What you will learn

You will learn how to construct and interpret measures of company performance along several dimensions.  The first is profitability: you will learn how to take information from a company’s filings and measure its profitability.  Some of the concepts here include the gross profit margin, operating profit margin, and NOPAT margin (NOPAT stands for “Net operating profit after tax”).  All these measure a company’s ability to convert sales into profits, taking into account items such as interest expense and taxes.   Profitability can also be measured by considering returns, for example, what is the return being generated for shareholders?  How exactly is this return being generated?

The next set of measures deal with efficiency of operations, including management of working capital and efficiency of asset utilization.  The third set deals with risk, mostly different ways of measuring the extent to which a company can meet its liabilities.  The fourth set covers earnings quality.  Here, a simple question is asked: how reasonable are the profitability numbers?  The need for this topic arises because there are different ways to book a profit or a sale and different ways to account for one-time gains and losses.

The last topic is price ratios.  The measures described above (which are sometimes called “Business Ratios”) are historical: they tell you what a company’s performance was, as revealed in its financial statements.  Prices, on the other hand, are determined by the willingness of investors to buy the company’s stock and so are based on expectations of future performance.  For example, the Price to Earnings (P/E) ratio measures the price of $1 of earnings.  Consider a company that has a high P/E ratio relative to others, i.e. a high price and low earnings.  The only way this can be rationalized is that the company’s earnings are expected to grow more rapidly than those of others.   This may not be reflected in earnings growth calculated from the company’s filings.  In practice, investors' adopt different measures to examine the impact of expected growth.  These include Price/Expected Earnings and the (P/E)/Expected Growth (PEG) ratio.  So the study of price ratios extends financial statement analysis to account for the impact of expectations upon ratio analysis.