Professional Documents
Culture Documents
and Valuation
Income Statement
Liquidity Ratios
Current Ratios
Acid Test or Quick Ratios
Solvency Ratios
Times Interest Earned (Interest Coverage Ratios)
Dividend coverage ratio
Times fixed charges-earned ratio
Debt to equity ratios
Profitability Ratios
Profit margin
Pretax profit
EBIT
Gross Profit
Valuation Ratios
EV/EBIT
EV/EBIT = Enterprise Value / Earning before Interest and
Tax
Buffetts rule of thumb is to pay 10x pretax when acquiring
businesses.
FCF to Sales
FCF to Sales = FCF / Sales
What percentage of sales is converted directly to FCF. - The
higher the better
Any company hash FCF to Sales > 10%, is a FCF generating
machine.
Inventory Turnover
Inventory Turnover = COGS / Average Inventory
Measure how quickly company sell it inventory
The goal is to quickly turn inventory into cash, then reinvest the cash back
into inventory, and then turn it to cash again for even more profits.
Compare inventory turn over with similar companies.
High inventory turnover can be achieved via
Tight inventory management (excellent)
Reducing price to quickly sell (bad)
Piotroski Score
It is a quality score that leads to an easier valuation.
The first four criteria of the Piotroski Score count towards profitability.
Points 5-7 of the Piotroski Score, looks at the health of the balance sheet in terms of debt and the number
of shares outstanding.
The last two factors of the Piotroski Score looks at operating efficiency.
The Model
Use this idea to express current equity value of the firm
as a function of book value of the firms and abnormal
earnings:
Equity Value0 = BV0 + [AEt /(1+r)t] t=1
where: BVt = Book value of equity at beginning of year t
r = Cost of equity capital
AEt = Expected value of abnormal earnings in year t
= Projected earnings in yr t - (r * BV of equity at
beginning of year t)
Step 3: Estimate expected abnormal earnings in each yr. t = 1,..,T in forecast horizon:
AEt= Et - (r * BVt-1 )
Step 4: Use r to estimate the PV of abnormal earnings during the forecast horizon:
AE1/(1+r)1 + AE2/(1+r)2 + .... + AET/(1+r)T
Step 5: Estimate the PV of expected abnormal earnings beyond the forecast horizon:
Use perpetuity
Use growing perpetuity