CMA USA Part 2 study material

 

MARKET RATIOS:

Market ratios are meaningful for publicly held companies only.

Market ratios are used in securities valuation because they portion to the market value of the individual common shares that are traded on the secondary market.

MARKET RATIOS included,

·       Book value per share

·       Market book ratio

·       Basic earnings per share[BEPS]

·       Diluted earning per share[DEPS]

·       Price earning ratio[PER]

·       Earning yield

·       Dividend yield

·       Dividend payout ratio

·       Shareholders return

 

>book value per share:

Book value per common share = total equity- preferred equity ÷number of common shares outstanding

Or

Common equity÷number of common shares outstanding

 

Book value per share represents the per share amount for the common shareholders that would result if the company were to be liquidated at the amount that is reported on the company's balance sheet.

note: a firm book value does not equal its market value,

book value per share does not equal its market value per share.

Book value per common share can be misleading because it's based on historical cost.

 

MARKET TO BOOK RATIO:

It also called price to book ratio

=market value per share÷ book value per share

Or

Current stock price per share ÷book value per share

 

Note: the market book ratio will generally be greater than 1 if the market expects abnormally high earnings in the future.

The market book ratio is lower than 1 if the market expects abnormally low earnings In the future.

 

PRICE-EARNINGS RATIO:

= market price/common share÷ basic earning per share

The price ratio gives an indication of what shareholders are paying for continuing earnings per share.

 

Note: a company in a high growth stage will usually have a high price ratio, because of the market's expectation of future profits.

[which makes the market price higher]

A company in a low growth stage generally has a low price ratio.

The price ratio is not meaningful when a company is at the loss.

Because the PE ratio would be negative.

 

EARNING YIELD RATIO:

= earnings per share ÷market price /share

It is an inverse of the PE ratio

It measures the income-producing power of one common share at the current market price.

 

DIVIDEND YIELD RATIO:

= dividend per share ÷ market price per share

It measures the relationship between the current annual dividend and the current market price of the stock.

It is the annual percentage return on the dividends received by a shareholder based on the stock's current market price and current dividend

 

DIVIDEND PAYOUT RATIO:

 =dividend per share÷ earning per share

This equation is per share basis

The dividend payout ratio is the proportion of earnings available to common shareholders that are paid out as a dividend to them

The dividend payout ratio can be calculated whole company basis

Or

=total common share dividend ÷ income available for common shareholder

 

SHAREHOLDERS RETURN:

Shareholders return = [end stock price- beg stock price] + dividend /share ÷ beg stock price

 

Note: when a company issues a stock dividend number of the common shares will increase and the book value per share decrease

 

EARNING PER SHARE[EPS] :

Two versions of eps must be disclosed in a companies financial statement

1.     Basic earning per share [BEPS]

2.     Diluted earnings per share [DEPS]

Basic earnings per share:

It is an earning per share for all common shareholders that was actually outstanding during the period.

BEPS= income available for common shareholders÷ weighted average number of common shares outstanding

IAC= net profit-preferred dividend

Usually, preferred shares received a fixed stated percentage of the preferred share as a dividend each year.

Dividends can be paid only if the company's board of directors declares.

Two types of preferred dividends:

1.     Cumulative

2.     Non-cumulative

Cumulative preferred dividend :

It is subtracted from the net income in the year they are earned whether or not they declared that the year.

Noncumulative preferred share:

 

It is subtracted from net income in the year they're declared.

 

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:

It is a denominator of BEPS calculations.

>stock split

>stock dividend

It is a dividend rather than in cash.

 

Profitability analysis:

ROA= icome÷ average asset

 

ROA = total asset+turnover ratio×net profit margin

Or

income÷ average asset

 

ROE:

=income÷average equity

ROE= ROA×financial coverage ratio

income÷avg equity

 

 

SUSTAINABLE GROWTH RATE:

It is a growth rate at which the company's sales can grow each year, without the company needing to increase its current level of financing.

In another word, it’s a growth rate that the company can fund internally through the retention of its profit.

The sales growth rate that the company can fund internally through retention of its profit.

Sales growth requires cash

The company must pay the additional upfront costs before the cash from the increased sale begins to come in

 

>the upfront cost includes,

1. increased inventory to support growth sale

2. increased payroll [salary] due to hiring additional employees

3. investment in the additional asset

 

>the needed cash can be generated by

1. retained earnings[internal source]

2. external financing [ equity loans, loans, shares, etc.]

 

Sustainable growth rate= [1-dividend payout ratio]×return on equity [common]

 

ROE= asset TOR ×net profit × FLR margin

 

>DILUTED EARNING PER SHARE:[DEPS]

DEPS calculates a company's earnings per share [eps] if all potential common shares are converted into common shares.

POTENTIAL COMMON SHARES:

1. Options

2. warrant

3. convertible bond

4. convertible preferred shares

 

They are classified as potentially issuable shares because they are not currently outstanding as shares, but someone other than the company can convert them into common shares.

Calculation of DEPS is done so that investors and potential investors can understand what EPS would have been if these potentially issuable shares had actually been outstanding.

If the company has no potential common shares.

It has a simple capital structure and its DEPS will be the same as BEPS.

If the company has potential common shares it has a complex capital structure.

>steps in diluted earning per share

BEPS = IAC÷ WANCSO

>calculation of the impact of option warrant

·       The second step is to calculate the EPS effect of the option warrant

·       Potential common shares are included in the calculation of DEPS only if they're dilutive.

·       Dilutive means they decrease basic earnings per share.

·       If they would have an increase in BEPS.

·       They're anti-dilutive and not included in the calculation of dilutive earnings per share[DEPS]

>OPTION AND WARRANTY:

It issued by the company is evaluated for its dilutive potential using the treasury stock method.

>the treasury stock assumes that,

·       The option and warrant converted into common stock at the beginning of the period, if issued during the period.

·       The cash proceeds from the issuance of the option warrants were used to purchase the company's common stock[treasury stock].

·       At the average market price during the period

 

 

>If option or warrant are dilutive, ad their effect to wants and calculate intermediate dilutive earning per share

CONVERTIBLE PREFERRED SHARE:

EPS effect of convertible Preferred share

=preferred dividend ÷ number of common shares converted

 

>Rank EPS effect from convertible bond and convertible preferred share

Convertible securities are ranked according to their EPS effect from lowest to highest ratio.

[ from most dilutive to least dilutive]

EPS effect of,

Convertible preferred share = .4 rank 1

Convertible bond =3.5 ranks 2

 

>add the EPS effect of each convertible security to IAC and WANCSO according to their ranking.

> add the EPS effect of the convertible bond.