Chapter 13 COMPANY ANALSYSIS:

LOOKING FORWARD• Is there a long-term relationship between

earnings and stock prices?

• How are earnings calculated?

• What are the simple quantitative methods for forecasting earnings?

• How are business models used to forecast earnings?

• What are some of the other financial variables the analyst needs to estimate?

Earnings and stock prices

• Long term relationship between stock prices and earnings

• Relationship between earnings announcements and stock prices

Figure 13.1 – Earnings and Stock Prices for Johnson & Johnson

Earnings and earnings forecasts• Measuring earnings per share

– Number of shares outstanding

– Basic earnings per share

• Definition

• Continuing and discontinued operations

– Diluted measures of earnings per share

Earnings forecasts

• Consensus forecasts

• Earnings surprises

• Management forecasts

Forecasting earnings

• Approaches to forecasting earnings

– Qualitative forecasts

– Quantitative forecasts

– Bottom-up forecasts

– Top-down forecasts

Forecasting earnings- Cont.

• Trend based forecasts

– Assumptions behind trend based forecasts

– Average compound growth rate

– Trend based regression

Figure 13.2 – Earnings per Share for Kohl’s Corporation

Figure 13.3 – Actual vs. Predicted Earnings per Share

Business models

• What is a business model

• Understanding the business

• Total revenues (Sales)

• Operating expenses and operating profit

• Net income and earnings per share

Business models- Cont.

• Sensitivity analysis

–What is the purpose of sensitivity analysis

– How to conduct a sensitivity analysis

Forecasting other financial variables

• Dividends

– Dividend payout ratio

– Stability of dividends versus earnings

• Cash flow

• Required return

Figure 13.6 – Earnings and Dividends for Johnson & Johnson

Cash flow

– Differences between cash flow and earnings

– Free cash flow

– Operating cash flow

Required return

– Required return versus expected return

– Estimating required return