Session 07

NSE Certified Capital Market Professional (NCCMP)

E-I-C Analysis Working Sheet 0

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GNP projections
Business cycle / Growth rate cycle Macro-economic policy changes Population projections Demographic profile Income distribution Industry life cycle Technological changes Industry related policy changes

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Industry sales estimates

Quality of management Quality of technology Market share of the company

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Company sales estimates

Net profit margin

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n2 p2 q2

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n4 p4 q4

n5 p5 q5

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n10 p10 q10

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Net profit
Number of equity shares

EPS

Groups of Financial Ratios

# Liquidity # Activity # Debt # Profitability

Liquidity Analysis
Liquidity refers to the solvency of the firm's overall financial position, i.e. a "liquid firm" is one that can easily meet its short-term obligations as they come due.

Important Liquidity Ratios

Net Working Capital (NWC)
NWC = Current Assets - Current Liabilities

Current Ratio (CR)

CR = Current Assets Current Liabilities

Quick (Acid-Test) Ratio (QR)

QR = Current Assets - Inventory Current Liabilities

Current Liabilities : Liabilities including loans, deposits and bank overdrafts which fall due for payment in a relatively short period, normally not more than twelve months. (ICAI)
Guidance Note on Terms used in Financial Statements issued by the Institute of Chartered Accountants of India (ICAI)

Current Assets : Cash and other assets that are expected to be converted into cash or consumed in rendering of services in the normal course of operations of the firm. (ICAI)

Current Ratio : An indication of a company's ability to meet short-term debt obligations; the higher the ratio, the more liquid the company is.

Inventories : A company's merchandise, raw materials, and finished and unfinished products which have not yet been sold. These are considered liquid assets, since they can be converted into cash quite easily.

Quick Ratio : An indication of a company's ability to meet very short-term debt obligations; the higher the ratio, the more liquid the company is.

Activity Analysis
Activity analysis is a more sophisticated analysis of a firm's liquidity, evaluating the speed with which certain accounts are converted into sales or cash; also measures a firm's efficiency.

Important Activity Ratios

Inventory Turnover (IT) Average Collection Period (ACP) Average Payment Period (APP) Fixed Asset Turnover (FAT) Total Asset Turnover (TAT)
IT = Cost of Goods Sold Accounts Receivable Accounts Payable Sales Inventory

ACP = APP= FAT =

Annual Sales / 360

Annual Purchases / 360 Net Fixed Assets Total Assets Sales

TAT =

Accounts receivable : Amount receivable by an enterprise on account of goods sold or services rendered or in respect of contractual obligations. (ICAI) Also termed as creditors, trade creditors or sundry creditors.

Accounts payable : Amount payable by an enterprise on account of goods purchased or services received or in respect of contractual obligations. (ICAI) Also termed as debtors, trade debtors or sundry debtors.
Guidance Note on Terms used in Financial Statements issued by the Institute of Chartered Accountants of India (ICAI)

Fixed Assets : Assets held for the purpose of providing services and that are not held for resale in the normal course of operations of the firm. (ICAI)

Current Assets : Cash and other assets that are expected to be converted into cash or consumed in rendering of services in the normal course of operations of the firm. (ICAI)

Guidance Note on Terms used in Financial Statements issued by the Institute of Chartered Accountants of India (ICAI)

Average collection period : The average time period for which receivables are outstanding. Equal to accounts receivable divided by average daily sales. Also called collection ratio. Total / Fixed asset turnover : This is a measure of how well assets are being used to produce revenue.

Average payment period : The number of days a firm takes to pay off credit purchases.

Debt Analysis
Debt allows for the generation of profits with the use of creditors money, but creates claims on earnings with a higher priority than those of the firm's owners. Financial leverage is a term used to describe the magnification of risk and return resulting from the use of fixed-cost financing such as debt and preferred stock.

There are two general types of debt ratios :

Degree of indebtedness. Ability to service debts.

Important Debt Ratios

Debt Ratio (DR) Debt-Equity Ratio (DER) Times Interest Earned Ratio (TIE) Fixed Charge Coverage Ratio (FPC)
DR = Total Liabilities Total Assets Long-Term Debt Stockholders Equity (EBIT) Interest EBIT + Lease Payments Interest + Lease Payments + Principal Payments + Preferred Stock Dividends

DER=

TIE =

FPC =

Earnings before interest and taxes : A measure of a company's earning power from ongoing operations, equal to profit before deduction of interest payments and income taxes. Also called operating profit or operating income. Times interest earned ratio : A measure of the creditworthiness of a company.

Debt ratio : This tells how much the company relies on debt to finance assets. When calculating this ratio, it is conventional to consider both current and non-current debt and assets. In general, the lower the company's reliance on debt for asset formation, the less risky the company is since excessive debt can lead to a very heavy interest and principal repayment burden.

Profitability Ratios
Profitability ratios assess the firm's ability to operate efficiently.

A Common-Size Income Statement, which expresses each income statement item as a percentage of sales, allows for easy evaluation of the firms profitability relative to sales.

Basic Profitability Ratios

Gross Profit Margin (GPM) Operating Profit Margin (OPM) Net Profit Margin (NPM) Return on Total Assets (ROA) Return On Equity (ROE) Earnings Per Share (EPS) Price/Earnings (P/E) Ratio
GPM = Gross Profits Sales Operating Profits (EBIT) Sales Net Profit After Taxes Sales Net Profit After Taxes Total Assets Net Profit After Taxes Stockholders Equity Earnings Available for Stockholders Number of Shares Outstanding Market Price Per Share Earnings Per Share OPM =

NPM = ROA = ROE = EPS =

P/E =

Gross profit : What remains from sales after a company pays out the cost of goods sold. These costs can include manufacturing expenses, raw materials, labor, selling, marketing and other expenses. Operating profit : A company's earning from ongoing operations, equal to earnings before deduction of interest payments and income taxes. Operating profit = Gross profit overheads and other indirect costs. Net profit : Net profit = Operating profit Interest Taxes.

Gross profit margin : The Gross Profit Margin measures the profit a company makes after paying off its cost of goods sold. It indicates how efficient the management is in using the labour and raw materials in the process of production.

Operating profit margin : The Operating Profit Margin measures how efficiently the firm is using business operations to generate profit.

Net profit margin : It is an indicator of how effective a company is at cost control. The higher the net profit margin, the more effective the company is at converting revenue into actual profit. The net profit margin is a good way of comparing companies in the same industry, since such companies are generally subject to similar business conditions. However, the net profit margin is also a good way to compare companies in different industries in order to gauge which industries are relatively more profitable.

Return on equity : It is an indicator of the company's efficiency - how much profit it is able to generate given the resources provided by its stockholders.

Return on total assets (ROA) : A measure of how effectively a company uses its assets. Calculated by (income before interest and tax) / (fixed assets + current assets).

P/E ratio : The most common measure of how expensive a stock is. The higher the P/E ratio, the more the market is willing to pay for each rupee of annual earnings. Companies with high P/E ratios are more likely to be considered "risky" investments than those with low P/E ratios, since a high P/E ratio signifies high expectations. Comparing P/E ratios is most valuable for companies within the same industry. The last year's P/E ratio would be actual, while current year and forward year P/E ratios would be estimates, but in each case, the "P" in the equation is the current price. Companies that are not currently profitable (that is, ones which have loss) don't have a P/E ratio at all. Also called earnings multiple.

A Complete Ratio Analysis

DuPont System of Analysis is an integrative approach used to dissect a firm's financial statements and assess its financial condition.

Du Pont System of Analysis

It ties together the income statement and balance sheet to determine two summary measures of profitability, namely ROA and ROE.

RATIO ANALYSIS
Current Ratio Quick Ratio

1.06 0.64 6.90 24.96 11.72 3.06 0.78 0.37 3.70 33.33% 5.67% 3.47% 10.61% 47.71% $0.10 29.41

1.16 0.63 5.39 35.30 11.74 2.80 0.73 0.25 3.07 33.55% 5.74% 3.10% 8.68% 31.58% $0.10 52.08

1.40 0.77 5.20 33.88 12.59 2.93 0.57 0.05 7.20 38.82% 12.71% 10.06% 29.43% 68.40% $0.34 16.08

Inventory Turnover Average Collection Period Fixed Asset Turnover Total Asset Turnover Debt Ratio Debt-to-Equity Times Interest Earned Gross Profit Margin Operating Profit Margin Net Profit Margin Return on Total Assets (ROA) Return on Equity (ROE) Earnings Per Share Price/Earnings Ratio

A case study

How the Growth Outliers Do It

by Rita Gunther McGrath
[ Harvard Business Review : January February 2012 ]

Steady, predictable growth is what every big company strives for and what investors prize above all else.

How many publicly traded companies with a market capitalization of at least US$1 billion grew by 5% each year for five years ending with 2009 ?

8% of the 4,793 companies in the sample grew their Revenues by at least 5% year after year, and 4% achieved a Net Income growth of at least 5% in each of the five years. 10 of the 2,347 companies that qualified across that entire period grew their Net Income by 5% in all 10 years, and five grew both Revenues and Net Income every year.

The Growth Outliers

Infosys Information Technology, India Founded: 1981 Market Cap: $31.9 b

Yahoo Japan Internet Search And Navigation, Japan Founded: 1996 Market Cap: $20.3 b

ACS Commercial and Heavy Construction, Spain Founded: 1983 Market Cap: $15.5 b Cognizant Information Technology, U.S. Founded: 1994 Market Cap: $13.3 b

Krka Group Pharmaceuticals, Slovenia Founded: 1954 Market Cap: $3.2 b

Indra Sistemas Information Technology, Spain Founded: 1993 Market Cap: $3.7 b

Atmos Energy Natural Gas Distribution And Marketing, U.S. Founded: 1906 Market Cap: $2.6 b

The Conventional Wisdom

1. A companys growth rate will be determined largely by the industry its in.

The above outliers are in wildly different industries, including pharmaceuticals, beer, construction, and banking. All outperformed their industry. Moreover, most of them are in very competitive industries, without the protections that patents or trade secrets provide.

2.

The outliers were not small relative to the full pool of companies we analyzed. By number of employees, the largest is ACS, a Spanish construction company, with nearly 140,000 people. The smallest, FactSet Research Systems, a U.S.-based financial research company, employs more than 4,000. Market cap also varied widely above our $1 billion threshold.

Larger a company gets, the harder it is to sustain growth.

Outliers come from both high-growth emerging economies and mature economies. The degree to which the companies are globalized also does not seem to be a factor. Although Infosys and ACS both focus on overseas opportunities, Yahoo Japan conducts business almost entirely in Japan, HDFC Bank operates only in India, and Atmos Energy focuses on the U.S. market. Tsingtao Brewery earns 50% of its revenue from exports, but it didnt venture outside China to manufacture until 2007. Krka Group is mainly a regional player, manufacturing generic pharmaceuticals throughout Eastern Europe..

3. Consistently higher growth rates are possible only in fast-growing markets.

4.

More than half the outliers were established in their current form after 1980, but the two oldest date from 1903 and 1906. All the companies have performed well throughout major shifts in globalization, underlying technology, and business practices.

Growth slows as companies age.

5. Companies started by entrepreneurs have an edge.

Although two of the outliers (Infosys and FactSet) were indeed start-ups, with founders who maintained a strong presence throughout the study period, others (Indra Sistemas, ACS, Atmos, Krka) were the product of mergers and consolidations, and still others (Cognizant, HDFC, Yahoo Japan) were spun out of or funded by existing organizations.

The Factors That Do Explain The Steady Growth

The growth outliers do a tremendous amount of experimentation and innovation. They develop and deploy new technologies, move into new markets, explore new business models, and even open up new industries. They take on acquisitions and aggressively seek input from people and organizations quite unlike their own. They rapidly adjust and readjust resources and are comfortable moving executives and other employees from one role to another.

1.

Rapid Adaptation.

They make small bets early and diversify their portfolios. These companies take what we call an options-oriented approach to new markets. They tend to move earlier than competitors into spaces that appear attractive, making small initial investments and following up with more substantial ones - or getting out as the opportunity warrants. They are likely to pursue a constant stream of relatively small initiatives.

HDFCs history of entering new growth markets is illustrative. In 1998 HDFC joined the Cirrus interbank network so that Mastercard holders worldwide could use its ATMs. In 2001 it became the first bank in India to launch an international debit card, in association with Visa. It introduced various credit card innovations, including a card specifically for farmers, and then reached an agreement with Tata Pipes to offer the farmers credit.

In contrast, ICICI Bank, a key competitor, didnt even begin to explore regular debit cards until 2000. HDFC moved early and built from initial success in other new markets as well, including telebanking, mobile banking, and foreign exchange services. Indeed, the only market in which a competitor seems to have beaten it is rural India, where the State Bank of India was well established.

Unlike their competitors, outliers appear to make fewer big, high-risk bets - which is also consistent with an options orientation. Comparing Indra with its rival BAE, for instance, both had made acquisitions and divestitures during the study period, but most of Indras acquisitions were under $100 million, whereas most of BAEs were much higher, including its $4.5 billion acquisition of Armor Holdings, in 2007.

The outliers have diverse but related portfolios, with enough variety to enable investment in their core businesses even as they explore new alternatives. When one segment goes into decline, another could be leveraged. Indra, for example, used acquisitions to move from the defense industry into computer systems design and financial software solutions. Through subsequent acquisitions it built and maintained a formidable solutions portfolio that didnt depend on one business model or end market.

Even the single-product outliers, Tsingtao Brewery and Yahoo Japan, honoured this principle : Tsingtao diversified geographically; and Yahoo Japan diversified by selling into new segments and offering new services.

The outlier companies appreciate the value of acquisitions for building new capabilities and getting into new markets quickly. And they have a better-than-average record of making those acquisitions work. For example, Indra expanded its capabilities and accessed new geographies by acquiring a strategic consultancy, Europraxis, in 2001; a Portuguese IT company, CPC-IS, in 2002; and an Australian IT company, Interscan, in 2007.

2.

Active acquisitions.

Tsingtao has been heavily involved in domestic and foreign M&A deals since its privatization in the early 1990s, which is credited with helping it to somewhat consolidate the highly fragmented Chinese beer market.

FactSet was actually criticized for some of its activity: It spent $92 million on acquisitions in 2005, when the companys net income was only $72 million. Nonetheless, it continues to acquire companies to broaden the offerings it can provide to its customers.

ACS used several major acquisitions in 2002, 2005, and 2007 to consolidate its position and gain access to new markets.

Outliers manage major resource allocations centrally. At many companies, resources are held hostage at the divisional or business-unit level. When one division is under threat, or an opportunity falls between units, the company cant respond effectively because incumbent executives resist. But at outliers, decision making with respect to major strategic challenges appears to be centrally coordinated. They have processes that support speed and flexibility.

3.

Centralised resource allocation.

Outliers favor adaptability over pure efficiency, even though it occasionally leads to less-than-perfect outcomes. Their strategy adjustments and resource allocation shifts are more likely to occur quarterly than annually, as are their promotions and personnel evaluations. This allows them to be more responsive to changes in the environment than companies with rigid annual processes.

4. Integrating processes.

Outliers build innovation into everyday operations. At many traditional companies, the most powerful people run the large, wellestablished lines of business, and growthoriented innovation is managed by a separate, less powerful group. Innovation at the outliers tends to be better integrated. Its mentioned prominently in recruitment materials, marketing messages, and employee communications.

innovation

into

everyday

Innovation is also built into the companys resource allocation and promotion processes. Every year at Infosys, for example, the senior executive team asks each unit to name two big things it is going to do that will dramatically move the business forward in real time - and to go public with those intentions. Yahoo Japan has identified four major growth strategies; its managers are regularly asked to identify the next set of promising opportunities in those areas, and resources are liberally allocated to the best ideas that emerge from their discussions..

In outliers the changes are evolutionary and adaptations are rapid. One finds among them little evidence of the kind of wrenching change that many companies experience.

5. Unusual stability coupled with exceptional flexibility.

Outliers focus management attention on culture and shared values. They pay close attention to values, culture and alignment. They make significant investments in creating an appropriate corporate culture, in employee training and in executive development.

Infosys, for example, is famous for its Global Education Center, the largest dedicated corporate education facility in the world, with the capacity to train 14,000 students at any one time. HDFC Bank scores high on organisational effectiveness, employee engagement and a supportive environment.

They avoid dramatic divestitures. It is difficult to find instances where growth outliers exited segments or canceled major projects - no instances of sudden, disruptive exits. These companies tend to reallocate resources gradually rather than to dramatically divest or restructure. They use industry evolution as an opportunity to leave old businesses and enter new, higher-growth segments.

They avoid dramatic divestitures. It is difficult to find instances where growth outliers exited segments or canceled major projects - no instances of sudden, disruptive exits. These companies tend to reallocate resources gradually rather than to dramatically divest or restructure. They use industry evolution as an opportunity to leave old businesses and enter new, higher-growth segments.

Infosys, for example, is famous for its Global Education Center, the largest dedicated corporate education facility in the world, with the capacity to train 14,000 students at any one time. HDFC Bank scores high on organisational effectiveness, employee engagement and a supportive environment.

They avoid dramatic divestitures. It is difficult to find instances where growth outliers exited segments or canceled major projects - no instances of sudden, disruptive exits. These companies tend to reallocate resources gradually rather than to dramatically divest or restructure. They use industry evolution as an opportunity to leave old businesses and enter new, higher-growth segments.

Cognizant, for instance, made nine strategic acquisitions but no divestitures during the period of the study. The company began by offering straightforward technology services. Over the years, it moved into professional consulting services and differentiated itself with a strong industry focus and co-location of its teams with clients. It shifted technology and people from lowgrowth businesses such as plain-vanilla business process outsourcing to people intensive, high-touch businesses such as complete, complex software solutions. This shift occurred without the wholesale downsizing that Satyam Computer Services and other competitors experienced.

They hold on to their talent. One of the implications of executing transformations without wrenching change is that talented employees are less likely to have their careers cut short unnecessarily. Like Cognizant, the other outliers are slow to downsize, and their habit of gradually moving resources into new businesses means that emerging leaders have new places to go.

The head of strategy for Infosys, describing an evolutionary path similar to Cognizants, makes this point : When we decide to get out of something, we slow down on allocating resources to it. It finds its way to insignificance in a period of time. You dont need to chop it off - you need to let it live its life. Since we are in a talent business, its easy for us to repurpose the leadership and the talent.

The recognition that talent needs a place to go is complemented by a commitment to employee training. The combination probably explains why senior managers nearly always come from inside the company.

They dont change high-level strategies quickly. The study period was a tumultuous time : It included the burst of the dot-com bubble, the tragedy of 9/11, the global housing and credit bubbles, the introduction of the euro, wars in Iraq and Afghanistan, the explosion of the internet as a vehicle for commerce and the Great Recession of 2008. Yet, the outliers strategies remained remarkably stable.

At Tsingtao Brewery, after the sudden death of its hard-driving president Peng Zuoyi in 2001, subsequent leaders committed to following through on his international expansion strategy. When ACS was founded, in 1983, its CEO expressed his commitment to making it Spains most profitable public construction company; that strategy is still in place. Atmos Energy is now executing the strategy crafted in 1997 by a former CEO, leveraging efficiency in its regulated business and driving growth in its unregulated businesses. FactSets strategy statement has not changed at all since the companys founding in 1978, despite radical shifts in underlying technologies and an explosion of information relevant to key clients.

They have a reliable customer base. Outliers relationships with their clients are remarkably stable as well - probably because their gradual strategic shifts allow them to change as their customers change. FactSets client retention rate reached 92% in 2011. Analysts have observed that both Infosys and Cognizant have strong client retention. Cognizant reported a 90% client satisfaction rate in a recent survey, and Infosys reported a 95% retention rate in a recent interview with us. To some extent this stability also characterizes outliers relationships with suppliers.

They keep their senior leadership stable. At all 10 companies on the list, the top executive had been promoted internally; there were no white knights or outside-the-industry saviors. Interestingly - and consistent with the findings of other researchers over the years - these chief executives generally kept a low profile. They were respected, known to have made major contributions and somewhat visible in the press, but not charismatic.

Stability is what enables these companies to innovate and to maintain steady growth. Coupled with transparent values, it allows employees to feel confident about taking the risks that experimentation requires. Strong values help maintain ethical standards. Continual small changes keep an organization from becoming stale. Management continuity permits the building of informal internal networks, which are known to be a factor in successful innovation. The result is a high-performing organization that delivers consistent results over a reasonably long period in the face of environmental volatility

Session 08
G H I J Industry life cycle Technological changes Industry related policy changes Industry sales estimates