Chapter 11 Equity Analysis And ValuationEquity

Topics: Income, Financial statements, Revenue Pages: 33 (9648 words) Published: November 9, 2014
Chapter 11 - Equity Analysis And Valuation

Equity Analysis and Valuation
REVIEW
Equity analysis and valuation is the focus of this chapter. This chapter extends earlier analyses to consider earnings persistence and earning power. Earnings persistence is broadly defined and includes the stability, predictability, variability, and trend in earnings. We also consider earnings management as a determinant of persistence. Earning power refers to the ability of the core operations of a company to operate profitably. Our valuation analysis emphasizes earnings and other accounting measures for computing company value. Earnings forecasting considers earning power, estimation techniques, and monitoring mechanisms for analysis. This chapter describes several useful tools for equity analysis and valuation. We describe recasting and adjustment of financial statements. We also distinguish between recurring and nonrecurring, operating and nonoperating, and extraordinary and nonextraordinary earnings components. Throughout the chapter we emphasize the application of earnings-based analysis with several illustrations.

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Chapter 11 - Equity Analysis And Valuation

OUTLINE


Earnings Persistence
Recasting and Adjusting Earnings
Determinants of Earnings Persistence
Persistent and Transitory Items in Earnings



Earnings-Based Equity Valuation
Relation between Stock Prices and Accounting Data
Fundamental Valuation Multiples
Illustration of Earnings-Based Valuation



Earning Power and Forecasting for Valuation
Earning Power
Earnings Forecasting
Interim Reports for Monitoring and Revising Earnings Estimates

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Chapter 11 - Equity Analysis And Valuation

ANALYSIS OBJECTIVES


Analyze earnings persistence, its determinants and its relevance for earnings forecasting.



Explain recasting and adjusting of earnings and earnings components for analysis.



Describe earnings-based equity valuation and its relevance for financial analysis.



Analyze earning power and its usefulness for forecasting and valuation.



Explain earnings forecasting, its mechanics and its effectiveness in assessing company performance.



Analyze interim reports and consider their value in monitoring and revising earnings estimates.

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Chapter 11 - Equity Analysis And Valuation

QUESTIONS
1. The significance and potential value of research and development costs are among the most important for financial statement analysis and interpretation. They are important not only because of their relative amount but also because of their significance for the projection of future performance. The analyst must pay careful attention to research and development costs and to the absence of such costs. In many companies they represent substantial costs, much of them of a fixed nature. We must make a careful distinction between what can be quantified in this area, and consequently analyzed, and what cannot be quantified and must consequently be evaluated in qualitative terms. While a quantitative measure of the amount of R&D expenses is not difficult, it is often difficult to evaluate the quality of research and development costs and their effect on future earnings. There seems to be no clear-cut definition of "research." Therefore, it may not be meaningful to compare the quality of the research and development costs of two companies. Still, the analyst should evaluate such qualitative factors as the caliber of the research staff and organization, the eminence of its leadership, as well as the commercial results of their efforts. One would also want to consider whether the research and development is government-sponsored or company-sponsored. 2. The reported values of most assets in the balance sheet ultimately enter the cost streams of the income statement. Therefore, whenever assets are overstated, then income is overstated because it has been relieved of charges needed to bring such assets down to...
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