FSA Review Notes

Mid-Term Exam #3

• Scheduled for May 13 (Tue).
• 75 minutes in class; closed book and closed notes.
• Bring a pencil, an eraser, and a calculator.
• Arrive 5-10 minutes early.
• Friday discussion focuses on the practice exam.
• All make-up exams must be completed by May 16.
• There is NO final exam, despite what Testudo might say!

Accounting as the Language of Business

• Accounting is the language of business.
  • Vocabulary: Assets, Liabilities, Shareholders’ equity
  • Grammar: Revenue recognition principle, Matching principle
• Goal: To become an informed user of financial statements.

Warren Buffett's Reading Habits

• Warren Buffett, CEO of Berkshire Hathaway, emphasizes reading.
• He primarily reads K's, Q's, and multiple newspapers daily.
• His advice for new investors: Read lots of K's and Q's, reading every page.

Introduction to Financial Statement Analysis

• Topics covered:
  • Common-size F/S
  • Financial ratios
  • Alternative data
  • Mini case 3

Common-Size Balance Sheet

• Restate balance sheet items as a percentage of total assets.
• Example Provided: Target
  • Cash and cash equivalents
  • Inventory
  • Accounts and other receivables
  • Vendor income receivable
  • Prepaid expenses
  • Other
  • Other current assets
  • Current assets
  • Property and equipment, net
  • Operating lease assets
  • Goodwill and intangible assets
  • Company-owned life insurance
  • investments, net of loans
  • Other
  • Other noncurrent assets
  • Noncurrent assets
  • Total assets

Common-Size Income Statement

• Restate income statement items as a percentage of net sales revenue.
• Key Ratios:
  • Gross Profits = \frac{Sales}
  • Net profit margin = \frac{Net Income}{Sales}

Profitability Ratios

• Return on assets (ROA) = \frac{Earnings before interest}{Average total assets}
  • The return earned on assets that company invests in
• Return on equity (ROE) = \frac{Net income}{Average shareholders’ equity}
  • The return earned on investment made by company shareholders
• Gross profit margin (GM) = \frac{Gross profit}{Sales revenue}
  • Where gross profit = sales revenue – COGS
  • The percentage of revenue left after deducting direct costs of sales
• Net profit margin (NM) = \frac{Net income}{Sales revenue}
  • The percentage of revenue left after deducting operating expenses, depreciation, amortization, interest, and income taxes

Financial Ratios

• Categories: Profitability, Asset turnover.
• Comparing financial ratios involves:
  • Time-series analysis: Comparing a firm’s performance over time.
  • Cross-sectional analysis: Comparing a firm's performance to other firms, such as industry peers.

Asset Turnover Ratios

• Provide insights into a company’s productivity and efficiency.
• Asset Turnover = \frac{Sales revenue}{Average total assets}
  • Measures how effectively companies are using their assets to generate sales
• Accounts Receivable Turnover (ART) = \frac{Net credit sales}{Average A/R}
  • Measures how many times a company sells on credit and collects the payment from customers
• Days receivable outstanding = \frac{365}{ART}
  • Average number of days that it takes a company to collect payment for a sale from customers.
• Inventory Turnover (IT) = \frac{COGS}{Average inventory}
  • Measures how many times a company sells and replaces its inventory
• Days inventory outstanding = \frac{365}{IT}
  • Average number of days that a company holds inventory for before turning it into sales.

ROA Decomposition

• ROA = \frac{Earnings before interest}{Average total assets} = \frac{Earnings before interest}{Sales revenue} \times \frac{Sales revenue}{Average total assets}
  • ROA = Profit Margin \times Asset Turnover
• What drives ROA - profitability and efficiency

ROA Decomposition: Apple

• Increase in asset turnover and increase in net profit margin affect ROA.
• Observed differences before and after 2021.

Profit Margin and Asset Turnover Across Industries

• Discusses profit margin and asset turnover across different industries.
• Includes a median ROA for all companies.
• Highlights industries with:
  • Low asset turnover and high profit margin
  • High asset turnover and low profit margin

Takeaways

• Key topics covered:
  • Common-size financial statements
  • Financial Ratios
    • Time-series analysis
    • Cross-sectional analysis
  • Alternative data

Alternative Data

• Alternative Data:
  • Datasets from unofficial sources.
  • Not disclosed by firms in their official reports.
  • Examples include: social media sentiment, satellite images, point-of-sale retail scanner data.

Mini Case 3: Apollo Investment

• Types of information analysts gather:
  • Annual and quarterly filings (10-K, 10-Q)
  • Press releases
  • Earnings conference call
  • Management guidance (earnings forecast)
  • Corporate site visits
  • Alternative data

Advantages of Alternative Data

• Two main advantages:
  1. More objective
     • Official disclosures (10K and 10Q) are subject to discretion.
     • Alternative data is generated by third-parties.
  2. Much timelier than information from official sources (10K, 10Q)
     • Timing is crucial.
     • Some alternative data can be generated almost in real time.

Alternative Data: Luckin Coffee's Accounting Fraud

• Highlights Luckin Coffee's accounting fraud as an example of the value of objective data.

Alternative Data: Tesla

*Tesla Stock Slips After Q4 Revenue, Earnings Miss Estimates
*Shares of Tesla slipped in after-hours trading as investors digested quarterly financial results released after the close that missed Wall Street's projections for earnings per share and revenue.

• Tesla announced 2024 Q4 earnings Open price: 207.83
• Close price: 182.63
• Tesla stock price plunged 12.13% on 1/25/2024.

Research on Alternative Data

• Research by Dichev and Qian (2022) explores:
  • Whether alternative data contains information about firm GAAP revenues.
  • Whether investors can use alternative data for investing.
  • Focus on point-of-sale retail scanner data (e.g., Coca-Cola sales at Walmart).

Predicting Manufacturer GAAP Revenue

• Using consumer purchases to predict manufacturer GAAP revenue.
• Example: Using Coca-Cola Company’s consumer purchases to predict their GAAP revenue.
• The data is released much timelier, giving investors a timing advantage.
• The question is whether consumer purchases of coke can indicate Coca Cola Company’s performance.

Using Big Data to Form Portfolios

• Process:
  • Consumer purchases data from 1/1/2006 to 1/28/2006.
  • Aggregate past 4-week consumer purchases for each firm.
  • Compute seasonal changes of consumer purchases (∆CP) and sort all firms into five quintiles.
  • Buy/sell stocks in the top/bottom quintile.
  • Hold for 4 weeks until Mar 09, 2006.

Returns to Hedge Portfolio Based on Changes in Consumer Purchases

• Figure 3 illustrates 4-week returns to a hedge portfolio based on changes in consumer purchases by calendar year.
• Demonstrates an annualized return of 14%-19%.