Financial Ratio Analysis Presented by Evan Friscia
G Gross P Profit fit Margin M i The Gross Th G Profit P fit Margin M i is i obtained bt i d by dividing the Gross Profit (R (Revenues – costt off sales) l ) by b the th total revenue. Gross Profits Gross Profit Margin = Revenue
What does Gross Profit Margin tell us? ď‚› This
ratio tells us how effective a company is at converting its assets into profit profit. The higher the ratio, the more effective a company is at converting its assets into profit. fit
Net Profit Margin ď‚› Net
Profit Margin is the Net Income divided by the company’s company s revenue
Net Profit Margin =
Net Income Revenue
What does Net Profit Margin tell us? ď‚› This
ratio demonstrates how much profit a company was able to generate in a year. year While an important number, an investor should not rely on it solely, as it should be j t juxtaposed d with ith other th ratios. ti
ALU 50.00 Gross Profit Margin (%)
40.00 30.00
20000.00 Operating Profit Margin (%)
10.00 0.00
-20 00 -20.00 -30.00
30000.00 25000.00
20.00
-10.00
Revenue
2007
2008
2009
15000.00 10000.00
2010 Net Profit Margin (%)
5000.00 0.00 2007
2008
2009
2010
-40.00
Stable GPM indicates stable expense on the cost of production such as cost of raw materials, labor and manufacturing-related fixed assets. Given stable GPM, fluctuation of both OPM and NPM indicates bad cost management on SG&A We didn’t include pretax profit margin, because it’s ignorable as OPM and NPM are very close that we can treat them the same. Negative profit!
ERICSSON
rev
50.00
31000.00
45.00
30000.00
40.00 29000.00
35.00 30.00
Gross Profit Margin 28000.00
25 00 25.00
Operating O ti P Profit fit Margin
27000 00 27000.00
Net Profit Margin
26000.00
20.00 15.00
25000.00
10.00
24000.00
5.00
2007
2008
2009
0.00 2007 ď‚›
ď‚›
2008
2009
2010
All three ratio share same movement mo ement trend, trend this reflects the GPM has strong influence on OPM and NPM (dependence on GPM). On the other hand, this shows the scales of economics on the profit: the large gross profit, the higher the operating and net profits; it also demonstrates high efficiency of cost management as gross profit increase. However, ratios did not increase until 2010.( meanwhile, the sales rev i increase) ) decreasing d i profit fit as rev expands; d reaching hi the th lilimit it off economic i scale? Or bad cost control on production as business expand?
2010
Profitability ALU
50.00
50.00 Gross Profit Margin (%)
40.00 30 00 30.00
ERIC
45.00 40.00 35.00
20.00
Operating Profit Margin (%)
10.00 0.00 2007 007
10 00 -10.00
2008 008
2009 009
2010 0 0 Net Profit Margin (%)
-20.00
30.00 25.00 20.00 15 00 15.00 10.00
-30.00
5.00
-40.00
0.00 2007
• • • •
2008
2009
2010
Eric’s profit is higher ALU has better control on cost efficiency; it’s higher and better ERIC has lower cost management ERIC is has higher profitability
Return on Assets ď‚› Return
on Assets is calculated by dividing Net Income by Average Total Assets
Net Income Return on Assets= Average Total Assets
What does Return on Assets tell us? ď‚› Different
industries require different amounts of assets in order to operate. operate This will cause the average ratio to vary among different industries. Due to this variance, i thi this ratio ti iis nott very h helpful l f l when h comparing between industries.
Return on Equity ď‚› Return
on Equity is calculated by dividing Net Incom by Average Total Equity
Return on Equity=
Net Income Average Total Equity
What does Return on Equity tell us? ď‚› This
ratio measures a company’s ability to earn more specifically, earn, specifically how well a company uses investors money. The higher the ratio, the more effectively the company is i able bl tto use investor i t money.
Growth of business 20.00
ALU
net income 0.00
0.00 2007
2008
2009
2010
-1000.00
2007
2008
2009
-20.00 -2000.00 40 00 -40.00
ROA (%) ROE (%)
-60.00 -80.00
ROCE (%)
-3000.00 -4000.00 -5000.00 -6000.00
-100.00 -120.00
-7000.00 -8000.00
• ROE drops sharply at 2008, much more than ROA and ROE; shows shrinking equity. • Negative ROCE also indicates the increasing borrowing is eroding company’s company s equity equity. • Negative ROA and ROE also indicates the negative earning is eroding company’s equity.
2010
Ericsson 20.00
net income
18.00 16.00
4000.00 3500.00 3000.00 ROA (%) 2500.00 ROE (%) 2000.00 ROCE (%) 1500.00 1000.00 500.00 0.00
14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 2007
ď‚›
2008
2009
2010
2007
2008
2009
While revenue, ROA and ROE was decreasing, the increase of ROCE from 2008-2009 2008 2009 shows stronger ability to better utilize the capitals. ROCE runs ahead of both ROA and ROE which shows it as a potential indicator of ROE, ROA and revenue.
2010
Profitability y comparison p II ALU
ERICSSON
20.00
20.00 18.00
0.00 2007
2008
2009
16.00
2010
14.00
-20.00
12.00 ROA (%)
-40.00
ROE (%) -60.00
10.00
ROCE (%)
8.00 6.00
-80.00
4.00 2.00
-100.00
0.00 2007
-120.00
ď‚›
2008
2009
Ericsson has better ability to generate profit using assets, assets equity and capital. capital
2010
Debt Ratio ď‚› The
Debt Ratio is the Total Liabilities divided by Total Assets
Total Liabilities Debt Ratio= Total Assets
What does the Debt Ratio Tell us? ď‚› The
higher the Debt Ratio the riskier the company is to invest in in. A higher debt ratio means that a company is leveraged against and has a higher chance of going i outt off business. b i
Debt to Equity The
Debt to Equity Ratio is the Total Liabilities divided by Share Holder Holder’ss Equity. Equity
Debt to Equity=
Total Liabilities Share Holder’s Equity
What does the Debt to Equity Ratio tell us? ď‚› The
Debt to Equity ratio tells us how much debt a company has relative to the amount of equity it has. The higher the ratio the more leveraged the company is and d th the riskier i ki it is i tto iinvestt in. i
Long Term Debit to Equity Ratio ď‚› The
Long Term Debt to Equity ratio is calculated by dividing long term debt by equity
Long Term Debt Long Term Debt to Equity= Equity
What does the Long Term Debt to Equity Ratio tell us? ď‚› This
ratio says how much leverage is against the company in the long run. run The higher the ratio, the more long term debt the company has the riskier the i investment t t is i in i the th long l term. t
Cash Flow to Debt Ratio ď‚› Cash
Flow to Debt Ratio is calculated by dividing the Cash Flow by Debt
Cash Flow Cash Flow to Debt Ratio=
Debt
What does the Cash Flow to Debt Ratio tell us? ď‚› This
ratio lets investors know how strong a company is able to generate revenue or if a company has taken on a large amount of debt. A large ratio implies fi financial i l strength t th while hil a llow ratio ti symbolizes either a poor cash flow or that a company p y has taken on excessive debts.
Capitalization Ratio The Capitalization Ratio is calculated by dividing Long Term Debt by the sum of Long Term Debt and Shareholder’s Equity Long Term Debt Capitalization Ratio=
Long Term Debt + Shareholder’s Equity
What does the Capitalization Ratio tell us? The Capitalization Ratio is a measurement of the long term assets a company has. has A large ratio means a company has a large amount of debt and his highly l leveraged, d but b t a low l ratio ti signals i l fi financial i l health.
Capital Structure ALU
ERIC
7.00 Debt Ratio D bt R ti
6.00 5.00
Debt Equity Ratio
4.00 3 00 3.00
Capitalization ratio
2.00 Cash Flow to Debt ratio
1.00 0.00 -1.00
2007
2008
2009
2010
long term debt to equity
• The high debt ratio reflects high level of leverage • Debt to equity is soaring, (due to shrinking equity mainly); shareholders have to carry greater burden on the debt. Company has too much debt!!! • *high and increasing capitalization ratio and long term debt to equity indicates growing long term debt in debt structure, more than 50% in 2010!!! • Low and decreasing Cash flow to debt ratio indicates company is losing its financial strength to cover the debt with its cash flow, esp in short run. Conclusion: in both short run and long run, ALU is exposed to serious financial risk. This would give other companies greater chance to gain larger market share as they have more money to invest. The situation would be worse in economic downturn!
Ericsson – Capital Structure 1.20 1.00 0.80
Debt Ratio Debt to Equity
0.60
Capitalization Ratio Cash Flow to Debt
0.40
Long term Debt to Equity
0.20 0.00 2007 • • • • • •
2008
2009
2010
Low debt ratio reflects low leverage Debt to equity q y is lower 1 g give shareholders little burden on the debt; Low capitalization ratio and long term debt to equity shows low portion of long term debt in debt structure; indicates possible healthy financial condition in long run Increasing cash flow to debt and decreasing debt to equity from 2008 shows the growing financial strength. strong All ratios are quite stable stable, even in economic downturn downturn. Indicating good financial risk condition Conclusion: strong financial competiveness!
C it l structure t t i Capital comparison 7.00 D bt R Debt Ratio ti
1.20
6.00 1.00 5.00
Debt Equity Ratio
4 00 4.00 Capitalization ratio
3.00 2.00
Cash C h Flow Fl to t Debt ratio
1.00
0.80
0.60
0.40
0.20 0.00 2007 -1.00 1 00
2008
2009
2010
long term debt to equity
0.00 2007
2008
2009
2010
Quick Ratio ď‚› The
Quick Ratio is Current Assets – I Inventories t i divided di id d by b Current C t Liabilities Li biliti
Quick Ratio=
Current Assets - Inventories Current Liabilities
What does the Quick Ratio tell us? ď‚› The
Quick ratio is a measurement of a company’ss liquidity, company liquidity as it measures a company’s current assets (not counting inventories) against its current liabilities. H However, some currentt assets t can nott be b liquidated as fast as others, so a company might g struggle gg to cover debts if it needs to in a short period of time.
Liquidity –Quick ratio 1.40 1.20 1.00 0.80 ALU
0.60
ERIC
0.40 0.20 0.00 2007
2008
2009
2010
Ericsson shows stronger ability to pay off short term debts
Price to Book Ratio The
Price to Book Ratio is the Stock Price per share divided by the Share Holder Holder’ss Equity per Share Stock Price per Share
Price to Book Ratio=
Share Holder’s Equity per Share
What does the Price to Book Ratio tell us? ď‚›A
high P/B ratio means the company is trading for more than its book value value. This means people see growth potential in the stock and are willing to pay more now on th chance the h that th t it grows later. l t If a stock t k iis trading for less than its P/B ratio it means investors believe a company p y to be worth less than the company’s stated value and that it is not a good buy.
Price to Earnings Ratio ď‚› The
Price to Earnings Ratio is the Stock Price per share divided by the Earnings per Share Stock Price per Share
Price to Earnings Ratio=
Earnings per Share
What does the Price to Earning ratio tell us? The P/E ratio signals how much investors are willing to pay for a stock based on the company’s earnings. The higher the P/E ratio, the less you have to pay for earnings. i While Whil a low l P/E ratio ti is i desirable, the average P/E ratio will vary greatly g y between industries.
Valuation ratio P/E Ratio
P/B Ratio
70.00
2.00
60.00
1.80 1.60
50.00
1.40
40.00
1.20
30.00
ALU 1.00
20.00
ERIC 0.80
10.00
0.60 0.40
0.00 -10.00
1
-20.00
2
3
4
0.20 0.00 2007
ď‚›
ď‚›
2008
2009
2010
Telecommunication equipment industry Telecomm nication eq ipment ind str is a project based business model industry, which means it cannot generate continuous cash flow from contract. In this case, P/E and P/B ratio is better than DCF model. P/E ratio ti give i a more accurate t valuation l ti iin thi this case.
Questions?