Investments, tenth edition

(1)

(2)

(3)

(4)

(5)

(6)

(7)

Year

ROE

Net 

Profit/

Pretax 

Profit

Pretax 

Profit/

EBIT

EBIT/

Sales 

(Margin)

Sales/

Assets 

(Turnover)

Assets/

Equity

Compound 

Leverage 

Factor 

(2) 3 (5)

ROA 

(3) 3 (4)

P/E

P/B

2013

7.51%

.6

.650

30%

.303

2.117

1.376

9.09%

8

.58

2014

6.08

.6

.470

30

.303

2.375

1.116

9.09

6

.35

2015

3.03

.6

.204

30

.303

2.723

0.556

9.09

4

.12

Industry 

average

8.64

.6

.800

30

.400

1.500

1.200

12.00

8

.69

 Table 19.12 

 Key financial ratios of Growth Industries, Inc. 

bod61671_ch19_635-677.indd   656

bod61671_ch19_635-677.indd   656

7/17/13   4:13 PM

7/17/13   4:13 PM

Final PDF to printer

---

  C H A P T E R  

1 9

 Financial 

Statement 

Analysis 

657

generating enough cash flow to support the extra interest burden of the debt, as the falling 

cash flow from operations indicates. Eventually, when the firm loses its ability to borrow 

further, its growth will be at an end. 

 At this point GI stock might be an attractive investment. Its market price is only 12% of 

its book value, and with a P/E ratio of 4, its earnings yield is 25% per year. GI is a likely 

candidate for a takeover by another firm that might replace GI’s management and build 

shareholder value through a radical change in policy.    

2013

2014

2015

Cash flow from operating activities

Net income

$ 11,700

$ 10,143

$   5,285

1

 Depreciation

15,000

18,000

21,600

1

 Decrease (increase) in accounts receivable

(5,000)

(6,000)

(7,200)

1

 Decrease (increase) in inventories

(15,000)

(18,000)

(21,600)

1

 Increase in accounts payable

     6,000

     7,200

     8,640

    Cash provided by operations

$ 12,700

$ 11,343

$   6,725

Cash flow from investing activities

Investment in plant and equipment*

$(45,000)

$(54,000)

$(64,800)

Cash flow from financing activities

Dividends paid

†

$   

 

0

$   

 

0

$   

 

0

Short-term debt issued

   42,300

   54,657

   72,475

Change in cash and marketable securities

‡

$ 10,000

$ 12,000

$ 14,400

 Table 19.13 

 Growth Industries statement of cash flows ($ thousand) 

  *Gross investment equals increase in net plant and equipment plus depreciation.  

   

†

 We can conclude that no dividends are paid because stockholders’ equity increases each year by the full amount of net income, imply-

ing a plowback ratio of 1.0.  

   

‡

 Equals cash flow from operations plus cash flow from investment activities plus cash flow from financing activities. Note that this 

equals the yearly change in cash and marketable securities on the balance sheet.  

 You have the following information for IBX Corporation for the years 2013 and 2015 (all figures are in 

$ million):   

2013

2015

Net income

$   253.7

$   239.0

Pretax income

411.9

375.6

EBIT

517.6

403.1

Average assets

4,857.9

3,459.7

Sales

6,679.3

4,537.0

Shareholders’ equity

2,233.3

2,347.3

 What is the trend in IBX’s ROE; how can you account for it in terms of tax burden, margin, turnover, and 

financial leverage? 

 CONCEPT CHECK 

19.4 

bod61671_ch19_635-677.indd   657

bod61671_ch19_635-677.indd   657

7/17/13   4:13 PM

7/17/13   4:13 PM

Final PDF to printer

---

658 

P A R T   V

 Security 

Analysis

 Financial statement analysis gives us a good amount of ammunition for evaluating a com-

pany’s performance and future prospects. But comparing financial results of different com-

panies is not so simple. There is more than one acceptable way to represent various items 

of revenue and expense according to generally accepted accounting principles (GAAP). 

This means two firms may have exactly the same economic income yet very different 

accounting incomes. 

 Furthermore, interpreting a single firm’s performance over time is complicated when 

inflation distorts the dollar measuring rod. Comparability problems are especially acute 

in this case because the impact of inflation on reported results often depends on the par-

ticular method the firm adopts to account for inventories and depreciation. The security 

analyst must adjust the earnings and the financial ratio figures to a uniform standard before 

attempting to compare financial results across firms and over time. 

 Comparability problems can arise out of the flexibility of GAAP guidelines in account-

ing for inventories and depreciation and in adjusting for the effects of inflation. Other 

important potential sources of noncomparability include the capitalization of leases and 

other expenses, the treatment of pension costs, and allowances for reserves.