162-66 inventory in, 159-60 leases in, 166-68 marketable securities in, 158-59 net income versus comprehensive income in, 137-38 nonrecurring items in, 136-37 postemployment benefits in, 186-88 proforma statements in, 138-39 revenue recognition in, 132-33 segment reporting in, 181-82 special purpose entities in, 168-69 S&P's core earnings in, 138-39 stock options in, 180-81 updating annual report information in, 143 accounting choice, 32 Accounting Principles Board (APB), 25, 159 Opinion 14,46 Opinion 16,205 Opinion 20,136 Opinion 30, 136 accounting reporting, evaluating completeness of, 141 Accounting Research Bulletin (ARB) No 40,204 accounts payable, 60 accounts receivable, 23, 60 accounts receivable growth, 84 accrual accounting, 134 accumulated benefit obligation (ABO),187 acid test ratios, 60, 68 Ackerman, Duane, 239 acquisitions, 160,203 accounting for, 204-{i market reaction to announcements, 208-10 by personal computer manufacturers, 211-12 strategic, 216 acquisition values, 41 activity ratios, 59, 61-63, 68-69,82 administrative costs, 253 adverse selection, 31 agency costs, 31 agency theory, 27 aggressive revenue recognition, 133-34 Alcoa depreciation for, 162 fixed assets for, 161 289 inventory for, 160 Altman, Edward, 223 Altman's Z-score, 227-29 Amazon.corn, credit analysis for, 245-47 American Airlines, 134 acquisiton of TWA by, 225 American Electic Power, liabilities of, 224 American Stock Exchange (Amex), 22,103 analysts' forecasts, 106 annual management fees, 253 annual reports, 56 management discussion and analysis in, 6-7 updating information in, 143 antitrust violations, 211 AOL Time Warner, 137, 169,204, 206-7,209-10 Apple Computer, 3, 5, 56 abbreviated financial statements for, 57 abbreviated income statement for, 84 accounting analysis for, 218-20 activity ratios, 63 annual earnings growth rate for, 85 assets of, 43 beta analysis for, 31,113, 114 bond ratings for, 230 business strategy for, 260 common-size statements for, 58, 59 corporate debt for, 223 debt to market equity for, 111 depreciation for, 161, 162 Dupont Model calculations for, 66 earnings per share for, 105 290 I FINANCIAL ANAlYSIS: A USER APPROACH EBITDA for, 135 effective tax rate for, 165, 166 financial statements for, 57 fiscal year for, 84 fixed assets for, 161 forecasts for, 106 geographic segment analysis for, 184 industry segments for, 182 intrinsic value per share, 115 inventory for, 160 leases for, 167 leverage ratios for, 64, 65 liquidity for, 61 marketable securities for, 158 market to book ratio for, 110 performance for, 85, 86 price earnings ratio for, 107, 108 price earnings to earnings growth rates for, 112 quarterly analysis for, 87-88 revenue recognition for, 133 segment reporting for, 181 stock options for, 180, 181 stock prices for, 103 trend analysis for Z-score calculation for, 228 asset plays, 272 assets, 40 on balance sheet, 41-43 current, 43 financial, 43 fixed,41 intangible, 43 net, 46 noncurrent, 43 physical, 43 asset turnover, 66-67 available-for-sale securities, 158 average age, 161, 169 average age %, 161, 162, 169 average days inventory in stock ratios, 63 average days payable outstanding ratios, 63 average days receivables outstanding ratios, 63 average depreciable life, 170 B balance sheet, 26, 41-46 assets on, 41-43 liabilities on, 44-45 stockholders' equity on, 45-46 bank loans, 22 bankruptcy, 225-26, 239 bankruptcy models in assessing credit risk, 223 bankruptcy risk, 222, 224-25 basic earnings per share, 105 BellSouth, 239 benchmark, 56 beta (B) analysis, 30-31,113-14,271 Black-Scholes economic model, 42 Boeing, 133 bond markets, 21 bond ratings, 229-30 in assessing credit risk, 223 bonds corporate, 254 international, 254 investment grade, 230 junk, 230 municipal, 254 Treasury, 254 bonus plans, 31 book value, 109 largest firms by, 276 book value leverage ratios, 110 bounded rationality, 31 Bristol-Myers Squibb, 136 Bush, George W., 24 business combinations, 203-12 accounting issues for, 204-6 analysis and forecasts of merger activity for, 210-11 business acquisitions by the PC manufacturers, 211-12 characteristics of potential target firms, 208 impact on financial statements and ratios, 207-8 market reaction to acquisition announcements, 208-10 public policy issues for, 211 SFAS Nos 141 and 142 and, 206-7 business strategy, 5-8 for Dell Computer, 6-8 factors in, 5-6 buy and hold, 271 c capital, human, 42 capital asset pricing model, portfolio theory, 29-30 capital leases, 166, 167 capital markets, 21, 22 capital structure, 222 Carnegie Steel, 203 cash earnings, 135 cash flow adequacy (CFA), 140, 144 cash flow information, 25 cash flows from financing (CFF), 139 cash flows from investments (CFI), 48,139 cash flows from operations (CFO), 48,139 cash flows from operations per share, 144 cash flows from operations to liabilities, 144 cash flow statement, 132 accounting analysis using, 139-40 cash positions ratios, 82 cash ratios, 60, 68 cash to current assets ratios, 82 cash turnover ratios, 82 Chance Vought, 204 chemical industry financial leverage and solvency ratios in, 231-32 Z-scores in, 232-33 CI return, 144 Cisco Systems,134-35 Citigroup, 30 dosing stock price, 107 Coca-Cola, 3, 272 collateral, 244 commercial aircraft, revenue recognition for, 133 commercial banks, 21, 23 commercial loans, 10,23,241 commissions for load funds, 253 Committee on Accounting Procedure,25,159 SUBJECT INDEX common sense, 56 common-size analysis, 8, 5&-59, 67, 88 company assets, 23 Compaq, 103, 141 acquisition by Hewlett-Packard, 211 acquisition of Digital Equipment Corporation, 211 comprehensive analysis in credit analysis, 240, 244 in equity investment analysis, 256, 263-64 in financial analysis, 2, 10 green flags in, 10 red flags in, 10 comprehensive income, 40, 41, 45, 137-38 concentration ratios, Conceptual Framework (FASB),40, 44,132 conformity rule, 159 conglomerate mergers, 204 Conoco, 85, 136,137 conservative revenue recognition, 133-34 Continental Airlines, 134 contingencies, 44 at Microsoft, 152-53 contracting costs, 31 ConvergeNet Technologies, acquisition by Dell Computer, 211 cookbook accounting, 167,205 core competencies, core earnings, 138 corporate bonds, 254 corporate debt, 223-24 corporate ethics, 53-54, 129-30, 156,269 corporate overview in business strategy, 5-8 in credit analysis, 240, 242 in equity investment analysis, 256,260 in financial analysis, 2, in industry analysis, 3-5 corporate welfare, 164 corporations, 242 cost of goods sold (COGS), 61, 159 credit analysis, 24Q-47 accounting analysis and forecasts in, 240, 243-44 comprehensive analysis in, 240, 244 corporate overview in, 240, 242 loan decisions in, 240, 244 loan purpose in, 240, 241-42 quantitative financial analysis in, 240,242-43 credit decisions, 23 credit risk, 222, 24Q-41, 243 tools in assessing, 223 creditworthiness, 240, 243 of dot.corns, 245-47 currency See foreign currency currency swaps, 189 current assets, 43, 59, 68 current liabilities, 60 current liability position ratios, 82 current ratios, 60, 68 cyclicals,272 D DaimlerChrysler, 204 debt, 64 corporate, 223-24 debt covenants, 244 debt ratios 64, 69 debt to equity ratios, 64, 69 debt to market equity ratios, 64, 69, 110-11 default risk, 222, 224-25 deferred tax assets, 42,164-65 defined benefit pension plans, 187 reporting, 187 defined contribution pension plans, 187 Dell Computer, 3, 5, 24, 26, 56 abbreviated financial statements for, 57-58 abbreviated income statement for, 84 accounting analysis for, 218-20 acquisition of ConvergeNet Technologies, 211 activity ratio for, 62 annual earnings growth rate for, 85 annual report for, 56, 143 asset position for, 43-44 balance sheet for, 59 I 291 beginning balances for fiscal year in,50 beta analysis for, 30-31,113,114 bond ratings for, 230 business strategy, &-8 cash flow statement for, 139, 140 comprehensive analysis for, 270 corporate debt for, 223 corporate overview for, 8, 260, 270 credit analysis for, 244 current ratio for, 60, 63 debt to market equity for, III deferred taxes for, 165 depreciation for, 161, 162 detailed accounting analysis for, 270 DuPont Model calculations for, 66 earnings per share, 105, 106 EBITDA for, 135 effective tax rate for, 164-165 equity analysis for, 25&-57 executive summary for, 270 financial accounting overview for, 141 financial analysis for, 261 financial reporting for, 185-86 financial statement analysis for, 270 financial statements for, 40 fiscal year for, 84 fit to the growth fund, 258-59 fixed assets for, 161 income statement for, 9,164 income statements of, 46 industry segment analysis for, 183 industry segments for, 182 intrinsic value per share for, 115 inventory for, 160 investment decision for, 270 investment decisions for, 264 investment purpose for, 270 leases for, 167 leverage ratio for, 64, 65 liabilities of, 44 liquidity ratio for, 61 marketable securities for, 158 market analysis for, 261 market share of,S market to book ratio for, 110 292 I FINANCIAL ANALYSIS: A USER APPROACH net assets for, 109 operations by geographic region for, 181 options used by, 189-90 price earnings ratio for, 107, 108 price earnings to earning growth rate for, 112 quarterly analysisr, 87-88, 97-99 ratio analysis for, 226-27 reconciled cash for, 48 revenue recognition for for, 133 sales to net assets ratio for, III segment reporting for, 181 shares issued by, 45 stock options for, 179, 180-81 stock prices for, 103 trend analysis for, 86 Z-score caluation for, 228 Delta Airlines, inventory for, 160 depreciation, 134, 160 accelerated, 166 double-declining balance, 160, 163 purpose of, 160 straight line, 160, 161, 163, 166 derivatives, 188-90 accounting for, 189 at Microsoft, 200-201 detailed accounting analysis, 140-42 in equity investment analysis, 256, 261-62 in financial analysis, 2, 9-10 formal structure for, 132 detailed accounting information, 26 Digital Equipment Corporation, acqusition by Compaq, 211 diluted earnings per share, 105 dirty surplus, 45 disclosure, management incentives for, 26-27 discussion memorandum (DM), 25 Disney, compensation at, 199-200 distributions to owners, 40 diversification, advantages of, 204 dividend discount model, 114-15 dividend payout ratios, 65, 69 dividend yields, 102, 109 dollar-cost averaging, 271 double-declining balance depreciation, 160, 163 Dow Jones Industrial Average (DJIA), 23, 44, 103,257 Dow Theory, 271 Drexel Burnham Lambert, 239 due process, 25 Duke Energy, 161,162 corporate debt for, 224 depreciation for, 162 fixed assets for, 161 Dun & Bradstreet, 56 DuPont, 44, 109, 136, 142 acquisition and divestment strategy of, 216 assets of, 51 business segment information for, 179 cash flows from operations for, 52 corporate overview and business strategy, 12-14 credit analysis for, 244 preferred stock at, 51-52 DuPont Model, 56, 66-67 DuPont Pharmaceuticals, 85, 136 dynergy,27 E earnings, firms by most, 276 earnings-based growth model, 114-15 earnings before interest, taxes, depreciation, and amortization (EBITDA), 135 earnings before interest and taxes (EBIT),135 earnings management, 9, 27, 37-38, 132, 141, 142 accounting choice and, 32-33 evaluating potential for, 141-42 incentives for, 157 earnings manipulation, 27, 37-38 earnings per share (EPS), 47,105-6, 107-8 earnings power, 46 earnings quality, 131-32 earnings surprise, 27-28 Eastman Kodak, 30 Ebbers, Bernard, 216 economic consequences, 33 economic indicators, 264 economic rationality and behavior, 31-32 economic reality, 138 economic value analysis, 42 economies of scale, EDGAR database, 24 effective tax rates, 164-66, 170 efficient contracting, 31 efficient markets, 27-28 8-K, 132, 143 Eisner, Michael, 199 Employee Retirement Income Security Act (1974) (ERISA), 186 engineering and construction companies, revenue recognition for, 133 Enron, 22,24,27, 168-69 environmental regulations, equity, 40, 63 equity capital markets, 27 equity investment analysis, 251-65 comprehensive analysis in, 256, 263-64 corporate overview in, 256, 260 detailed accounting analysis in, 256,261-62 financial and market analysis in, 256,260-61 investment decision in, 256, 264-65 investment portfolio in, 252-53 investment purpose in, 252, 256, 257-60 mutual funds in, 253-56 equity investment decisions, 23 equity markets, 22 ethics See also Corporate ethics stock options and, 201-2 evaluator, 115 execution risk, 239 executive summary, 263 exercise price, 180 expenses, 40-41,134-35 exposure draft (ED), 25 ExxonMobil,204 projected growth rate for, 257 F failure events, 225 fast growers, 272 SUBJECT INDEX 1193 Federal Deposit Insurance Corporation (FDIC), 22 Federal Reserve, 22 federated, leases for, 167 Financial Accounting Foundation (FAF),25 financial accounting overview, 141 Financial Accounting Standards Board (FASB),22, 25, 40, 169 Conceptual Framework, 40, 44,132 financial analysis, 10 comprehensive analysis in, 2, 10 context of, 2-3 corporate overview in, 2, 3-8 decision in, 2, 100H detailed accounting analysis in, 2, 9-10 in equity investment analysis, 256, 260 61 multiperiod quantitative, 83-89 purpose of, 2-3 quantitative, 2, 8-9, 157,240, 242-43 steps in, financial analysis decision, in financial analysis, 2, 10-11 financial analysts, tools used by, financial assets, 43 financial environment, 21-33 financial information, reevaluating or restating, 142 financial leverage, 226-27 financial leverage index (FLI), 226 financial leverage ratios, 82 financial ratios, 8, 59, 68, 82 activity ratios, 59, 61-63 leverage ratios, 59 leverage/solvency, 63-64 liquidity ratios, 59, 60 61 performance ratios, 59 profitability, 65-66 financial reporting, 24-26,166, 185-86 financial statements, 25-26, 39-50 See also balance sheet; income statement; statement of cash flows; statement of stockholders' equity business compinations and, 207-8 quantitative financial analysis using information from, 55-68,82 financial structure leverage index (FSLR),226 financial theory, theoretical perspectives from, 27-33 financial trends, first-in first-out (FIFO), 141, 159 fixed assets, 23, 41, 160 62 fixed assets turnover, 62 fixed asset turnover ratios, 62, 69 fluctuating currencies, 183 Ford Motor, 6, 109 classifying debt for, 236-38 corporate debt for, 224 corporate overview and business strategy for, 17-19 depreciation for, 162 fixed assets for, 161 marketable securities for, 159 Z-scores in, 235 forecasts, 243-44 in credit analysis, 240, 243-44 foreign countries, operating in, 183-84 foreign currency, 182-84 accounting for, 184-86 foreign currency risk, 200 foreign currency translation, 184-85 form IO-Q, 24 form 10-K, 24 Fortune 500 companies, 3, 4, 240 by book value, 276 by market value, 275 by most earnings, 276 by profit growth performance,276 by return on equity, 277 by return on sales, 277 by revenue, 275 by revenue growth performance,277 by total return to shareholders, 278 forward contract, 189 free cash flows (FCF), 139-40, 144 frequent flier miles, revenue recognition associated with, 153 futures contract, 189 G gains, 41, 45 Gateway Computer, 3, 5, 56 abbreviated financial statements for, 57 abbreviated income statement for, 84 accounting analysis for, 218-20 acquisition of NECX Direct, 211 activity ratio for, 61, 62, 63 annual earnings growth rate for, 85 annual growth percentage for, 85 assets for, 43 balance sheet for, 59 beta analysis for, 11,31,114 bond ratings for, 230 business strategy for, 260 closing stock prices for, 104 common-size analysis for, 58 corporate debt for, 223 daily trends for, 103 depreciation for, 161, 162 DuPont Model calculations for, 66 earnings per share for, 105, 106, 107 EBITDA for, 135 effective tax rate for, 165, 166 financial accounting overview for, 141 financial statements for, 57 fiscal year for, 84 fixed assets for, 161 geographic segment analysis for, 183 industry segment analysis for, 184 industry segments for, 182 intrinsic value per share for, 115 inventory for, 160 investment decisions for, 264 leases for, 167 leverage ratios for, 65 marketable securities for, 158 market to book ratio for, 110 price earnings to earnings growth rates for, H2 profitbility ratio for, 66 quarterly statements for, 143 294 I FINANCIAL ANALYSIS: A USER APPROACH quaterly analysis for, 87-88 red flags for, 142 revenue recognition for, 133 segment reporting for, 181 stock options for, 180, 181 trend analysis for, 86 Z-score caluation for, 228 General Electric (GE), 3-4, 272 debt levels at, 236 evaluating stock options and pensions at, 196-97 income statement items for, 53 as old economy company, 109 pension plans for, 188 projected growth rate for, 257 generally accepted accounting principles (GAAP), 9, 22, 24, 25, 26, 40, 42,46,114,134,138,159 General Motors (GM) corporate debt for, 224 special purpose entities for, 168-69 Z-scores in, 235 geographic segments, 181 comparing, 182 Global Crossing, 27, 129-30, 134,239 gold standard, 182-83 good~iII,42,43,205-6 government fixed-price contracts, 133 green flags, in comprehensive analysis, 10 gross margin, 46 gross margin ratios, 65, 69 growth analysis, 83-86 growth fund, Dell's fit to, 258-59 growth rates, 84 H held to maturity securities, 158 fI~lett-Packard,3, 103 acquisiton of Compaq by, 211 Hilton Hotels, 52 corporate overview and business strategy, 14-16 revenue and operating expenses for, 52 historical cost, 42 historical cost accounting, 41 historical earnings per share, 105 historical values, 41 Hoovers, 4, 116 horizontal mergers, 203 hotel and resort industry financial leverage and solvency ratios in, 233-34 Z-scores in, 234-35 human capital, 42 hybrid securities, 46 I IBM (International Business Machines), 3, 5, 19 ICO return, 144 income comprehensive, 137-38 net, 137-38 income from continuing operations (ICO),46-47, 136 income smoothing, 32 income statement, 26, 46-47 income tax allocation, 162-66 index funds, 271 industry analysis, 3-5 industry averages, 56 industry segments, 181 information asymmetries, 31 initial public offerings (IPOs), 22 insider trading, 22 intangible assets, 43 Intel, projected growth rate for, 257 interest coverage ratios, 64, 69 interest rate risk, 201 interest rate swaps, 189 international bonds, 254 International Paper, projected growth rate for, 257 interperiod tax allocation, 163-64 intraperiod tax allocation, 163 intrinsic value per share, 115 inventory, 23, 42, 60, 159-60 methods of, 32 inventory turnover, 61 inventory turnover ratios, 62, 68 investment banks, 21 investment brokers, 23 Investment Company Act (1940), 24 investment decision in equity investment analysis, 256, 264-65 investment grade bonds, 230 investment portfolio, in equity investment analysis, 252-53 investment purpose, in equity investment analysis, 252, 256, 257-60 investments alternative strategies in, 271 categories of, 272 byo~ers,40 investor advisory fees, 253 ISM,161 J junk Bonds, 230 K Kennedy, John F., 24 Kennedy, Joseph P, 24 Kmart, bankruptcy filing by, 225 L last-in first-out (LIFO), 159 lease financing, 241 leases, 166-68 length of operating cycle ratios, 63 leverage, 63-64 leverage ratios, 59, 64, 69, 82, 168-69 liabilities, 40 on balance sheet, 44-45 lines of credit, 241 Ling, James, 204 Ling Electronic, 204 Ling-Temco-Vought (LTV), 204 liquidity ratios, 9, 59, 60-61, 68, 82 liquidity risk, 239 loan decisions, in credit analysis, 240,244 loan purpose, in credit analysis, 240, 242-43 long-term debt to equity ratios, 64, 69 losses, 41, 45 lower-of-cost-of-market (LCM), ·159 Lucent Technologies, 139-40, 142 M management compensation, stock options as form of, 180 management discussion and analysis (MD&A), 6-7, 9, 26 management incentives for disclosure, 26-27 manufacturing industries,S SUBJECT INDEX Marathon Oil, 4, 204 marketable securities, 42, 60, 158-59 market analysis, 107 in equity investment analysis, 256, 260-61 market averages, 56 market equity, 64 market information, in quantitative financial analysis, 102-16 market model, 29 market reaction to acquisition announcements, 208-10 market-related ratios, 110 beta (8) analysis, 113-14 calculating, 106-10 debt to market equity, llo-ll price earnings to earnings growth rates, 111-13 sales to net assets and sales to market value, III market share,S market to book value ratio, 110 market value, 109 largest firms by, 275 Markowitz, Harry, 29 matching principle, 134 Merck, projected growth rate for, 257 mergers, 203 analysis and forecasts of, 210-11 conglomerate, 204 effect of, on economic activity, 211 horizonal, 203 vertical, 204, 211 Merrill Lynch, 22, 269 Microsoft,30, 161, 169 contingencies at, 152-53 financial risks and use of derivatives at, 200-201 projected growth rate for, 257, 258 stock option reporting at, 197-99 monetary items, 183-84 Moody's, 229, 230 moral hazard, 31 Morgan, ] P., 203 multiperiod quantitative financial analysis, 83-89 growth analysis in, 83-86 trend analysis in, 86-89 municipal bonds, 254 mutual funds, 23, 253-56 N NASDAQ,23 National Association of Securities Dealers Automated Quotations (NASDAQ),23,103 NCR,3 near competitors, 56 NECX Direct, acquisition by Gateway, 211 net assets, 40, 46, 63, 64, 109 net fixed assets, 161 net income, 9, 46, 137-38 New York Stock Exchange (NYSE), 22, 23, 103, 269 noncurrent assets, 43 nonmonetary items, 184 nonrecurring items, 47,136-37,141 North American Industry Classification System (NAlCS), o obedience, 31 off-balance-sheet financing, 9, 166, 167,169 operating cash flow ratios, 60 operating earnings, 135 operating expenses, 46 operating leases, 9,166,167 operating profit margin, 182 operating profit margin ratios, 82 operating ratios, 68 opportunism, 31 options, 189 Seealso Stock options other postemployment benefits (OPEB),188 Owens Corning, 28, 44 p partnerships, 242 patents, 43 payables turnover ratios, 62, 69, 82 pension plans, 186 defined benefit, 187, 188 defined contribution, 187 pensions, 186 Pepsi,3 percentage change analysis, 88 performance ratios, 59 period costs, 134 personal computer industry,S I 295 business acquisitions in, 211-12 PETCO, 138 pharmaceutical companies,S, Philip Morris, projected growth rate for, 257 physical assets, 43 Piles of Tiles, 241-42, 244 credit analysis for, 242 Pitney Bowes, Pitt, Harvey, 24 pooling of interests, 204-5 financial statements under, 207 portfolio theory, capital asset pricing model in, 29-30 postemployment benefits, 186-88 defined benefit plans as, 187 defined contribution plans as, 187 other, 188 pension plans as, 186 PPG,44 pretax profit margin ratios, 82 pretax return on assets ratios, 65, 69 price earnings (PE) ratios, 102, 107-8 price earnings to earnings growth rates (PEG), 111-13 primary markets, 22 prime rate, 242 Procter & Gamble, 30, 115 product costs, 134 product warranties, 44 profitability, 6s-66 profitability ratios, 65, 69 profit growth performance, firms by,276 profit ratios, 82 pro forma earnings, 132, 138-39 pro forma statements, 138-39 projected benefit obligation (PBO),187 property, plant, and equipment, 160-62 public securities, 23 purchase method, 204-5 financial statements under, 207 purpose, in financial analysis, 2-3 Q quantitative financial analysis, 157 in credit analysis, 240, 242-43 in financial analysis, 2, 8-9 296 I FINANCIAL ANALYSIS: A USER APPROACH financial statement information in, 55-68, 82 market information in, 102-16 multiperiod, 83-89 quarterly analysis,87-89 quarterly earnings per share, 105 Quicken, 4-5, 106, 112, 113 quick ratios, 60, 68 Qwest,239 Risk Grades, 113-14 Rockefeller, John D., 203 Roosevelt, Franklin, 24 S salesto net assets and salesto market value, III Sarbanes-OxleyAct (2002),24 Sears,leases for, 167 secondary markets, 22 R sector Updates,S random walk theory, 29 SecuritiesAct (1933), 24 rating scale,61 Securities and Exchange Act (1934),24 ratio analysis,59 Securities and ExchangeCommission limitations of, 67-68 (SEC),21-22, 41 ratios Seealso Financial ratios regulation by, 24, 133 business combinations and, 207-8 securities price risk, 200-201 receivables turnover ratios, 62, 68 segment reporting, 181-82 self-interest, 31 red flags in accounting analysis, 142 service industries,S in comprehensive analysis, 10 slow growers, 272 default risk and, 225 sole proprietorships, 242 inventory write-downs and, 159 solvency See leverage time series trends and comparsolvencyratios, 69 isons in spotting, 61 Southern Company, 109 regression analysis,30 special purpose entities, 168-69 research and development (R&D), 33 S&P 500 index fund, 23 costs of, 42 Staff Accounting Bulletin (SAB) restatements, 142 101, 133 retained earnings, 45 stalwarts, 272 return on assets ratios, 65, 69 standard industrial classification return on assets (ROA),67 (SIC) codes, return on common equity ratios, 82 Standard Oil, 203 return on equity (ROE), 66 Standard & Poor's, 229, 230 firms by, 277 bond rating information for return on sales, firms by, 277 related companies, 230 return on sales ratios, 65, 69 core earnings, 138-39 return on total equity ratios, 65, 69 Standard & Poor's 500, 23, 255 revenue, 40, 46 statement of cash flows, 47-50 largest firms by, 275 Statement of Financial Accounting RevenueAct (1938), 159 Concepts (SFACs), 40 revenue growth performance, firms No.6, 44 by, 277 Statement of Financial Accounting revenue recognition, 132-33 Standards (SFAS), 25 associated with frequent flier No.13, 166 miles, 153 No.1, 183 conservativeversus aggressive, No.5, 44 133-34 f(~No.8, 183 SI n; ( ,No 14,181,182 revenue restatement, a ~erox, 153-56 - "No 52, 183 J- il~,(1 -":··" No 87,187 No 95,47 ,No 106, 186, 188 No 115, 158 No 123, 180 No 130, 137 No 132, 187 No 133, 181, 182, 189 No 141,204,206-7 No 142, 137,204,205,206-7 No 144, 136 statement of stockholders' equity, 50 stock dilution, 180 stockholders' equity, on balance sheet, 45-46 stock markets, 21 stock options, 31,179,180-81 ethics and, 201-2 stock prices, 103-5 closing, 107 stock screening, 115-16 straight line depreciation, 160, 161, 163, 166 strategic acquisition, timing of, 216 Sun Microsystems,3 swaps, 189 Seealso Currency swaps; Interest rate swaps T Target inventory for, 160 leasesfor, 167 target firms, characteristics of potential,208 taxes paid rate, 170 taxes payable, 165 taxes payable rate, 170 Temco,204 temporary tax differences, 163 10-K,56,143 1O-Q, 132, 143, 168, 169 360networks, 239 time series trends, 61 times interest earned ratios, 64 total asset turnover ratios, 62, 69 total return to shareholders, firms by, 278 total stockholder equity, 109 Toyota,6 trademarks, 43 SUBJECT INDEX trading securities, 158 transaction cost, 31 transactions cost economics, 27 Trans World Airlines (TWA), 137 bankruptcy filing by, 225 Z-score caluation for, 229 treasury bonds, 254 treasury stock, 48 trend analysis, 56, 86-89 quarterly analysis in, 87-89 turnarounds, 272 12b-l fees, 253 Tyco,22 u United Airlines, proposed merger with US Air, 214-15 unrealized gains and losses, 158 US Air, proposed merger with United Airlines, 214-15 USX (U.S Steel), 4, 203, 204 utilities, v valuation models, 114 earnings-based growth (dividend discount) model, 114-15 intrinsic value per share, 115 vertical mergers, 204, 211 working capital, 60 working capital loans, 241 working capital turnover, 62 working capital turnover ratios, 62, 69 WorldCA>m,22,27,156,216 x Xerox, 3, 22, 134 restatement of revenue, 153-56 y w WalMart, 225 web sites of companies analyzed, 274 list of useful, 273-74 Winnick, Gary, 129-30, 239 I 297 Yahoo, z Zacks, 106, 112 z-score, 227-29 Printed in the United Kingdom by Lightning Source UK Ltd 106589UKSOOOO2B/299-342 1111/111/11/11/11111111111 780471 467120 Access world-class business content with Core Concepts and Business Extra Select! Outstanding Conten Material s Ir III LeaUl l BII wilcy.coml.collcgc{giroux I call n ISBN 0-471 -46712 -X III I 46712~ 80471 90000 ... preparer Within the user approach, the concentration can be on financial analysis that is internal or external to the company The internal focus is usually associated with financial and managerial... industry and specific purpose of the analysis Quantitative financial analysis techniques Calculate common-size statements, financial ratios, financial models, and forecasts using the financial statements... passed Company and market news have an impact on stock prices In my financial analysis course, an equity financial analysis is used as a major project The PC companies are presented as an example