INTRODUCTION TO FUNDAMENTAL ANALYSIS

Andrey Alikberov

AUGUST 20, 2015

Andrey Alikberov, Introduction to Fundamental Analysis, 2015

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Contents Difference between Fundamental and Technical Analysis ........................................................................... 3

Introduction .............................................................................................................................................. 3

Fundamental Analysis ................................................................................................................................... 4

Major Assumptions of Fundamental Analysis: .......................................................................................... 4

Advantages of Fundamental Analysis: ....................................................................................................... 4

Disadvantages of Fundamental Analysis: .................................................................................................. 4

Fundamental Analysis Measurements: ......................................................................................................... 5

Liquidity Measurement ratios ................................................................................................................... 5

1. Liquidity ratio or Current Ratio ...................................................................................................... 5

2. Quick Ratio or Acid-Test ratio ........................................................................................................ 6

3. Cash Ratio ...................................................................................................................................... 6

4. Cash Conversion Cycle ................................................................................................................... 7

Investment Valuation Ratios ..................................................................................................................... 8

1. Price/Book Value ratio ................................................................................................................... 8

2. Price/Earnings ratio ....................................................................................................................... 8

3. Price/Earnings to Growth ratio ...................................................................................................... 8

4. Price/Sales ratio ............................................................................................................................. 9

5. Dividend Yield ................................................................................................................................ 9

6. Enterprise Value Multiple .............................................................................................................. 9

Profitability ratios .................................................................................................................................... 10

1. Gross Profit Margin ..................................................................................................................... 10

2. Net Profit Margin ......................................................................................................................... 10

3. ROI or ROA ................................................................................................................................... 10

4. ROE .............................................................................................................................................. 11

5. Operating ratio ............................................................................................................................ 11

6. Return on Capital Employed (ROCE) ............................................................................................ 11

7. Contribution Margin Ratio ........................................................................................................... 11

Debt ratios ............................................................................................................................................... 12

1. Debt ratio .................................................................................................................................... 12

2. Debt-Equity ratio ......................................................................................................................... 12

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3. Capitalization ratio ...................................................................................................................... 12

4. Interest Coverage Ratio ............................................................................................................... 13

5. Cash Flow to Debt Ratio .............................................................................................................. 13

Operating Performance Ratios ................................................................................................................ 13

1. Fixed Asset Turnover Ratio .......................................................................................................... 14

2. Fixed Asset Turnover Ratio .......................................................................................................... 14

1. Operating Cash Flow/Sales Ratio ................................................................................................. 14

2. Free Cash Flow/Operating Cash Flow Ratio ................................................................................. 15

3. Cash Flow Coverage Ratios (4) .................................................................................................... 15

4. Dividend Payout Ratio ................................................................................................................. 16

EBITDA ........................................................................................................................................................ 16

CAMP Beta .................................................................................................................................................. 16

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Difference between Fundamental and Technical Analysis

Introduction

Do you believe in reading charts and looking at trends? If yes, then you have a mind-set based on Technical

analysis. Or do you believe in making investment decisions based on Financials, Growth and EPS? Well, then you

have a mind-set based on fundamental analysis!

No doubt, that some may find both types of analysis useful for examining market action. It’s just that they both have

a different School of thought. Your trading style and attitude will determine the kind of analysis beneficial for you. I

have seen many investors combining both these analysis. While others concentrate only on one aspect and ignore

the other.

Fundamental Analysis

Technical Analysis

Meaning Includes evaluating company’s stock to find its intrinsic value, and analyze factors that may affect the price in future

It is a statistical method used to find pattern and predict future movements based on past market data

Methodology

Financial Data

Industry trends

Competitor’s performance

Economic outlook

Price movements

Market psychology

Time Horizon Long-term Short-term

Function Investing Trading

Data source Financial statements Charts

Concepts

P/E, P/S, P/B, D/E ratios

EBITDA

ROE, ROA

CAMP Beta

Dividend yield

Net Margin

Dow Theory

IRR

NVP

Moving averages

MACD

RSI

Stochastic Oscillator, Bollinger bands

Main Goal To find the intrinsic value of a stock To find the right time to enter or exit based on the past and current trend

Vision Looks backward and forward Looks backward

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Fundamental Analysis

Fundamental analysis aims to find the value of the company. This means arriving at its intrinsic price. This kind of

analysis uses Economic factors. These factors prove as the fundamental elements to determine the price. So if you

are opting for the Fundamental route, be sure to perform the following analysis:

Industry Analysis

Company Analysis

Economic Analysis

Major Assumptions of Fundamental Analysis:

1. In the long run Stock Price corrects itself.

2. You can make gains by purchasing an under-valued stock and then wait for the market to correct itself.

Advantages of Fundamental Analysis:

Use of Analytical methods: The methods and approaches used in Fundamental analysis are based on sound

financial data. This eliminates the room for personal bias.

360 Degree Focus: Fundamental analysis also considers long term economic, demographic, and technologic

and consumer trends.

Systematic approach for deducing the Value: The statistical and analytical tools used, help in arriving at a

proper Buy/Sell recommendation.

Better Understanding: Rigorous accounting and financial analysis, helps to gauge better understanding of

everything.

Disadvantages of Fundamental Analysis:

Time consuming: Carrying out Industry analysis, financial modelling and valuation, is not a cup of tea. It can

get complicated and may need lot of hard work to start with.

Assumptions centric: Assumptions play a vital role in forecasting the financials. So it is important to

consider the best and the worst case scenario. Unexpected negative economic, political or legislative

changes, may cause problems.

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Fundamental Analysis Measurements: Financial Ratios

To begin with, there are many ratios for many different purposes that follow separate categories.

These categories are:

Liquidity Measurement ratios

Investment Valuation ratios

Profitability ratios

Debt ratios

Operating Performance ratios

Cash Flow Indicator ratios

Liquidity Measurement ratios

Liquidity Measurement ratios measure the company’s ability to pay off its short term debt obligations if they were

come down. These measures do this by comparing the company’s most liquid assets (current assets – cash and cash

equivalents etc.) to its short term liabilities.

In general, the more current assets a company has relative to its short term liabilities, the more likely it would be

able to pay off its short-term liabilities if they are come down.

1. Liquidity ratio or Current Ratio

Current ratio is the ratio used to determine how well a company could pay off its short term liabilities with

the short term or current assets.

Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Current Ratio 1 is considered as “good”, the higher the ratio – the better

Current Ratio 1 is a signal that there are financial problem on horizon

Ex: current ratio of a company ABC = 2.30 $. That means for every dollar of their current liabilities,

the company ABC has $2.30 of current assets. Now it make sense why current ratio below 1 is

considered as “bad”, right?

Current assets:

Cash available with company

Bank balance of the company

Debtors of the company after deducting provision for bad debts

Bills/Accounts receivables

Short term investments of the company

Prepaid expenses paid by the company

Inventories

Stock of goods available with the company (which expected to be sold within a year)

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As you can see, current assets can be different, therefore the liquidity of a company is differ with

different current assets. For instance, suppose there are two companies, ABC and XYZ, which both

have current ratio of 1.5. However, in company ABC current assets consists of mostly cash, and in

company XYZ current assets are made up of mainly inventory and accounts receivables. For this

reason, company ABC is more (and highly) liquid and the company XYZ will face some troubles meeting

their obligations, especially if it takes among to collect accounts receivables.

2. Quick Ratio or Acid-Test ratio

Quick Ratio or Acid-Test ratio is a measure of liquidity that describes how well a company could pay off its

current liabilities with its current assets. A quick ratio is a more conservative measure that the current ratio

because it excludes inventory funds’ calculation (considering the most liquid current assets only).

Quick Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Another formula of quick ratio is:

Quick Ratio = 𝐶𝑎𝑠ℎ & 𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠+𝑆ℎ𝑜𝑟𝑡−𝑡𝑒𝑟𝑚 𝐼𝑛𝑣𝑒𝑡𝑚𝑒𝑛𝑡𝑠+𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Generally, the higher quick ratio, the better. Higher ratio means that the company is less likely to

experience financial stress if all current liabilities are come due. Landers such as banks looking at quick

ratio, the higher it is, the more likely that the banks will provide services such as loans, credits etc.

However, it is not always mean that higher quick ratio is better. The company could just keep always

earnings in cash and build up liquidity ratios. But this could be at the expense of owners, if these earnings

were not paid as dividends or invested in profitable projects.

Quick ratios avoid problems with inventory uncertainty. However, if two companies have the same quick

ratios, one is always more liquid then the other depending on how fast it collects accounts receivable.

3. Cash Ratio

The cash ratio is an indicator of a company's liquidity that further refines both the current ratio and

the quick ratio by measuring the amount of cash, cash equivalents or invested funds there are in current

assets to cover current liabilities.

Cash Ratio = 𝐶𝑎𝑠ℎ+𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠 +𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐹𝑢𝑛𝑑𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Cash ratio only looks at the most liquid short-term assets of the company, which are those that can be most

easily used to pay off current obligations. It also ignores inventory and receivables, as there are no

assurances that these two accounts can be converted to cash in a timely matter to meet current liabilities

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4. Cash Conversion Cycle

This liquidity metric expresses the length of time (in days) that a company uses to sell inventory, collect

receivables and pay its accounts payable. The cash conversion cycle (CCC) measures the number of days a

company's cash is tied up in the production and sales process of its operations and the benefit it gets from

payment terms from its creditors. The shorter this cycle, the more liquid the company's working capital

position is. The CCC is also known as the "cash" or "operating" cycle.

Cash Conversion Cycle (CCC) = DIO + DSO – DPO,

Where:

DIO – days Inventory Outstanding DSO – Days Sales Outstanding DPO – Days Payables Outstanding

DIO is computed by:

1. Dividing the cost of sales (income statement) by 365 to get a cost of sales per day figure; 2. Calculating the average inventory figure by adding the year's beginning (previous yearend

amount) and ending inventory figure (both are in the balance sheet) and dividing by 2 to obtain an average amount of inventory for any given year; and

3. Dividing the average inventory figure by the cost of sales per day figure.

DIO gives a measure of the number of days it takes for the company's inventory to turn over, i.e., to be converted to

sales, either as cash or accounts receivable.

DSO is computed by:

1. Dividing net sales (income statement) by 365 to get a net sales per day figure; 2. Calculating the average accounts receivable figure by adding the year's beginning

(previous yearend amount) and ending accounts receivable amount (both figures are in the balance sheet) and dividing by 2 to obtain an average amount of accounts receivable for any given year; and

3. Dividing the average accounts receivable figure by the net sales per day figure.

DSO gives a measure of the number of days it takes a company to collect on sales that go into accounts receivables

(credit purchases).

DPO is computed by:

1. Dividing the cost of sales (income statement) by 365 to get a cost of sales per day figure; 2. Calculating the average accounts payable figure by adding the year's beginning (previous

yearend amount) and ending accounts payable amount (both figures are in the balance sheet), and dividing by 2 to get an average accounts payable amount for any given year; and

3. Dividing the average accounts payable figure by the cost of sales per day figure.

DPO gives a measure of how long it takes the company to pay its obligations to suppliers.

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Investment Valuation Ratios

1. Price/Book Value ratio

Price to book ratio (P/B Ratio) is a ratio used to compare a stock's market value (stock's per-share price) to

its book value (shareholders' equity). It is calculated by dividing the current closing price of the stock by the

latest quarter's book value per share.

Price/book Value ratio= 𝑆𝑡𝑜𝑐𝑘 𝑃𝑟𝑖𝑐𝑒

𝑆ℎ𝑎𝑟𝑒ℎ𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

2. Price/Earnings ratio

The price/earnings ratio (P/E) is the best known of the investment valuation indicators. The P/E ratio has its

imperfections, but it is nevertheless the most widely reported and used valuation by investment

professionals and the investing public. The financial reporting of both companies and investment research

services use a basic earnings per share (EPS) figure divided into the current stock price to calculate the P/E

multiple (i.e. how many times a stock is trading (its price) per each dollar of EPS)

P/E = Price of a Stock / EPS

where EPS, or Earnings per share = (net income – dividends on preferred stock) / outstanding shares

The less EPS, the best (as the less the denominator, the more is the result of P/E ratio)

3. Price/Earnings to Growth ratio

The price/earnings to growth ratio, commonly referred to as the PEG ratio, is obviously closely related to

the P/E ratio. The PEG ratio is a refinement of the P/E ratio and factors in a stock's estimated earnings

growth into its current valuation. By comparing a stock's P/E ratio with its projected, or estimated, earnings

per share (EPS) growth, investors are given insight into the degree of overpricing or underpricing of a

stock's current valuation, as indicated by the traditional P/E ratio.

If the PEG ratio indicates a value of 1 - the market is correctly valuing (the current P/E ratio) a stock in

accordance with the stock's current estimated earnings per share growth. If the PEG ratio is less than 1 -

EPS growth is potentially able to surpass the market's current valuation. In other words, the stock's price is

being undervalued. On the other hand, stocks with high PEG ratios can indicate just the opposite - that the

stock is currently overvalued.

PEG ratio= 𝑃/𝐸

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) 𝑔𝑟𝑜𝑤𝑡ℎ

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4. Price/Sales ratio

A stock's price/sales ratio (P/S ratio) is another stock valuation indicator similar to the P/E ratio. The P/S

ratio measures the price of a company's stock against its annual sales, instead of earnings.

Like the P/E ratio, the P/S reflects how many times investors are paying for every dollar of a company's

sales. Since earnings are subject, to one degree or another, to accounting estimates and management

manipulation, many investors consider a company's sales (revenue) figure a more reliable ratio component

in calculating a stock's price multiple than the earnings figure.

P/S ratio = 𝑆𝑡𝑜𝑐𝑘 𝑃𝑟𝑖𝑐𝑒

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 (𝑅𝑒𝑣𝑛𝑢𝑒) 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

Where Sales per Share = 𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 (𝑆𝑎𝑙𝑒𝑠)

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

5. Dividend Yield

This measures how much in dividends the company pays out compared to their stock price.

Dividend Yield (%) = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

𝑆𝑡𝑜𝑐𝑘 𝑃𝑟𝑖𝑐𝑒 * 100

It is more important how much in dividends the company pays out compared to their stock price, than the stock

price itself. The company with higher stock price is not better than the company with lower, if the dividend yield of

the latter company is higher.

6. Enterprise Value Multiple

Overall, this measurement allows investors to assess a company on the same basis as that of an acquirer. As a rough

calculation, enterprise value multiple serves as a proxy for how long it would take for an acquisition to earn enough

to pay off its costs (assuming no change in EBITDA).

Enterprise Value Multiple = 𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒

𝐸𝐵𝐼𝑇𝐷𝐴

Enterprise value is calculated by adding a company's debt, minority interest, and preferred stock to its market capitalization Enterprise value, also referred to as the value of the enterprise, is basically a modification of market capitalization, which is determined by simply multiplying a company's number of shares outstanding by the current price of its stock. Obviously, a company's stock price is heavily influenced by investor sentiment and market conditions, which, in turn, will be determined by a company's market-cap value.

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Profitability ratios

A class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. For most of these ratios, having a higher value relative to a competitor's ratio or the same ratio from a previous period is indicative that the company is doing well.

1. Gross Profit Margin

A financial metric used to assess a firm's financial health by revealing the proportion of money left over from revenues after accounting for the cost of goods sold. Gross profit margin serves as the source for paying additional expenses and future savings (measures the percentage of each sales’ dollar remaining after the firm has paid for its goods).

Gross Profit Margin (%) = 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡

𝑆𝑎𝑙𝑒𝑠 * 100

Where Gross Profit = Sales – Cost of goods sold

2. Net Profit Margin

The ratio of net profits to revenues for a company or business segment - typically expressed as a percentage – that shows how much of each dollar earned by the company is translated into profits (measures the percentage of each sales’ dollar remaining after all costs and expenses, including interest and taxes, have been deducted).

Net Profit Margin (%) = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡

𝑆𝑎𝑙𝑒𝑠 * 100

Where Net Profit = Revenue – (Cost of goods) sold COGS – Operating Expenses – Interest and Taxes

The higher is ratio, the better. This ratio is getting higher either by increasing sales or decreasing costs.

3. ROI or ROA

Return on Investment or Return on Assets measures the firm’s overall effectiveness in generating profits with

its assets. ROI measures the amount of return on an investment relative to the investment’s cost.

ROI = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 * 100

or

ROI (%) = (𝐺𝑎𝑖𝑛 𝑓𝑜𝑚 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡−𝐶𝑜𝑠𝑡 𝑜𝑓 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡)

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 * 100

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4. ROE

Return on Equity is the amount of net income returned as a percentage of shareholders equity. Return

on equity measures a corporation's profitability by revealing how much profit a company generates with the money

shareholders have invested.

ROE = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦 * 100

5. Operating ratio

Operating ratio is a ratio that shows the efficiency of a company's management by comparing operating expense to net sales.

Operating ratio = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑐𝑒

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 * 100

6. Return on Capital Employed (ROCE)

Return on Capital Employed (ROCE) is a financial ratio that measures a company's profitability and the efficiency with which its capital is employed.

ROCE (%) = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 (𝐸𝐵𝐼𝑇)

𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 * 100

“Capital Employed” as shown in the denominator is the sum of shareholders' equity and debt liabilities; it can be simplified as (Total Assets – Current Liabilities). Instead of using capital employed at an arbitrary point in time, analysts and investors often calculate ROCE based on “Average Capital Employed,” which takes the average of opening and closing capital employed for the time period.

A higher ROCE indicates more efficient use of capital. ROCE should be higher than the company’s capital cost; otherwise it indicates that the company is not employing its capital effectively and is not generating shareholder value.

7. Contribution Margin Ratio

A cost accounting concept that allows a company to determine the profitability of individual products.

CM Ratio = 𝑆𝑎𝑙𝑒𝑠−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑠

𝑆𝑎𝑙𝑒𝑠

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Debt ratios

There are two types of liabilities - operational and debt. The former includes balance sheet accounts, such as

accounts payable, accrued expenses, taxes payable, pension obligations, etc. The latter includes notes payable and

other short-term borrowings, the current portion of long-term borrowings, and long-term borrowings.

1. Debt ratio

The debt ratio compares a company's total debt to its total assets, which is used to gain a general idea as to the amount of leverage being used by a company. A low percentage means that the company is less dependent on leverage, i.e., money borrowed from and/or owed to others. The lower the percentage, the less leverage a company is using and the stronger its equity position. In general, the higher the ratio, the more risk that company is considered to have taken on.

Debt Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

2. Debt-Equity ratio

The debt-equity ratio is another leverage ratio that compares a company's total liabilities to its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committed. To a large degree, the debt-equity ratio provides another vantage point on a company's leverage position, in this case, comparing total liabilities to shareholders' equity, as opposed to total assets in the debt ratio.

Debt-Equity Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

Similar to the debt ratio, a lower the percentage means that a company is using less leverage and has a stronger equity position.

3. Capitalization ratio

The capitalization ratio measures the debt component of a company's capital structure, or capitalization (i.e., the sum of long-term debt liabilities and shareholders' equity) to support a company's operations and growth. A company's capitalization (not to be confused with market capitalization) describes its composition of permanent or long-term capital, which consists of a combination of debt and equity. A company's

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reasonable, proportional use of debt and equity to support its assets is a key indicator of balance sheet strength. A healthy capital structure that reflects a low level of debt and a corresponding high level of equity is a very positive sign of financial fitness.

Capitalization Ratio = 𝐿𝑜𝑛𝑔−𝑇𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

4. Interest Coverage Ratio

The interest coverage ratio is used to determine how easily a company can pay interest expenses on outstanding debt. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.

Interest Coverage ratio = 𝐿𝑜𝑛𝑔−𝑇𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

5. Cash Flow to Debt Ratio

This coverage ratio compares a company's operating cash flow to its total debt, which, for purposes of this ratio, is defined as the sum of short-term borrowings, the current portion of long-term debt and long-term debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. *coverage ratio is a measure of a company's ability to meet its financial obligations. In broad terms, the

higher the coverage ratio, the better the ability of the enterprise to fulfil its obligations to its lenders.

Cash Flow to Debt Ratio = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡

Operating Performance Ratios

Each of these ratios have differing inputs and measure different segments of a company's overall operational performance, but the ratios do give users insight into the company's performance and management during the period being measured. These ratios look at how well a company turns its assets into revenue as well as how efficiently a company converts its sales into cash. Basically, these ratios look at how efficiently and effectively a company is using its resources to generate sales and increase shareholder value. In general, the better these ratios are, the better it is for shareholders.

Andrey Alikberov, Introduction to Fundamental Analysis, 2015

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1. Fixed Asset Turnover Ratio

This ratio is a rough measure of the productivity of a company's fixed assets (property, plant and equipment or PPE) with respect to generating sales. For most companies, their investment in fixed assets represents the single largest component of their total assets. This annual turnover ratio is designed to reflect a company's efficiency in managing these significant assets. Simply put, the higher the yearly turnover rate, the better.

Fixed Asset Turnover Ratio = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

𝑃𝑃𝐸

2. Fixed Asset Turnover Ratio

As a gauge of personnel productivity, this indicator simply measures the amount of dollar sales, or revenue, generated per employee. The higher the dollar figure the better. Here again, labour-intensive businesses (ex. mass market retailers) will be less productive in this metric than a high-tech, high product-value manufacturer.

Sales/Revenue per Employee Ratio = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠 (𝐴𝑣𝑒𝑟𝑎𝑔𝑒)

An earnings per employee ratio could also be calculated using net income (as opposed to net sales) in the

numerator.

Cash Flow Indicator ratios

This section of the financial ratio tutorial looks at cash flow indicators, which focus on the cash being generated in terms of how much is being generated and the safety net that it provides to the company. These ratios can give users another look at the financial health and performance of a company.

1. Operating Cash Flow/Sales Ratio

This ratio, which is expressed as a percentage, compares a company's operating cash flow to its net sales or revenues, which gives investors an idea of the company's ability to turn sales into cash. It would be worrisome to see a company's sales grow without a parallel growth in operating cash flow. Positive and negative changes in a company's terms of sale and/or the collection experience of its accounts receivable will show up in this indicator.

OCF/Sales ratio = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 (𝑅𝑒𝑣𝑒𝑛𝑢𝑒)

Andrey Alikberov, Introduction to Fundamental Analysis, 2015

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2. Free Cash Flow/Operating Cash Flow Ratio

The free cash flow/operating cash flow ratio measures the relationship between free cash flow and operating cash flow. Free cash flow is most often defined as operating cash flow minus capital expenditures, which, in analytical terms, are considered to be an essential outflow of funds to maintain a company's competitiveness and efficiency. The cash flow remaining after this deduction is considered "free" cash flow, which becomes available to a company to use for expansion, acquisitions, and/or financial stability to weather difficult market conditions. The higher the percentage of free cash flow embedded in a company's operating cash flow, the greater the financial strength of the company.

FCF/OCF ratio = 𝐹𝑟𝑒𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

The more the percentage, the better.

3. Cash Flow Coverage Ratios (4)

This ratio measures the ability of the company's operating cash flow to meet its obligations - including its liabilities or ongoing concern costs. The operating cash flow is simply the amount of cash generated by the company from its main operations, which are used to keep the business funded. The larger the operating cash flow coverage for these items, the greater the company's ability to meet its obligations, along with giving the company more cash flow to expand its business, withstand hard times, and not be burdened by debt servicing and the restrictions typically included in credit agreements.

1. Short-term Debt Coverage = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

𝑆ℎ𝑜𝑟𝑡−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

2. Capital Expenditure Coverage = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠

3. Dividend Coverage = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

𝐶𝑎𝑠ℎ 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠

4. CAPEX + Cash Dividend Coverage = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤

𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠 + 𝐶𝑎𝑠ℎ 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠

Andrey Alikberov, Introduction to Fundamental Analysis, 2015

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4. Dividend Payout Ratio

This ratio identifies the percentage of earnings (net income) per common share allocated to paying cash dividends to shareholders. The dividend payout ratio is an indicator of how well earnings support the dividend payment. Here's how dividends "start" and "end." During a fiscal year quarter, a company's board of directors declares a dividend. This event triggers the posting of a current liability for "dividends payable." At the end of the quarter, net income is credited to a company's retained earnings, and assuming there's sufficient cash on hand and/or from current operating cash flow, the dividend is paid out. This reduces cash, and the dividends payable liability is eliminated. The payment of a cash dividend is recorded in the statement of cash flows under the "financing activities" section.

Dividend Payout ratio (%) = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

EBITDA

EBITDA is the earning of a company before Interest, Taxes, Depreciation and Amortization. It is frequently used as an

indicator of firm’s financial health.

Revenue

- Operational Expenses

EBITDA

- Expenses (incl. Tax, Interest, Depreciation and Amortization)

Net Income

Companies can include or exclude certain items at their own description. Companies can change items in

their EBITDA calculation for each reporting period, in order to make good news sound better and put a

positive spin on disappointing results. For this reason, investors should consider other performance

indicators to get a full picture of a company’s financial health.

CAMP Beta

CAMP, or, Capital Asset Pricing Model – a model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.

The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).