Financial Statement Analysis

1. War Financial Statement Analysis Overstock.com

2. Overstock.comOverview of Business • What do they do? www.overstock.com • Performance? • http://finance.yahoo.com/q/bc?s=OSTK&t=5y&l=on&z=l&q=l&c=

3. Overstock.com: Overview of Business Key success factors? Key risks factors?

4. Q2: What are the Critical Accounting Policies? • Revenue Recognition Major switch from commission basis to gross basis for fulfillment partner revenue on July 1, 2003 • Reserve for Returns • Allowance for Doubtful Accounts • Allowance for Obsolete and Damaged Inventory • Accounting for Income Taxes • Valuation of Long-Lived and Intangible Assets and Goodwill

5. Q3: Is 2003 sales growth rate sustainable? • What is the GAAP based growth rate in sales? 238.9/91.8 - 1 = 160% • What is the gross merchandise sales growth rate? 294.8/154.5 - 1 = 91%

6. GAAP vs. Gross Basis Sales (see reconciliation on page 4 of 10K) …is it sustainable?

7. Mean reversion in sales growth rate Source: Nissim and Penman (2001)

8. Q4: Explain growth rate in gross profit • What is the GAAP based growth rate in gross profit? 25.3/18.3 = 39% • What is the gross basis growth rate in gross profit? 25.3/18.3 = 39%

9. GAAP Basis vs. Gross Basis Gross Profit

10. Accounting Performance vs. Economic Performance • Overstock.com is ‘investing’ significant amounts to fuel sales growth, customer loyalty and brand awareness. • Most of these amounts must be immediately expensed for accounting purposes: - Sales and marketing expenses - General and administrative expenses - Loss-leading margins on BMV merchandise

11. Next, Financial AnalysisFramework for of Business Analysis and Valuation Other Public Data: industry data, analyst reports, competitor financials, bond ratings, beta factors, security prices etc. Financial Statements Analysis Tools Strategy Analysis Accounting Analysis Financial Analysis Prospective Analysis Business Application Context equity security analysis, credit analysis, M&A analysis, IPO analysis etc.

12. How to Create Lots and Lots of Value…? • Earn an ROE > r (cost of equity capital) • Grow! #1 without #2 is okay but #2 without #1 is terrible!

13. Decomposing ROE: The “Baby” Dupont Model ROA

14. Strategic choices influencing tradeoff between profitability (margin) and turnover Maximizing return on assets (PMxTurns) involves tradeoff between margin & turnover. Lower turnover & higher margins result from: - following product differentiation versus cost leadership strategy. • following vertical integration versus outsourcing strategy. • other examples?

15. Bricks and Mortar Internet Department Store Discount Retailer Trade-Off 1:Internet vs. Bricks-n-Mortar Trade-Off 2:Direct vs. Fulfillment Partner Trade-Off 3:Discount Retailer vs. Department Store Fulfillment Partner (commission basis) Direct Fulfillment Partner (gross basis)

16. Margin vs. turnover tradeoff for OSTK, AMZN, ROST, and MAY May Department Stores Ross Stores Amazon.com Overstock.com

17. Basic DuPont Analysis

18. Margins and Turnover 12.8% 9%

19. Would Operating Accruals have identified Boston Chicken’s distortion? Boston Chicken, 1996 average noncash Net Operating Assets = $930,534k, so DnonCurrentOperatingAssets/noncashNetOperatingAssets = 525,025/930,534 = 56%.

20. A Comprehensive Analysis of Accruals • total accruals = accounting income – cash income = NI - (net dividends + Dcash) = DCE – Dcash = (DAssets – Dcash) – DLiabilities • total accruals = DNoncash Net Operating Assets + DNet Financial Assets (i.e. mkt securities less debt) • total accruals = DNon-Cash Working Capital + DNon-Current Net Operating Assets + DNet Financial Assets

21. Future Stock Returns and Accrual Decomposition Richardson, Sloan, Soliman, Tuna (2002)

22. How big is a big accrual? on page 121 in textbook

23. why are net operating assets growing? which cause of NOA growth is best? which is the worst?

24. Future Stock Returns and Accrual Decomposition II Richardson, Sloan, Soliman, Tuna (2002)