2.2 Profitability Measures 2 (When is really good, good enough?)

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Do curso por The University of Melbourne

The Language and Tools of Financial Analysis

725 classificações

The University of Melbourne

The Language and Tools of Financial Analysis

725 classificações

Curso 1 de 5 em Specialization Essentials of Corporate Finance

In this course, participants will learn the foundations of accounting principles and financial analysis, develop an understanding of the links between these, and the measurement of value creation at the firm level. This is the first course in a four-course Specialization on the Essentials of Corporate Financial Analysis and Decision-Making, created in partnership between the University of Melbourne and Bank of New York Mellon (BNY Mellon).

Na lição

An Intuition-based Introduction to Financial Analysis

Understanding the importance and the accounting principles underpinning the key financial statements of a company, we now turn our attention to synthesizing and condensing the financial statement information for the purpose of financial analysis. Specifically, we demonstrate how financial analysts use ratio analysis to measure relative profitability, leverage, efficiency and the liquidity of a company. Again, we utilise information from the financial statements of Kellogg's and its competitor Kraft to demonstrate these financial analysis techniques.

2.0 Introduction: An Intuitive Understanding of Financial Analysis (Let‘s get crunching!)8:58

2.1 Profitability Measures 1 (When is good really good?)10:57

2.2 Profitability Measures 2 (When is really good, good enough?)4:34

2.3 Leverage Measures (Creating value with other people‘s money)9:08

2.4 Efficiency Measures (Are we doing more with less?)6:50

2.5 Liquidity Measures (Staying ahead of the curve?)4:03

Conheça os instrutores

Paul Kofman
Dean, Faculty of Business and Economics
Sidney Myer Chair of Commerce
Sean Pinder
Associate Professor
Faculty of Business and Economics

Another way of looking at profitability measures,

is looking at how the market responds to the earnings that the company is making.

And, two of the most often quoted and related financial ratios,

are the earnings per share, EPS, and the price/earnings, P/E ratio.

Earnings per share is defined as net income, that we take off the

profit and loss statement, and

divide that by the average outstanding number of shares over the year.

Again, keep in mind, we've got this relationship between the flow variable,

measured over a period, and a stock variable,

measured at the end of the period.

Once we have the earnings per share, we can easily compute

the price/earnings ratio, which is defined as the market capitalization.

Number of shares,

number of outstanding shares times the share price, divided by net income.

That translates into the share price divided by the earnings per share,

the price/earnings ratio.

So, for Kellogg's in 2014, we compute the earnings per share as $632 million,

divided by 358 million shares.

That gives us $1.77 earnings per share.

When we then compute the price earning's ratio of Kellogg's for

that same end of financial year 2014, we find that the share price was

$65.58 divided by the earnings per share of $1.77 per share.

And, we find a ratio, also known as a multiple, of 37.15.

That ratio tells you that the price is 37 times earnings.

We can actually use that formula in a very quick way to compute

a forecast share price.

So, a fast track analysts price/earnings forecast is given, as follows.

We take the forecast of the price, say, at the end of 2015,

as equal to the forecast of the earnings per share over that year,

multiplied by the price/earnings ratio of the previous year.

Of course, we still need a forecast here for the earnings per share.

But, once we've got the earnings forecast, we automatically get the price

forecast, assuming that the price/earnings ratios are stable.

Because, another way of looking at this equation is that the price/earnings ratio

at the end of 2015 equals the price/earnings ratio at the end of 2014.

So, that assumes that the number of times the shareholder is willing to pay for

earnings is stable over time.

Is that really true?

What we've got here is a picture of the price/earnings ratio for

the Dow Jones Industrials over a five year period.

And, we can see that it varies wildly, so

price/earnings ratios are clearly not stable from one year to the next.

There was a clear dip in the price/earnings ratio for

the Dow Jones Industrials in the first three years of this graph,

and then it goes up to higher levels for the remaining three years of the graph.

Typically though the values that are indicated here in this graph tell you that

price/earnings multiples hover somewhere between 10 and 20.

Well, at least for the Dow Jones industrials.

What about our companies?

Well, look at the price earnings multiples that we find for

Kellogg’s, our Corporation, in comparison with Kraft, it's competitor.

We find that the 2014,

Kellogg's price/earnings ratio was 37 times earnings.

In 2013, on the other hand, it was only 12 times earnings.

And, the numbers for Kraft are remarkably similar.

So, the 37 for Kellogg's and Kraft in

2014 are way outside the range that we've just seen for the Dow Jones industrials.

And, that is not uncommon.

If we look at price/earnings multiples for different types of industries,

be they manufacturing companies, services industries, or high growth companies

like biotech companies, we'll find multiples that are very different from

that typical range that we've seen for the Dow Jones industrials.

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