Financial Statement Analysis

1. Financial Statement Analysis Marvin Gaye -- What's Going On • Overview of class • Organizational details • Boston Chicken part A • Next class (acctg analysis)

2. Class Topics up to 1st Midterm • Business Strategy Analysis • 1 session • Accounting Analysis • 3 sessions • Financial Analysis • 1 session • Forecasting • 4 sessions Review/Midterm (2/15)

3. Class Topics after Midterm • Valuation (but its really forecasting) • 4 sessions • Valuation Complications • 2 sessions • 2nd Midterm (3/29) • Group Projects

4. Group Project • small groups • project is a complete analysis of a company • presentation with debate • portfolio decision • the 1998 portfolio earned 83% • the 1999 portfolio earned 55% • in Australia for 2000 • the 2001 portfolio earned 33% • the 2002 portfolio earned 58% • the 2003 portfolio earned 45% • the 2004 portfolio earned 67% • the 2005 portfolio earned 18% www.valuedog.com

5. Organizational Details • Required: Equity Valuation and Analysis textbook and eVal software (included) • Required: Coursepack • Coursetools in M-track ctools.umich.edu

6. Grades • midterm 1 20% • midterm 2 20% • group cases (5) 25% • group project 25% • class participation 10%

7. Homework

8. Changing Nature of Equity Analysis • Meeker, Blodget and Grubman • Sarbanes – Oxley and Reg. FD • Spitzer

9. Analysts and Investment Bankers NO affiliated analysts made a forecast Source: Dechow, Hutton and Sloan. CAR 2000

10. Three Steps to Equity Valuation Understand the Past Collect information Understand the strategy accounting ratios cash flows Forecast the Future Structured approach Income statements Balance Sheets Cash Flows Valuation Cost of capital Valuation models Valuation Ratios Complications

11. Business Strategy Analysis • why won’t the company’s products/services become a commodity priced at the marginal cost of production? what is their competitive advantage?

13. A Strategy or a Platitude?Excerpts from the 1994 GE annual report • “We've described these three behaviors in past letters: boundarylessness, speed and stretch.” • Boundaryless behavior, an odd, awkward phrase just a few years ago, is increasingly a way of life at GE. It has led to an obsession for finding a better way -- a better idea -- be its source a colleague, another GE business, or another company across the street • From decision-making to deal-making to communications to product introduction, speed, more often than not, ends up being the competitive differentiator. • Stretch, in its simplest form, says, "Nothing is impossible," and the setting of stretch targets inspires people and captures their imaginations

14. Boston Chicken

15. The Big Picture US and Global Economy http://online.wsj.com/documents/ecocharts.htm Industry Restaurant Industry Industry http://0-www.netadvantage.standardandpoors.com.lib.bus.umich.edu/ Competitor Boston Chicken Competitor BC fact 1 BC fact 2 BC fact 3

16. Name the largest US restaurant chains Sales ($M) Units McDonalds 20051 13099 Burger King 8823 8248 Wendy’s 6241 5315 Pizza Hut 5000 7719 Taco Bell 4900 6444 KFC 4700 5399 Subway 4480 13247 Total 54195 Top 100 69205 Next 100 7235

17. Restaurant Industry Overview 5.3% annualized growth in disposable income = 5.3% growth in food 5.3% spent on food x 8000 B disposable income = $424 billion $2137/household in 2000 (bls survey)

18. Restaurant Industry Overview From Bureau of Labor Statistics Annual Consumer Expenditure Survey

19. Restaurant Industry Overview • full service growing faster than fast food, but “quick-casual” is best. • 1/3 cost is labor, 1/3 is the food. • high labor turnover (96% in fast food).

20. What business is BC in? • restaurants? • franchisor? • banking?

23. Key success factors Risks BC Banking $100 loan at 9%, no debt => ROE=9/100 = 9% $100 loan at 9%, $95 debt at 8% => ROE = (9 - .08(95))/5 = 28%

24. Key success factors Risks BC Franchising

25. Key success factors Risks BC Restaurants What must happen for all these businesses to succeed?

27. From note 3 on MidAtlantic and ENBC acquisitions Compare to reported consolidated NI of $67M

29. Strategy for Information goods • information has high fixed cost, low marginal cost of production • don’t use cost-based pricing! • information is an experience good every time • reputation and branding • information value varies across individuals • personalized pricing

30. Strategy for Technology goods • exist in systems • collaboration more important • network externalities • scale economies on the demand side • switching costs are huge • invest in an installed base, stagger useful lives in system

31. Purpose of Accounting Analysis • Evaluate how well accounting reflects the underlying economics of the business. • Adjust financial statements to mitigate accounting distortions - or- recognize that distortions must ultimately reverse.

32. Factors Affecting Acctg Quality • Restrictive nature of GAAP • Unintentional management forecast errors • Intentional biases introduced by management

33. Jackson 5 -- ABC (as easy as 123) Some Red Flags • using different accounting methods or estimates than the industry • unexplained changes in methods/estimates • big gap between NI and CFO • unusual income-boosting transactions • related-party transactions • change in auditor • poor overall disclosure