Financial Statements and Data Analysis (FIN357)

TIP If you do not understand

something,

ask me!

Administrative Issues and Course Overview

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The instructor

My name is Donglin Li. Email: donglinli2006@yahoo.com, or donglin@sfsu.edu ) Office hours: Mon 14:00-17:00, Tu 13:00-14:00,

Bus 315http://online.sfsu.edu/~donglin/courses.ht

ml Research interest:

Corporate finance: Agency cost, overinvestmentAccounting: Financial Statement Analysis, Market

AnomaliesCredit Risk Analysis

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My expectation in this course

I want everyone in the room to be able to understand fundamental financial statements identify potential areas of earnings

manipulation and earnings management and make necessary adjustments

carry out basic valuation analysis and credit analysis

master a set of statistical tools that will help you identify the relation between some accounting variables/ratios and stock returns.

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My experience

students who come to classes, listen, do problems, do projects, take tests, review the issues, and think, usually do well.

students who do not come to classes typically do poorly.

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Textbooks

“Financial Statement Analysis: A Global Perspective” By Robinson, Munter, and Grant, Pearson/Prentice Hall.

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Prerequisite

FIN350 with a grade of C- or better and ISYS 263 or pass computer information system proficiency test.

In addition, you should have a good knowledge of financial accounting and statistics.

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For the 2nd half course,

you may use any statistics/econometrics textbook that you are familiar with. The textbook should cover regression analysis.

“Analysis of Financial Data”, By Gary Koop, John Wiley “Introductory Econometrics with Applications” By

Ramanathan, 5e, South-Western.

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Add, drop and withdrawal policy

The business school has the policy for add, drop and withdrawal In the first four weeks, you have to get

enrolled in the class, if you want. Students can withdraw at most once.

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Homework

The best way to learn new concepts is to work through some problems. The solution will be posted on my web.

I will also put lecture slides and in-class-work on my web.

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Projects

You need to work independently on the 2 projects.

You need to have access to a PC.

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In-Class-Work

There will be 5 in-class work assignments.

The 2 lowest in-class-work scores will be dropped.

The schedule of these in-class projects will not be announced in advance, so just come to the lectures.

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The quizzes and final exam

The quizzes are closed-book. There are no make-ups.

The tests are based on material covered in lectures, in-class-work, homework, and textbooks.

The in-class-work will be relevant for the quizzes; The quizzes will be relevant for the final!

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Class performance

Any attempt to seek favor from the instructor will negatively affect your class performance.

The instructor cannot assign extra work to any individual to improve her/his grade.

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Grading Your available total points will be

allocated in the following way:Class performance 9%Projects 15%In class work 15% (drop 2

lowest)Quizzes 36%(drop 1 lowest)

Final 25%

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Curve grade

A range Top 15% B range Top 55% C range Top 80% D range Top 90% F Bottom 10%

The instructor reserves the right to make minor adjustment if necessary.

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Academic integrity

The instructor has zero tolerance for cheating or looking at each other during the exams.

In the exams, please sit as far as possible from each other.

In doing the in-class-work, feel free to discuss with your classmates.

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Communicate with the instructor

Teaching Style: Lectures and problem solving. Please pay attention to what is covered in class. The textbook may contain more material than required.

I APPRECIATE any constructive suggestions (in person or through email) that would improve the course. The teaching contents could be modified in response to your inputs.

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Course organization

This course is broken-down into two parts:

1: Financial Statements Analysis (analyzing one firm or comparing a few firms: a worm’s view.)

2: Data Analysis (analyzing a lot of firm’s financials at the same time: a bird’s view.)

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Why are financial statements important? (1st part of our course)

Managers use them to monitor and judge firm performance, acquire other businesses.

Financial analysts use financial statements to rate and value companies.

External investors read financial statements to select stocks and decide when to buy or sell.

Bankers use them in deciding whether to extend loans and determine loan terms.

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In this course, we emphasize the perspective of a financial analyst:

Understanding clean financial statementsIdentify questionable areas of earnings

managementIdentify questionable areas of earnings

manipulationMake necessary adjustmentsPut your restated inputs into the

frameworks for equity valuation and credit analysis.

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Why do we need to make adjustments on financial statements?

Earnings manipulation

Earnings management

Real earnings management

No earnings management

GAAP

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Equity Valuation Analysis

Discounted cashflow modelsResidual income model

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Credit Analysis

Z-scores Z=1.2 Net Working Capital/Total assets+1.4

Retained Earnings/Total assets+3.3 EBIT/Total assets +0.6 Market Value of Equity/Book Value of Liability+1.0 Sales/Total assets

( Z<1.8 indicates significant bankruptcy risk)

Other models

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We do not emphasize accounting rules.

A basic knowledge of rules and standards is ok.

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Why is Data Analysis useful?(2nd part of course)

Because you do not believe in semi-strong form of market efficiency.

Because you can identify variables/ratios that might be relied upon to predict future stock returns.

Earn huge bucks!Another eye-catching item on your

resume.

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Combining financial statement analysis and data analysis

After identifying several stocks from data analysis, you can apply financial statement analysis to distinguish which one is most attractive.

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In Data Analysis,

We will focus on regression techniques.

Example, is there a significant relation between firm investment and future stock returns?

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One-year-ahead hedge returns based on capital investment levels. ©Donglin Li 2004

Go long the lowest

investment stocks.

Go short the highest investment stocks.

12 month size adjusted buy and hold hedge returns after May each year.

Positive in 36 out of 39 years, average 12.6%

Pattern is consistent with market mispricing and inconsistent with semi-strong efficiency.

1 year ahead hedge returns between lowest and highest deciles of investment (d_PPE) firms

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

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Year

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Congratulations on enrolling this exciting (and challenging) course!