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9780073127132

Financial Statement Analysis And Security Valuation

by
  • ISBN13:

    9780073127132

  • ISBN10:

    0073127132

  • Edition: 3rd
  • Format: Hardcover
  • Copyright: 2006-01-30
  • Publisher: McGraw-Hill/Irwin
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Summary

This book describes valuation as an exercise in financial statement analysis. Students learn to view a firm through its financial statements and to carry out the appropriate financial statement analysis to value the firm's debt and equity. The book takes an activist approach to investing, showing how the analyst challenges the current market price of a share by analyzing the fundamentals. With a careful assessment of accounting quality, accounting comes to life as it is integrated with the modern theory of finance to develop practical analysis and valuation tools for active investing.

Table of Contents

List of Cases
xxiii
List of Accounting Clinics
xxiv
Introduction to Investing and Valuation
2(30)
Investment Styles and Fundamental Analysis
3(3)
Bubble, Bubble
6(3)
How Bubbles Work
7(1)
Analysts During the Bubble
7(2)
Fundamental Analysis Anchors Investors
9(1)
The Setting: Investors, Firms, Securities, and Capital Markets
9(3)
The Business of Analysis: The Professional Analyst
12(2)
Investing in Firms: The Outside Analyst
12(1)
Investing within Firms: The Inside Analyst
13(1)
The Analysis of Business
14(3)
Strategy and Valuation
14(1)
Mastering the Details
15(1)
The Key Question: Durability of Competitive Advantage
16(1)
Financial Statements: The Lens on the Business
17(1)
Choosing a Valuation Technology
17(4)
Guiding Principles
18(1)
Classifying and Ordering Information
18(2)
Anchoring Value in the Financial Statements
20(1)
How to Use this Book
21(1)
An Outline of the Book
21(1)
The Web Connection
22(1)
Key Concepts
22(1)
A Continuing Case: Kimberly-Clark Corporation
23(4)
Concept Questions
27(2)
Exercises
29(2)
Minicase
31(1)
Introduction to the Financial Statements
32(40)
The Analyst's Checklist
33(1)
The Form of the Financial Statements
33(9)
The Balance Sheet
34(1)
The Income Statement
34(4)
The Cash Flow Statement
38(1)
The Statement of Stockholders' Equity
39(1)
The Footnotes and Supplementary Information to Financial Statements
40(1)
The Articulation of the Financial Statements: How the Statements Tell a Story
40(2)
Measurement in the Financial Statements
42(11)
The Price-to-Book Ratio
42(3)
Measurement in the Balance Sheet
45(1)
Measurement in the Income Statement
45(4)
The Price-Earnings Ratio
49(1)
The Reliability Criterion: Don't Mix What You Know with Speculation
50(2)
Tension in Accounting
52(1)
Summary
53(1)
The Web Connection
53(1)
Key Concepts
53(1)
The Analyst's Toolkit
54(1)
A Continuing Case: Kimberly-Clark Corporation
55(5)
Concept Questions
60(1)
Exercises
61(5)
Minicase
66(6)
PART ONE FINANCIAL STATEMENTS AND VALUATION
72(162)
How Financial Statements Are Used in Valuation
74(44)
The Analyst's Checklist
75(1)
Multiple Analysis
76(6)
The Method of Comparables
76(2)
Screening on Multiples
78(4)
Asset-Based Valuation
82(2)
Fundamental Analysis
84(4)
The Process of Fundamental Analysis
84(3)
Financial Statement Analysis, Pro Forma Analysis, and Fundamental Analysis
87(1)
The Architecture of Fundamental Analysis: The Valuation Model
88(10)
Terminal Investments and Going-Concern Investments
90(1)
Valuation Models for Terminal Investments
91(2)
Valuation Models for Going-Concern Investments
93(1)
Criteria for a Practical Valuation Model
93(1)
What Generates Value?
94(4)
Valuation Models and Asset Pricing Models
98(1)
Summary
98(1)
The Web Connection
99(1)
Key Concepts
99(1)
The Analyst's Toolkit
100(1)
A Continuing Case: Kimberly-Clark Corporation
101(1)
Concept Questions
102(1)
Exercises
102(5)
Minicases
107(6)
Appendix The Required Return and Asset Pricing Models
113(5)
Cash Accounting, Accrual Accounting, and Discounted Cash Flow Valuation
118(36)
The Analyst's Checklist
119(1)
The Dividend Discount Model
120(2)
The Discounted Cash Flow Model
122(5)
Free Cash Flow and Value Added
125(2)
Reverse Engineering: Converting a Price to a Forecast
127(1)
Simple Valuation Models
128(1)
The Statement of Cash Flows
129(3)
Forecasting Free Cash Flows
131(1)
Cash Flow, Earnings, and Accrual Accounting
132(7)
Earnings and Cash Flows
132(4)
Accruals, Investments, and the Balance Sheet
136(3)
Summary
139(1)
The Web Connection
140(1)
Key Concepts
140(1)
The Analyst's Toolkit
141(1)
A Continuing Case: Kimberly-Clark Corporation
141(1)
Concept Questions
142(1)
Exercises
143(6)
Minicases
149(5)
Accrual Accounting and Valuation: Pricing Book Values
154(44)
The Analyst's Checklist
155(1)
The Concept Behind the Price-to-Book Ratio
155(1)
Beware of Paying Too Much for Earnings
156(1)
Prototype Valuations
156(3)
Valuing a Project
156(1)
Valuing a Savings Account
157(2)
The Normal Price-to-Book Ratio
159(1)
A Model for Anchoring Value on Book Value
159(8)
Residual Earnings Drivers and Value Creation
162(3)
A Simple Demonstration
165(2)
Applying the Model to Equities
167(6)
The Forecast Horizon and the Continuing Value Calculation
168(3)
Target Prices
171(1)
Converting Analysts' Forecasts to a Valuation
171(2)
Applying the Model to Projects and Strategies
173(2)
Features of the Residual Earnings Model
175(4)
Book Value Captures Value and Residual Earnings Captures Value Added to Book Value
175(1)
Protection from Paying Too Much for Earnings Generated by Investment
176(1)
Protection from Paying Too Much for Earnings Created by the Accounting
177(1)
Capturing Value Not on the Balance Sheet---for All Accounting Methods
178(1)
Residual Earnings Are Not Affected by Dividends, Share Issues, or Share Repurchases
179(1)
What the Residual Earnings Model Misses
179(1)
Reverse Engineering the Model for Active Investing
179(5)
Reverse Engineering the S&P 500
182(1)
Using Analysts' Forecasts in Reverse Engineering
183(1)
Implied Earnings Forecasts and Earnings Growth Rates
183(1)
The Building Blocks of a Residual Earnings Valuation
184(1)
Summary
185(1)
The Web Connection
186(1)
Key Concepts
186(1)
The Analyst's Toolkit
187(1)
A Continuing Case: Kimberly-Clark Corporation
187(1)
Concept Questions
188(1)
Exercises
189(5)
Minicases
194(4)
Accrual Accounting and Valuation: Pricing Earnings
198(36)
The Analyst's Checklist
199(1)
The Concept Behind the Price-Earnings Ratio
199(1)
Beware of Paying Too Much for Earnings Growth
200(1)
Prototype Valuation
200(4)
The Normal Forward P/E Ratio
202(1)
The Normal Trailing P/E Ratio
203(1)
A Poor P/E Model
204(1)
A Model for Anchoring Value on Earnings
204(6)
Measuring Abnormal Earnings Growth
206(2)
A Simple Demonstration
208(1)
Anchoring Valuation on Current Earnings
209(1)
Applying the Model to Equities
210(2)
Converting Analysts' Forecasts to a Valuation
211(1)
Features of the Abnormal Earnings Growth Model
212(3)
Buy Earnings
212(1)
Abnormal Earnings Growth Valuation and Residual Earnings Valuation
213(1)
Abnormal Earnings Growth Is Not Affected by Dividends, Share Issues, or Share Repurchases
214(1)
Accounting Methods and Valuation
215(1)
Reverse Engineering the Model for Active Investing
215(7)
Reverse Engineering the S&P 500
217(1)
Using Analysts' Forecasts in Reverse Engineering
218(1)
Implied Earnings Forecasts and Earning Growth Rates
218(1)
The Building Blocks of an Abnormal Earnings Growth Valuation
218(2)
Screening on Earnings Yield
220(1)
Screening on PEG Ratios
221(1)
Summary
222(1)
The Web Connection
223(1)
Key Concepts
223(1)
The Analyst's Toolkit
223(1)
A Continuing Case: Kimberly-Clark Corporation
224(1)
Concept Questions
225(1)
Exercises
225(6)
Minicases
231(3)
PART TWO THE ANALYSIS OF FINANCIAL STATEMENTS
234(226)
Business Activities and Financial Statements
236(26)
The Analyst's Checklist
237(1)
Business Activities: The Cash Flows
238(6)
The Reformulated Cash Flow Statement
241(1)
The Reformulated Balance Sheet
241(3)
Business Activities: All Stocks and Flows
244(1)
The Reformulated Income Statement
245(1)
Accounting Relations that Govern Reformulated Statements
245(3)
The Sources of Free Cash Flow and the Disposition of Free Cash Flow
246(1)
The Drivers of Dividends
246(1)
The Drivers of Net Operating Assets and Net Indebtedness
247(1)
Tying it Together for Shareholders: What Generates Value?
248(2)
Stocks and Flows Ratios: Business Profitability
250(2)
Summary
252(1)
The Web Connection
253(1)
Key Concepts
253(1)
The Analyst's Toolkit
254(1)
A Continuing Case: Kimberly-Clark Corporation
254(1)
Concept Questions
255(1)
Exercises
256(3)
Minicase
259(3)
The Analysis of the Statement of Shareholders' Equity
262(38)
The Analyst's Checklist
263(1)
Reformulating the Statement of Owners' Equity
263(6)
Introducing Nike and Reebok
264(1)
Reformulation Procedures
264(5)
Dirty-Surplus Accounting
269(2)
Comprehensive Income Reporting
270(1)
Ratio Analysis
271(2)
Payout and Retention Ratios
271(1)
Shareholder Profitability
272(1)
Growth Ratios
272(1)
Hidden Dirty Surplus
273(8)
Issue of Shares in Operations
273(3)
Issue of Shares in Financing Activities
276(1)
Share Transactions in Inefficient Markets
276(3)
Reformulating the Equity Statement to Incorporate Hidden Expenses
279(2)
The Eye of the Shareholder
281(1)
The Web Connection
282(1)
Summary
282(1)
Key Concepts
282(1)
The Analyst's Toolkit
283(1)
A Continuing Case: Kimberly-Clark Corporation
284(1)
Concept Questions
285(1)
Exercises
286(7)
Minicases
293(7)
The Analysis of the Balance Sheet and Income Statement
300(46)
The Analyst's Checklist
301(1)
Reformulation of the Balance Sheet
301(10)
Issues in Reformulating Balance Sheets
302(9)
Reformulation of the Income Statement
311(13)
Tax Allocation
312(4)
Issues in Reformulating Income Statements
316(8)
Comparative Analysis of the Balance Sheet and Income Statement
324(3)
Common-Size Analysis
324(2)
Trend Analysis
326(1)
Ratio Analysis
327(2)
Summary
329(1)
The Web Connection
330(1)
Key Concepts
330(1)
The Analyst's Toolkit
331(1)
A Continuing Case: Kimberly-Clark Corporation
332(1)
Concept Questions
333(1)
Exercises
333(8)
Minicases
341(5)
The Analysis of the Cash Flow Statement
346(24)
The Analyst's Checklist
347(1)
The Calculation of Free Cash Flow
347(2)
Gaap Statement of Cash Flows and Reformulated Cash Flow Statements
349(10)
Reclassifying Cash Transactions
350(6)
Tying It Together
356(3)
Cash Flow From Operations
359(1)
Summary
359(1)
The Web Connection
360(1)
Key Concepts
360(1)
The Analyst's Toolkit
360(1)
A Continuing Case: Kimberly-Clark Corporation
360(1)
Concept Questions
361(1)
Exercises
361(8)
Minicase
369(1)
The Analysis of Profitability
370(38)
The Analyst's Checklist
371(1)
Cutting to the Core of the Operations: The Analysis of Profitability
371(1)
First-Level Breakdown: Distinguishing Financing and Operating Activities and the Effect of Leverage
372(9)
Financial Leverage
372(2)
Operating Liability Leverage
374(2)
Summing Financial Leverage and Operating Liability Leverage Effects on Shareholder Profitability
376(1)
Return on Net Operating Assets and Return on Assets
377(4)
Financial Leverage and Debt-to-Equity Ratios
381(1)
Second-Level Breakdown: Drivers of Operating Profitability
381(3)
Third-Level Breakdown
384(5)
Profit Margin Drivers
384(1)
Turnover Drivers
384(3)
Borrowing Cost Drivers
387(2)
The Web Connection
389(1)
Summary
389(1)
Key Concepts
390(1)
The Analyst's Toolkit
390(1)
A Continuing Case: Kimberly-Clark Corporation
391(1)
Concept Questions
392(1)
Exercises
392(7)
Minicases
399(9)
The Analysis of Growth and Sustainable Earnings
408(52)
The Analyst's Checklist
409(1)
What Is Growth?
409(3)
Introduction to Growth Analysis
412(1)
The Analysis of Changes in Profitability and Sustainable Earnings
413(16)
Analysis of Changes in Operations
415(2)
Issues in Identifying Sustainable Earnings
417(9)
Operating Leverage
426(1)
Analysis of Changes in Financing
427(2)
The Analysis of Growth in Shareholders' Equity
429(2)
Growth, Sustainable Earnings, and the Evaluation of P/B Ratios and P/E Ratios
431(6)
How Price-to-Book Ratios and Trailing P/E Ratios Articulate
431(3)
Trailing Price-Earnings Ratios and Growth
434(1)
Trailing Price-Earnings Ratios and Transitory Earnings
435(1)
P/E Ratios and the Analysis of Sustainable Earnings
436(1)
Summary
437(1)
The Web Connection
437(1)
Key Concepts
438(1)
The Analyst's Toolkit
438(1)
A Continuing Case: Kimberly-Clark Corporation
438(2)
Concept Questions
440(1)
Exercises
440(8)
Minicases
448(12)
PART THREE FORECASTING AND VALUATION ANALYSIS
460(130)
The Value of Operations and the Evaluation of Enterprise Price-to-Book Ratios and Price-Earnings Ratios
462(48)
The Analyst's Checklist
463(1)
A Modification to Residual Earnings Forecasting: Residual Operating Income
464(5)
The Drivers of Residual Operating Income
467(2)
A Modification to Abnormal Earnings Growth Forecasting: Abnormal Growth in Operating Income
469(2)
Abnormal Growth in Operating Income and the ``Dividend'' from Operating Activities
469(2)
The Cost of Capital and Valuation
471(4)
The Cost of Capital for Operations
472(1)
The Cost of Capital for Debt
473(1)
Operating Risk, Financing Risk, and the Cost of Equity Capital
474(1)
Financing Risk and Return and the Valuation of Equity
475(11)
Leverage and Residual Earnings Valuation
475(2)
Leverage and Abnormal Earnings Growth Valuation
477(5)
Leverage Creates Earnings Growth
482(3)
Debt and Taxes
485(1)
Mark-to-Market Accounting: A Tool for Incorporating the Cost of Stock Options in Valuation
486(3)
Enterprise Multiples
489(5)
Enterprise Price-to-Book Ratios
489(1)
Enterprise Price-Earnings Ratios
490(4)
Summary
494(1)
The Web Connection
494(1)
Key Concepts
495(1)
The Analyst's Toolkit
495(1)
A Continuing Case: Kimberly-Clark Corporation
496(2)
Concept Questions
498(1)
Exercises
499(6)
Minicases
505(5)
Simple Forecasting and Simple Valuation
510(36)
The Analyst's Checklist
511(1)
Simple Forecasts and Simple Valuations from Financial Statements
512(10)
Forecasting from Book Values: SF1 Forecasts
512(2)
Forecasting from Earnings and Book Values: SF2 Forecasts
514(3)
Forecasting from Accounting Rates of Return: SF3 Forecasts
517(5)
Simple Forecasting: Adding Speculation to Financial Statement Information
522(1)
A Simple Forecast of Growth: Growth in Sales
523(1)
The Applicability of Simple Valuations
523(4)
Simple Valuations with Short-Term and Long-Term Growth Rates
527(1)
Simple Valuation as an Analysis Tool
528(3)
Reverse Engineering
529(1)
Enhanced Stock Screening
530(1)
Sensitivity Analysis
530(1)
Summary
531(1)
The Web Connection
532(1)
Key Concepts
532(1)
The Analyst's Toolkit
533(1)
A Continuing Case: Kimberly-Clark Corporation
533(1)
Concept Questions
534(1)
Exercises
534(5)
Minicases
539(7)
Full-Information Forecasting, Valuation, and Business Strategy Analysis
546(44)
The Analyst's Checklist
547(1)
Financial Statement Analysis: Focusing the Lens on the Business
548(11)
Focus on Residual Operating Income and Its Drivers
548(1)
Focus on Change
549(6)
Focus on Key Drivers
555(1)
Focus on Choices versus Conditions
556(3)
Full-Information Forecasting and Pro Forma Analysis
559(10)
A Forecasting Template
562(5)
Features of Accounting-Based Valuation
567(2)
Value Generated in Share Transactions
569(2)
Mergers and Acquisitions
569(1)
Share Repurchases and Buyouts
570(1)
Financial Statement Indicators and Red Flags
571(1)
Business Strategy Analysis and Pro Forma Analysis
571(3)
Unarticulated Strategy
573(1)
Scenario Analysis
574(1)
The Web Connection
574(1)
Summary
574(1)
Key Concepts
575(1)
The Analyst's Toolkit
576(1)
A Continuing Case: Kimberly-Clark Corporation
576(1)
Concept Questions
577(1)
Exercises
578(6)
Minicases
584(6)
PART FOUR ACCOUNTING ANALYSIS AND VALUATION
590(92)
Creating Accounting Value and Economic Value
592(40)
The Analyst's Checklist
593(1)
Value Creation and the Creation of Residual Earnings
593(3)
Accounting Methods, Price-to-Book Ratios, Price-Earnings Ratios, and the Valuation of Going Concerns
596(8)
Accounting Methods with a Constant Level of Investment
596(3)
Accounting Methods with a Changing Level of Investment
599(4)
An Exception: LIFO Accounting
603(1)
Hidden Reserves and the Creation of Earnings
604(4)
Conservative and Liberal Accounting in Practice
608(5)
LIFO versus FIFO
609(1)
Research and Development in the Pharmaceuticals Industry
610(1)
Expensing Goodwill and Research and Development Expenditures
611(1)
Liberal Accounting: Breweries and Hotels
612(1)
Profitability in the 1990s
612(1)
Economic-Value-Added Measures
613(1)
Accounting Methods and the Forecast Horizon
613(3)
The Quality of Cash Accounting and Discounted Cash Flow Analysis
614(2)
Summary
616(1)
The Web Connection
616(1)
Key Concepts
617(1)
The Analyst's Toolkit
617(1)
Concept Questions
618(1)
Exercises
618(5)
Minicases
623(9)
Analysis of the Quality of Financial Statements
632(50)
The Analyst's Checklist
633(1)
What is Accounting Quality?
633(4)
Five Questions About Accounting Quality
636(1)
Cutting Through the Accounting: Detecting Income Shifting
637(18)
Separating What We Know from Speculation
640(1)
Prelude to a Quality Analysis
641(1)
Quality Diagnostics
641(2)
Diagnostics to Detect Manipulated Sales
643(4)
Diagnostics to Detect Manipulation of Core Expenses
647(7)
Diagnostics to Detect Manipulation of Unusual Items
654(1)
Detecting Transaction Manipulation
655(3)
Core Revenue Timing
655(1)
Core Revenue Structuring
655(1)
Core Expense Timing
656(1)
Releasing Hidden Reserves
656(1)
Other Core Income Timing
657(1)
Unusual Income Timing
657(1)
Organizational Manipulation: Off-Balance-Sheet Operations
658(1)
Justifiable Manipulation?
658(1)
Disclosure Quality
658(1)
Quality Scoring
659(3)
Abnormal Returns to Quality Analysis
662(1)
Summary
662(1)
The Web Connection
662(1)
Key Concepts
663(1)
The Analyst's Toolkit
663(1)
Concept Questions
664(1)
Exercises
665(10)
Minicases
675(7)
PART FIVE THE ANALYSIS OF RISK
682(65)
The Analysis of Equity Risk and the Cost of Capital
684(36)
The Analyst's Checklist
685(1)
The Nature of Risk
686(6)
The Distribution of Returns
687(2)
Diversification and Risk
689(2)
Asset Pricing Models
691(1)
Fundamental Risk
692(4)
Return on Common Equity Risk
694(1)
Growth Risk
695(1)
Value-At-Risk Profiling
696(7)
Adaptation Options and Growth Options
701(1)
Strategy and Risk
702(1)
Discounting for Risk
702(1)
Fundamental Betas
703(1)
Price Risk
704(3)
Market Inefficiency Risk
704(3)
Liquidity Risk
707(1)
Inferring Expected Returns from Market Prices
707(1)
Adapting to the Risk Measurement Problem
708(3)
Evaluating Implied Expected Returns with Value-at-Risk Profiles
708(1)
Relative Value Analysis: Evaluating Firms within Risk Classes
709(2)
Conservative and Optimistic Forecasting and the Margin of Safety
711(1)
Summary
711(1)
The Web Connection
712(1)
Key Concepts
712(1)
The Analyst's Toolkit
713(1)
Concept Questions
713(1)
Exercises
714(6)
The Analysis of Credit Risk
720(27)
The Analyst's Checklist
721(1)
The Suppliers of Credit and the Price of Credit
721(1)
Ratio Analysis for Credit Evaluation
722(5)
Reformulated Financial Statements
722(2)
Short-Term Liquidity Ratios
724(2)
Long-Term Solvency Ratios
726(1)
Operating Ratios
727(1)
Forecasting and Credit Analysis
727(8)
Prelude to Forecasting: The Interpretive Background
727(1)
Ratio Analysis and Credit-Scoring
728(4)
Full-Information Forecasting
732(3)
Liquidity Planning and Financial Strategy
735(1)
The Web Connection
736(1)
Summary
737(1)
Key Concepts
737(1)
The Analyst's Toolkit
737(1)
Concept Questions
738(1)
Exercises
739(4)
Minicase
743(4)
Appendix: A Summary of Formulas 747(17)
Index 764

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