investing lesson 4 - printable version

Investing Lesson 4 Analyzing an IncomeStatementIntroduction

The primary objective of the income statement is to report toinvestors how much money a business made or lost during a specificperiod of time Years ago it was referred to as the Profit and Loss(or PampL) statement and has since evolved into the most well-knownand widely used financial report on Wall Street Many timesinvestors make decisions based entirely on the PampL report withoutconsulting the balance sheet or cash flow statements (which whilea mistake is a testament to how influential it is)

To an enterprising investor the income statement reveals muchmore than a businessrsquo earnings It can give important insights intohow effectively management is controlling costs how much is beingspent on research and development the total amount of taxes paidand interest coverage In a few short minutes an investor oranalyst can also calculate profit and operating margins to compare acompany to its competitors

As we progress through this series of investing lessons you mustremember John Burr Williamrsquos basic truth that a business is onlyworth the profit that it will generate for its owners from now untildoomsday discounted back to the present adjusted for inflationThe income statement is the ldquoreport cardrdquo of those earnings whichultimately determine the price you should be willing to pay for abusiness

Sit back in your chair take out a copy of an annual report and letrsquos

Investing for Beginners

Investing Lesson 4 - Printable Version httpbeginnersinvestaboutcomlibrarylessonsnlesson4htm

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begin working through it In the end I think yoursquoll be surprised byhow much yoursquove learned As always there will be quiz followingthe lesson you should be able to pass without missing more thantwo questions

Below is a sample income statement taken from Walt Disneyrsquos 2001annual report

Itrsquos important to note that not all income statements look alikealthough they necessarily contain much of the same information Aswe work our way through various income statements you willinevitably find they are much simpler and comparable than mayappear at first glance

Total Revenue or Total SalesThe first line on any income statement is an entry called total



revenue or total sales This figure is the amount of money abusiness brought in during the time period covered by the incomestatement It has nothing to do with profit If you owned a pizzaparlor and sold 10 pizzas for $10 each you would record $100 ofrevenue regardless of your profit or loss

The revenue figure is important because a business must bring inmoney to turn a profit If a company has less revenue all else beingequal itrsquos going to make less money For startup companies andnew ventures that have yet to turn a profit revenue can sometimesserve as a gauge of potential profitability in the future

Many companies break revenue or sales up into categories to clarifyhow much was generated by each division Clearly defined andseparate revenues sources can make analyzing an incomestatement much easier It allows more accurate predictions onfuture growth Starbucksrsquo 2001 income statement is an excellentexample

Starbucks CoffeeConsolidated Statement of Earnings ndash Excerpt

Page 29 2001 Annual Report

In thousands except earnings per share

Fiscal year ended Sep 30 2001 Oct 1 2000

Net Revenues

Retail $2229594 $1823607

Specialty 419386 354007

Total net revenues 2648980 2177614

Starbucksrsquo sales come primarily from two sources retail andspecialty In the annual report management explains the differencebetween the two several pages before the income statement



ldquoRetailrdquo revenues refer to sales made at company-owned Starbucksstores across the world Every time you walk in and order yourfavorite latte you are adding $3-5 in revenue to the companyrsquosbooks ldquoSpecialtyrdquo operations on the other hand are money thecompany brings in by sales to ldquowholesale accounts and licenseesroyalty and license fee income and sales through its direct-to-consumer businessrdquo In other words the specialty divisionincludes money the business receives from coffee sales madedirectly to customers through its website or catalog along withlicensing fees generated by companies such as Barnes and Nobleswhich pay for the right to operate Starbucks locations in theirbookstores

Cost of Revenue Cost of Sales Cost of Goods Sold (COGS)Cost of goods sold (COGS for short) is the expense a companyincurred in order to manufacture create or sell a product Itincludes the purchase price of the raw material as well as theexpenses of turning it into a product Cost of goods sold is alsoknown as cost of revenue or cost of sales

Going back to our Pizza Parlor example your cost of goods soldinclude the amount of money you spent purchasing items such asflour and tomato sauce

Gross ProfitThe gross profit is the total revenue subtracted by the cost ofgenerating that revenue It tells you how much money the businesswould have made if it didnrsquot pay any other expenses such as salaryincome taxes etc Gross Profit should be broken out and clearlylabeled on the income statement Herersquos the formula to calculate ityourself

Total Revenue - Cost of Goods Sold (COGS) = Gross Profit

The gross profit figure is important because it is used to calculatesomething called gross margin which we will discuss in a moment



Gross Profit MarginAlthough we are only a few lines into the income statement we canalready calculate our first ratio The gross profit margin is ameasurement of a companyrsquos manufacturing and distributionefficiency A company that boasts a higher percentage than itscompetitors and industry is more efficient Investors tend to paymore for businesses that have higher efficiency ratings than theircompetitors

To calculate gross margin use this formula

Gross Profit----------(divided by)----------

Total Revenue

For illustration purposes letrsquos calculate the gross margin ofGreenwich Golf Supply (a fictional company)

Greenwich Golf SupplyConsolidated Statement of Earnings ndash Excerpt



Total Revenue $405209 $315000

Cost of Sales $243125 $189000

Gross Profit $162084 $126000

Assume the average golf supply company has a gross margin of30 [You can find this sort of industry-wide information in variousfinancial publications online finance sites such asmoneycentralcom or rating agencies such as Standard and Poors]

We can take the numbers from Greenwich Golf Supplyrsquos incomestatement and plug them into our formula

$162084 gross profit



----------(divided by)----------$405209 total revenue

The answer 40 [or 40] tells us that Greenwich is much moreefficient in the production and distribution of its product than mostof its competitors

The gross margin tends to remain stable over time Significantfluctuations can be a potential sign of fraud or accountingirregularities If you are analyzing the income statement of abusiness and gross margin has historically averaged around 3-4and suddenly it shoots upwards of 25 you should be seriouslyconcerned For more information on warning signs of accountingfraud I recommend Howard Schilitrsquos Financial Shenanigans 2ndedition How to Detect Accounting Gimmicks and Fraud in FinancialReports

Putting It Together Thus FarWersquove actually covered a lot of ground Herersquos an example to helpreiterate and or clarify everything wersquove discussedIf the owner of an ice cream parlor purchased 10 gallons of vanillaice cream for $2 per gallon and sold each of those gallons to hercustomers for $5 the first three lines on her income statementwould look something like this

Total Revenue $50(The total revenue is the amount of money rung up at the cashregister The owner sold 10 gallons of vanilla ice cream to hercustomers for $5 per gallon 10 gallons x $5 a gallon = $50)

Cost of Revenue $20(The cost of goods sold was 10 gallons x $2 per gallon = $20)

Gross Profit $30(The total revenue subtracted by the cost to earn that revenue is$30 Before taxes and other expenses this is the ice cream parlorrsquosgross profit)



Gross Margin 6 (or 60)

Operating ExpensesThe next section of the income statement focuses on the operatingexpenses that arise during the ordinary course of running abusiness Operating expenses consist of salaries paid to employeesresearch and development costs and other misc charges that mustbe subtracted from the companyrsquos income As an investor owneryou want to work with managements that strive to keep operatingexpenses as low as possible while not damaging the underlyingbusiness

Research and DevelopmentRampD costs can range from nothing to billions of dollars dependingupon the type of business you are analyzing Unlike many othercosts (such as income taxes) management is almost entirely free todecide how should be spent In 2001 Eli Lilly one of the worldrsquoslargest pharmaceutical companies plowed nearly 26 of the totalgross profit back into RampD

How much should a company spend on RampD It depends In highlycreative and fast-moving industries the amount of money spent onthe research and development budget can literally determine thefuture of the business If Eli Lilly stopped funding the developmentof new drugs its future profitability would suffer causing a perhapspermanent decline in earnings In such cases it may be appropriateto compare the level of RampD funding to profitability over time aswell as to the percentage of gross profit competitors spend onresearch and development

Selling General and Administrative Expenses (SGampA)SGampA expenses consist of the combined payroll costs (salariescommissions and travel expenses of executives sales people andemployees) and advertising expenses a company incurs HighSGampA expenses can be a serious problem for almost any business Agood management will often attempt to keep SGampA expenses



limited to a certain percentage of revenue This can beaccomplished through cost-cutting initiatives and employee lay-offs

There have been several cases in the past where bloated sellinggeneral and administrative expenses have literally cost shareholdersbillions in profit In the 1980rsquos ABC (later merged with CAP Citiesthen bought by Disney) was spending $60000 a year on florists aswell as providing stretch limos and private dining rooms for itsexecutives It was the shareholders who were footing the bill [On arelated note at the same time these ABC executives weresquandering shareholdersrsquo capital they were artificially paddingearnings by selling original Jackson Pollack and Willem de Kooningpaintings the network owned]

Goodwill and other Intangible Asset Amortization ChargesIn the past companies were required to charge a portion of goodwillto the income statement reducing reported earnings For all goodpurposes these charges were ignored by the investor In June 2001the Financial Accounting Standards Board (FASB) [the folks whomake accounting rules in the United States] changed theguidelines no longer requiring companies to take theseamortization charges If the company through cash-flow analysisand other means determines that the goodwill is impaired[meaning itrsquos not worth the value itrsquos carried at on the balancesheet] management will announce a write-down and reducing thecarrying value of the goodwill Intangible assets that do not haveindefinite lives [such as patents] will continue to be amortized

The complexities of goodwill were explained in detail in the Goodwillsection of Lesson 3 Part 23

Non-Recurring and Extraordinary Items or EventsIn the unpredictable world of business events will arise that are notexpected and most likely not occur again These one-time eventsare separated on the income statement and classified as eithernon-recurring or extraordinary This allows investors to more



accurately predict future earnings If for instance you wereconsidering purchasing a gas station you would base your valuationon the earning power of the business ignoring one-time costs suchas replacing the stationrsquos windows after a thunderstorm Likewise ifthe owner of the station had sold a vintage Coke machine for$17000 the year before you would not include it in your valuationbecause you had no reason to expect that profit would be realizedagain in the future

What is the difference between non-recurring and extraordinaryevents A nonrecurring charge is a one-time charge that thecompany doesnrsquot expect to encounter again An extraordinary itemis an event that materially affected a companyrsquos finance and needsto be thoroughly explained in the annual report or SEC filingsExtraordinary events can include costs associated with a merger orthe expense of implementing a new production system [asMcDonaldrsquos did in the late 1990rsquos with the Made for You foodpreparation system]

Non-recurring items are recorded under operating expenses whileextraordinary items are listed after the net line after-tax

The term material is not specific It generally refers to anythingthat affects a company in a meaningful and significant way Someinvestors try to put a number on the figure saying an event ismaterial if it causes a change of 5 or more in the companyrsquosfinances

Accounting for Extraordinary and Non-Recurring Items orEvents in Your AnalysisWhen calculating a companyrsquos earning-power it is best to leaveone-time events out of the equation These events are not expectedto repeat in the future and doing so will give you a better idea ofthe earning power of the company

If you are attempting to measure how profitable a business hasbeen over a longer period say five or ten years you should average



in the one-time events to paint a more accurate picture Forexample if a company purchased a building for $1 in 1990 and soldit for $10 ten years later in 2000 it is improper to consider thecompany earned $10 extra in the year 2000 Instead theextraordinary income [in this case $10] should be divided by thenumber of years it accrued [10 years ndash 1990 to 2000] $10extraordinary income divided by 10 years = $1 a year

Although the income statement will reflect a $10 one-time profit forthe business the investor should restate the earnings during theiranalysis by going back and adding $1 to each of the years between1990 and 2000 This will increase the accuracy of a trend line Sincethe asset was quietly appreciating during this time it should bereflected

Operating IncomeOperating income or operating profit is a measurement of themoney a company generated from its own operations [it doesnrsquotinclude income from investments in other businesses for instance]Operating income can be used to gauge the general health of thecore business or businesses

Operating Income = gross profit ndash operating expenses

The operating income figure is tremendously important because it isrequired to calculate the interest coverage ratio and the operatingmargin

Operating Margin [or Operating Profit Margin]The operating margin is another measurement of managementrsquosefficiency It compares the quality of a companyrsquos operations to itscompetitors A business that has a higher operating margin than itsindustryrsquos average tends to have lower fixed costs and a bettergross margin which gives management more flexibility indetermining prices This pricing flexibility provides an addedmeasure of safety during tough economic times



To calculate the operating margin divide operating income by thetotal revenue

Operating income----------(divided by)----------

Total revenue

Interest IncomeCompanies sometimes keep their cash hoards in short-term depositinvestments [such as certificates or deposit with maturities up totwelve months savings account and money market funds] Thecash placed in these accounts earn interest for the business whichis recorded on the income statement as interest income

Interest income will fluctuate each year with the amount of cash acompany keeps on hand

Interest ExpenseCompanies often borrow money in order to build plants or officesbuy other businesses purchase inventory or fund day-to-dayoperations The borrowed money is converted to an asset on thebalance sheet (ie if a business borrows $1 million to build adistribution center the distribution center would add $1 million ofassets to the balance sheet after the cash was spent) The interest acompany pays to bondholders banks and private lenders on theother hand is an expense that it receives no asset for Henceinterest expense must be accounted for on the income statement

Some income statements report interest income and interestexpense separately while others report interest expense as ldquonetrdquoNet refers to the fact that management has simply subtractedinterest income from interest expense to come up with one figure[In other words if a company paid $20 in interest on its bank loansand earned $5 in interest from its savings account the incomestatement would only show interest expense ndash net $15]

The amount of interest a company pays in relation to its revenue



and earnings is tremendously important To gauge the relation ofinterest to earnings investors can calculate the interest coverageratio

Interest Coverage RatioThe interest coverage ratio is a measurement of the number oftimes a company could make its interest payments with its earningsbefore interest and taxes the lower the ratio the higher thecompanyrsquos debt burden

Interest coverage is the equivalent of a person taking the combinedinterest expense from their mortgage credit cards auto andeducation loans and calculating the number of times they can pay itwith their annual pre-tax income For bond holders the interestcoverage ratio is supposed to act as a safety gauge It gives you asense of how far a companyrsquos earnings can fall before it will startdefaulting on its bond payments For stockholders the interestcoverage ratio is important because it gives a clear picture of theshort-term financial health of a business

To calculate the interest coverage ratio divide EBIT (earningsbefore interest and taxes) by the total interest expense

EBIT (earnings before interest and taxes)-----------------------(divided by)-----------------------

Interest Expense

As a general rule of thumb investors should not own a stock thathas an interest coverage ratio under 15 A ratio below 10 indicatesthe business is having difficulties generating the cash necessary topay its interest obligations The history and consistency of earningsis tremendously important The more consistent a companyrsquosearnings the lower the interest coverage ratio can be

EBIT has its short fallings companies do pay taxes therefore it ismisleading to act as if they didnrsquot A wise and conservative investorwould simply take the companyrsquos earnings before interest and



divide it by the interest expense This would provide a moreaccurate picture of safety

Depreciation and AmortizationThere are two different kinds of ldquodepreciationrdquo an investor mustgrapple with when analyzing financial statements accumulateddepreciation and depreciation expense They are entirely differentthings and are often confused with one another In order tounderstand them we must discuss them individuallyDepreciation Expense

According to Ameritrade ldquoDepreciation is the process by which acompany gradually records the loss in value of a fixed asset Thepurpose of recording depreciation as an expense over a period is tospread the initial purchase price of the fixed asset over its usefullife [emphasis added] Each time a company prepares its financialstatements it records a depreciation expense to allocate the loss invalue of the machines equipment or cars it has purchasedHowever unlike other expenses depreciation expense is anon-cash charge This simply means that no money is actuallypaid at the time in which the expense is incurredrdquo

To help you understand the concept letrsquos look at an example

Sherryrsquos Cotton Candy Co earns $10000 profit a year In themiddle of 2002 the business purchases a $7500 cotton candymachine that is expected to last for five years If an investorexamined the financial statements they might be discouraged tosee that the business only made $2500 at the end of 2002 [$10kprofit - $75k expense for purchasing the new machinery] Theinvestor would wonder why the profits had fallen so much during theyear

Thankfully Sherryrsquos accountants come to her rescue and tell herthat the $7500 must be allocated over the entire period it is goingto benefit the company Since the cotton candy machine is expectedto last five years Sherry can take the cost of the cotton candy



machine and divide it by five [$7500 5 years = $1500 per year]Instead of realizing a one-time expense the company can subtract$1500 each year for the next five years reporting earnings of$8500 This allows investors to get a more accurate picture of howthe companyrsquos earning power The practice of spreading-out the costof the asset over its useful life is ldquodepreciation expenserdquo

This presents an interesting dilemma although the companyreported earnings of $8500 in the first year it was still forced towrite a $7500 check [effectively leaving it with $2500 in the bankat the end of the year [$10000 profit - $7500 cost of machine =$2500 left over] This means that the cash flow of the company isactually different from what it is reporting in earnings Thecash-flow is very important to investors because they need to beensured that the company can pay its bills on time The first yearSherryrsquos would report earnings of $8500 but only have $2500 inthe bank Each subsequent year it would still report earnings of$8500 but have $10000 in the bank since in reality the businesspaid for the machinery up-front in a lump-sum Hence if an investorknew that Sherry had a $3000 loan payment due to the bank in thefirst year he may incorrectly assume that the company would beable to cover it since it reported earnings of $8500 In reality thebusiness would be $500 short

This is where the third major financial report the Cash FlowStatement is important The cash flow statement is like acompanyrsquos checking account It shows how much cash was spent atwhat time and where That way an investor could look at theincome statement of Sherryrsquos Cotton Candy Co and see a profit of$8500 each year then turn around and look at the cash flowstatement and see that the company really spent $7500 on amachine this year leaving it only $2500 in the bank The cash flowstatement is the focus of Investing Lesson 5

Some investors and analysts incorrectly maintain that depreciationexpense should be added back into a companyrsquos profits because it



requires no immediate cash outlay In other words Sherry wasnrsquotreally paying $1500 a year so the company should have addedthose back in to the $8500 in reported earnings and valued thecompany based on a $10000 profit not the $8500 figure This isincorrect Depreciation is a very real expense Depreciationattempts to match up profit with the expense it took to generatethat profit This provides the most accurate picture of a companyrsquosearning power An investor who ignores the economic reality ofdepreciation will be apt to overvalue a business and find his or herreturns lacking

Depreciation expenses are deductible Sherryrsquos would only pay taxes on $8500each year spreading out her tax burden to the future Some investors assumeincorrectly that the business would pay taxes on $2500 the first year and thefull $10000 each year after

Accumulated DepreciationIf you purchased a new car for $50000 and resold it three yearslater for $30000 you would have experienced $20000 loss on thevalue of your asset This $20000 is due to a force calleddepreciation Accumulated depreciation is the reduction of thecarrying amount of the assets on the balance sheet to reflect theloss of value due to wear tear and usage Companies purchaseassets such as computers copy machines buildings and furnitureall of which lose value each day This depreciation loss must beaccounted for in the companyrsquos financial statements in order to giveshareholders the most accurate portrayal of the economic realty ofthe business

When you look at a balance sheet if you see the entry ldquoPropertyPlant and Equipment ndash netrdquo it is referring to the fact that thecompany has deducted accumulated depreciation from the figurepresented To see the amount of those depreciation charges youwill probably have to delve into the annual report or 10k

Straight Line Depreciation MethodThe simplest and most commonly used straight-line depreciation is



calculated by taking the purchase or acquisition price of an assetsubtracted by the salvage value divided by the total productiveyears the asset can be reasonably expected to benefit the company[called ldquouseful liferdquo in accounting jargon]

purchase price of asset ndash approximate salvage value-------------------------- (divided by) --------------------------

estimated useful life of asset

Example You buy a new computer for your business costingapproximately $5000 You expect a salvage value of $200 sellingparts when you dispose of it Accounting rules allow a maximumuseful life of five years for computers in the past your business hasupgraded its hardware every three years so you think this is a morerealistic estimate of useful life since you are apt to dispose of thecomputer at that time Using that information you would plug itinto the formula

$5000 purchase price - $200 approximate salvage value-------------------------- (divided by) --------------------------

3 years estimated useful life

The answer $1600 is the depreciation charges your businesswould take annually if you were using the straight line method

Accelerated Depreciation MethodsAnother way of accounting for depreciation is to use one of theaccelerated methods These include the Sum of the Yearrsquos Digitsand the Declining Balance [either 150 or 200] methods Theseaccelerated methods are more conservative and in most casesaccurate They assume that an asset loses a majority of its value inthe first several years of use

Sum of the Years DigitsTo calculate depreciation charges using the sum of the yearrsquos digitsmethod take the expected life of an asset (in years) count back toone and add the figures together Example



10 years useful life = 10 + 9 + 8 + 7 + 6 +5 + 4 + 3 + 2 + 1 Sumof the years = 55

In the first year the asset would be depreciated 1055 in value [thefraction 1055 is equal to 1818] the first year 955 [1636] thesecond year 855 [1454] the third year and so on Going backto our example from the straight-line discussion a $5000 computerwith a $200 salvage value and 3 years useful life would becalculated as follows

3 years useful life = 3 + 2 + 1 Sum of the years = 6

Taking $5000 - $200 we have a depreciable base of $4800 In thefirst year the computer would be depreciated by 36ths [50] thesecond year by 26 [3333] and the third and final year by theremaining 16 [1667] This would have translated intodepreciation charges of $2400 the first year $159984 the secondyear and $80016 the third year The straight-line example wouldhave simply charged $1600 each year distributed evenly over thethree years useful life

Double Declining Balance DepreciationThe double declining balance depreciation method is like thestraight-line method on steroids To use it accountants firstcalculate depreciation as if they were using the straight linemethod They then figure out the total percentage of the asset thatis depreciated the first year and double it Each subsequent yearthat same percentage is multiplied by the remaining balance to bedepreciated At some point the value will be lower than thestraight-line charge at which point the double declining methodwill be scrapped and straight line used for the remainder of theassetrsquos life [got all that] An illustration may help

In our straight-line example we calculated that a $5000 computerwith a $200 salvage value and an estimated useful life of threeyears would be depreciated by $1600 annually The first year wehave to compare this to the total amount to be depreciated in this



case $4800 [$5000 base - $200 salvage value = $4800] Dividing$1600 by $4800 we discover the straight-line depreciation charge[$1600] is 3333 of the total depreciation amount [$4800] Usingthis information we double the 3333 figure to 6667

In the first year we would take $4800 multiplied by 6667 to get atotal depreciation charge of approximately $3200 In the secondyear we would take the same percentage [6667] and multiply itby the remaining amount to be depreciated Continuing with theexample we find that $1600 is the remaining amount to bedepreciated at the start of the second year [$4800 - $3200 =$1600] Multiply 1600 by 6667 to get $1066 This is thedepreciation charge for the second year ndash or not Remember thatonce the depreciation charges dip below the amount that would becharged using the straight-line method the double decliningbalance is scrapped and straight line immediately utilized Thestraight line method called for charges of $1600 per yearObviously the $1066 charge is smaller than the $1600 that wouldhave occurred under straight line Thus the deprecation charge forthe second year would be $1600

For those of you who love algebra you may find it easier to use thisequation

depreciable base (2 100 useful life in years)

Comparing Depreciation MethodsJust to reinforce what wersquove learnt thus far herersquos a look at whatthe depreciation charges for the same $5000 computer would looklike depending upon the method used

Comparing Depreciation Methods

Method Year 1 Year 2 Year 3

Straight Line$1600

$1600 $1600



Sum of the Years $2400 $159984 $80016

Double Declining Balance$3200

$1600 $0

Obviously depending upon which method is used by managementthe bottom-line of a company can be seriously affected The level ofattention an investor must give depreciation depends upon the assetintensity of the business he or she is studying The more asset-intensive an enterprise the more attention depreciation should begiven

If you have two asset intensive businesses and they are usingdifferent depreciation methods and or useful lives you mustadjust them so they are on a comparable basis in order to get anaccurate picture of how they stack up against each other in terms ofprofit

Some managements will report depreciation expense broken out asa separate line on the income statement while others will be moreclandestine about it including it indirectly through SGampA expenses[for the deprecation costs of desks for instance] Either way youshould be able to garner the information either through the incomestatement itself or going through the annual report or 10k

In Security Analysis [the classic 1934 edition] Benjamin Grahamrecommended the investor answer three questions when dealingwith the effects of deprecation on a business [paraphrased]

1 Is depreciation reflected in the earnings statement2 Is management using conservative and [as much as possible]accurate depreciation rates Accounting rules allow assets to bewritten off over a considerable time period Buildings for examplecan be depreciated anywhere from ten to thirty years resulting inlarge differences in charges depending upon the time frame aparticular business uses A companyrsquos 10k filing should containinformation on the rates employed by the company3 Are the cost or base to which the depreciation rates applied



reasonable accurate A company may set unrealistic salvage valueson its assets thus reducing the amount of depreciation charges itmust take every year

Earnings Before Interest Tax Depreciation and Amortization- EBITDAEBITDA tells an investor how much money a company would havemade if it didnrsquot have to pay interest on its debt taxes or takedepreciation and amortization charges EBITDA is intended to be anindicator of a companyrsquos financial performance not free cash flowas many investor incorrectly assume originally coming intoexistence in the 1980rsquos during the leveraged-buyout frenzy thatepitomized the era of greed The measurement has become sopopular that many companies will boast charts and graphs of theirincreased EBITDA within the first five pages of their annual reportInvestors thinking this is wonderful get excited about the businessbecause it appears to be growing in leaps and bounds

In its brilliance Wall Street regrettably forgot one part of theequation common sense Companies do have to pay interesttaxes depreciation and amortization Treating these expenses likethey donrsquot exist is the same mentality of the five year old whobelieves no one can see them when their eyes are closed ndash whilethey may enjoy pretending for a while the IRS and the banks andbondholders who lent money to the company arenrsquot interested inplaying games When the bills come due these entities want themoney owed to them and can force bankruptcy if they arenrsquot paid

Still not convinced Picture this scenario

A man making $100000 annually walks into his local bank to get aloan on a new BMW He pays an annual taxes of about $30000leaving his take-home pay at $134615 per week [for simplicitysake letrsquos ignore payroll deductions etc] He currently has amortgage payment of $750 a month and student loan payments of$250 a month After paying out this $1000 each month he is left



with $34615 to live on

The loan officer crunches the numbers and comes up with anestimated monthly payment of $400 for the car The man pulls outhis pen to sign the papers The loan offer looks in confusion afterreviewing his information ldquoSirrdquo she says ldquoyou only make $34615a month after payments and taxes You canrsquot afford this loan Notonly can you not afford the payment you will then have nothing tolive onrdquo The man looks confused ldquobut I make $134615 per monthbefore my payments and taxesrdquo

See the fallacy The gentlemen in our example may ignore theloans but his creditors surely arenrsquot In fact the officer wouldprobably laugh at him Sadly this is exactly what corporations aredoing by presenting their EBITDA numbers to investors

The truth is in virtually all cases EBITDA is absolutely entirelyand utterly useless It is simply a way for companies that canrsquotmake money to dress-up their failures by reporting increasedsomething to investors When the traditional metric of profitcouldnrsquot be attained they created a new one that made themappear successful

In the accounting and business world EBITDA is a firestorm ofcontroversy There are some who will defend it vehemently andattempt to ridicule you for even suggesting it isnrsquot worth the time ittakes to pronounce the letters Often these people will appear to bevery intelligent driven and professional Donrsquot worry about it ndash fourhundred years ago the brightest men on earth thought the worldwas flat Smile and say a prayer of thanks because itrsquos folly such asthis that presents us with opportunity to profit in the market

If you are interested there is an excellent article at the MotleyFoolrsquos website called The Limits of EBITDA I highly recommend it

Additional information10 Critical Failing of EBITDA - Computer World



EBITDA The Good the Bad and The Ugly ndash InvestopediaIgnore EBITDA - The Motley FoolWhat is EBITDA - The Motley Fool

Income before TaxAfter deducting interest payments and [depending on the business]other expenses the analyst investor is left with the profit acompany made before paying its income tax bill It allows you tosee what the business would have earned if it did not have to paytaxes to the government

Income Tax ExpenseThe income tax expense is the total amount the company paid intaxes This figure is frequently broken out by source [federal stateetc] either on the income statement or somewhere in the annualreport or 10k

You should be fairly familiar with the tax laws affecting specificcompanies and or business transactions For instance say thebusiness you were analyzing just purchased $100 million worth ofpreferred stock that was paying a 9 yield [wersquoll talk more aboutpreferred stock later] You could rightly assume the company wouldreceive $9 million a year in dividends on the preferred If thecompany had a tax rate of say 35 you may assume that $315million of these dividends are going to be paid to the Uncle Sam Intruth corporations get an exemption on 70 of the dividends theyreceive from preferred stock [individuals do not enjoy this luxury]Hence only $27 million of the $9 million in dividends would besubject to taxation Donrsquot you love this stuff

For your reference here is a list of the corporate tax brackets fromsmbizcom It would serve you well to memorize themCorporate Income Tax Rates--2002 2001 2000 1999 amp 1998

Taxable income over Not over Tax rate

$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35

Minority Interests on the Income StatementIf Federated Department Stores [the owner of Macyrsquos andBloomingdales] purchased five percent of Saks Fifth Avenue Inccommon sense tells us that Federated would be entitled to fivepercent of Saksrsquo earnings How would Federated report their shareof Saksrsquo earnings on their income statement It depends on thepercentage of the companyrsquos voting stock Federated owned

bull Cost Method (If Federated owned 20 or less)The company would not be able to report its share of Saksrsquoearnings except for the dividends it received from the Saks stockThe asset value of the investment would be reported at the lower ofcost or market value on the balance sheet What does that mean

If Federated purchased 10 million shares of Saks stock at $5 pershare [for a total cost of $50 million] it would record any dividendsreceived on its income statement and add $50 million to thebalance sheet under investments If Saks rose to $10 per share the10 million shares would be worth $100 million [$10 per share x 10million shares = $100 million] However the balance sheet wouldcontinue to list the lsquovaluersquo of those 10 million shares at $50 million

On the other hand if the stock dropped to $250 per share thusreducing the investments to $25 million the balance sheet valuewould be written down to reflect the lower price

bull Equity Method (If Federated owned 21-49)In most cases Federated would include a single-entry line on theirincome statement reporting their share of Saksrsquo earnings Forexample if Saks earned $100 million and Federated owned 30percent they would include a line on the income statement for $30million in income [30 of $100 million] even if these earnings werenever paid out as dividends [meaning they never actually saw $30million]



bull Consolidated Method (If Federated owned 50+)The company would be required to include all of the revenuesexpenses tax liabilities and profits of Saks on the incomestatement It would then include an entry that deducted thepercentage of the business it didnrsquot own If Federated owned 65 ofSaks it would report the entire $100 million in profit and theninclude an entry labeled minority interest that deducted the $35million [35] of the profits it didnrsquot own

The Importance of Unreported or Look Through EarningsYoursquoll notice that the cost method which applies to holdings under20 only allows the company to report the cash it actually receivesin the form of dividends as income This can be misleading If yourcompany owned 15 of Microsoft you would never see a dime individends although your 15 share of the earnings was beingreinvested in the business on your behalf by management Thoseearnings will subsequently lead to long-term rise in the value ofyour stock holding and are therefore very important to youreconomic future

Donrsquot believe it Say you inherit a business that your great-grandfather founded a century ago At the end of every year heused some of the businessrsquo profits to buy shares of Thomas Edisonrsquoscompany General Electric By the time the company came underyour control in 2002 it owned 19 of GErsquos common stock[1888600000 shares] General Electric paid a dividend that yearof $072 per share According to GAAP accounting rules yourbusiness could only report the $1359792000 in dividends youreceived

However the year before General Electric had actually made aprofit of $146 billion of which nineteen percent indirectly belongedto you Although you could only report $136 billion in dividendsyou actually have a legal ownership to $2774 billion in thecompanyrsquos earnings ($136 billion were paid out to you asdividends with the remaining $14 billion retained by GE) This



means that you were not allowed to report more than $14 billion inearnings that indirectly belonged to you The general logic statesthat because you never see that money it shouldnrsquot count asincome This is both misinformed and dangerous The entire $2774billion belongs to you The portion of the earnings that were notpaid out will be reinvested into GErsquos business and subsequentlyresult in a rise in the stock price If someone were to value thebusiness they would include the entire $2774 billion in theircalculation because the entire amount was working to youreconomic benefit

Famed investor Warren Buffett referred to these unreported profitsas look-through earnings The successful investor strives to puttogether a portfolio with the highest possible look-through earningsfor each dollar invested This will result in market-beating returnsIn his 1980 Letter to Shareholders of Berkshire Hathaway Buffettexplained that Berkshirersquos income statement was reporting less thanhalf of what the companyrsquos true economic earnings were

ldquoOur holdings in this [20 or less] category of companies [has]increased dramatically in recent years as our insurance business hasprospered and as securities markets have presented particularlyattractive opportunities in the common stock area The largeincrease in such holdings plus the growth of earnings experiencedby those partially-owned companies has produced an unusualresult the part of lsquoourrsquo earnings that these companies retained lastyear (the part not paid to us in dividends) exceeded the totalreported annual operating earnings of Berkshire Hathaway Thusconventional accounting only allows less than half of our earningsldquoicebergrdquo to appear above the surface in plain viewrdquo

Thus you must add the non-reportable earnings of a companyrsquospartially owned businesses back into the income statement to comeup with an accurate estimate of economic earnings

Continuing Ongoing Operations vs Discontinued



OperationsIn the 1990rsquos Viacom owner of MTV VH1 and Nickelodeonpurchased Paramount Studios To pay for the acquisition Viacomtook on a large amount of debt The companyrsquos Chairman SumnerRedstone began selling assets and businesses the company ownedin order to help pay down debt

Simon amp Schuster a major book publisher was one of thebusinesses Viacom decided to let go ultimately selling it to Britishmedia group Pearson PLC for $46 billion dollars How did the dealaffect the companyrsquos revenue and earnings

This is where discontinued and ongoing operations come to therescue As soon as Viacom sold Simon it had a pile of cash from thebuyer However it lost all of the revenue and profit the publishergenerated Viacomrsquos management must somehow warn investorsldquoHey Simon generated [X amount] of our profit and revenue Sincewe no longer own the business you canrsquot plan on us earning thisrevenue profit next yearrdquo To do that the Viacom puts an entry ontheir income statement called ldquoDiscontinued Operationsrdquo Thisshows investors money that was earned from businesses that wonrsquotbe part of the companyrsquos holdings for very much longer

Continuing operations are the businesses the company expects to beengaged in for the foreseeable future

Net Income from Continuing OperationsAfter all of these expenses are deducted the investor is left with afigure called net income from continuing operations This is acalculation of the profit its continuing operations generated duringthe period

Net Income from Discontinued OperationsThe amount shown on the income statement under discontinuedoperations is the profit made during the period from the businessesthat will not be a part of the company in the future



Accounting ChangesGAAP accounting rules give management a large amount of leewayin determining how to report their earnings to shareholders Attimes a company may opt to change the way it has accounted for aparticular item in the past which will have the affect of increasingor decreasing the amount of reportable earnings although thecompany has not actually made or lost more money

Management is required to disclose accounting changes in SECfilings It is tremendously important that you determine if thechange was necessary or simply a maneuver to inflate the amountof profit reported to shareholders

Net IncomeThe net income is the total profit the business made for the periodbefore required dividend payments on the companyrsquos preferredstock

Preferred Stock and Other AdjustmentsPreferred stock is a mix between regular common stock and a bondEach share of preferred stock is normally paid a guaranteedrelatively high dividend and has first dibs over common stock at thecompanys assets in the event of bankruptcy In exchange for thehigher income and safety preferred shareholders miss out on largepotential capital gains [or losses] Owners of preferred stockgenerally do not have voting privileges

The terms of preferred shares can vary widely even when issued bythe same company Some of the many different kinds of preferredstock available are adjustable rate preferred stock convertiblepreferred stock first preferred stock participating preferred stockparticipating convertible preferred stock prior preferred stock andsecond preferred stock [For more information read the remainderof 091602 article Preferred Stock and Individual Investors]

The dividends paid to preferred shares are deducted as an expensebecause they are required payments unlike the common stock



dividend which is just a divvying-up part of the profits

Net Income Applicable to Common SharesThe net income applicable to common shares figure is thebottom-line profit the company reported To get the basic earnings-per-share [Basic EPS] figure analysts divide the net incomeapplicable to common by the total number of shares outstanding

The last line at the bottom of the income statement is the amountof money the company purports to have made (net income totalprofit or reportable earnings itrsquos all the same) Hence the clicheacuteldquowhatrsquos the bottom linerdquo

Net Profit MarginThe profit margin tells you how much profit a company makes forevery $1 it generates in revenue Profit margins vary by industrybut all else being equal the higher a companyrsquos profit margincompared to its competitors the better Several financial bookssites and resources tell an investor to take the after-tax net profitdivided by sales While this is standard and generally acceptedsome analysts prefer to add minority interest back into theequation to give an idea of how much money the company madebefore paying out to minority ldquoownersrdquo Either way is acceptablealthough you must be consistent in your calculations All companiesmust be compared on the same basis

Option 1 Net income after taxes-------------------------- (divided by) --------------------------

Revenue

Option 2 Net income + minority interest + tax-adjusted interest-------------------------- (divided by) --------------------------

Revenue

In some cases lower profit margins represent a pricing strategy Some businesses especially retailers may be known for their



low-cost high-volume approach In other cases a low net profitmargin may represent a price war which is lowering profits as wasthe case in the computer industry in 2000

Net Profit Margin ExampleIn 2002 Donna Manufacturing sold 100000 widgets for $5 eachwith a COGS of $2 each It had $150000 in operating expensesand paid $52500 in taxes What is the net profit margin

First we need to find the revenue or total sales If Donnas sold100000 widgets at $5 each it generated a total of $500000 inrevenue The companys cost of goods sold was $2 per widget100000 widgets at $2 each is equal to $200000 in costs Thisleaves a gross profit of $300000 [$500k revenue - $200k COGS] Subtracting $150000 in operating expenses from the $300000gross profit leaves us with $150000 income before taxes Subtracting the tax bill of $52500 we are left with a net profit of$97500

Plugging this information into our formula we get

$97500 net profit--------------(divided by)--------------

$500000 revenue

The answer 0195 [or 195] is the net profit margin Keep inmind when you perform this calculation on an actual incomestatement you will already have all of the variables calculated foryou your only job is to plug them into the formula [Why then did Imake you go to all the work I just wanted to make sure youveretained everything weve talked about thus far]

Cherry Pie Basic vs Diluted Earnings per ShareWhen you analyze a company you have to do it on two levels theldquowhole companyrdquo and the ldquoper sharerdquo If you decide ABC Inc isworth $5 billion as a whole you should be able to break it down bysimply dividing the $5 billion price tag by the number of shares



outstanding Unfortunately it isnrsquot always that simple

Think of each business you analyze as a cherry pie and each shareof stock as a piece of that pie All of the companyrsquos assetsliabilities and profits are represented by the pie as a whole ABCrsquospie is worth $5 billion If the baker [management] slices the pie into5 pieces each piece would be worth $1 billion [$5 billion pie dividedinto 5 pieces = $1 billion per slice] Obviously any intelligentconnoisseur of pastries would want to keep the baker from makingtoo many slices so his or her piece was as big as possible Likewisean ambitious investor hungry for returns is going to want to keepthe company from increasing the number of shares outstandingEvery new share management issues decreases the investorrsquosldquopiecerdquo of the assets and profits a tiny bit Over time this can makea huge difference in how much the investor gets to eat

ldquoHow can management increase the number of shares outstandingrdquoyou may ask There are four big knives [perhaps ldquocleaversrdquo wouldbe a more appropriate term] in any managementrsquos drawer that canbe used to add increase the number of shares outstanding stockoptions warrants convertible preferred stock and secondary equityofferings [all sound more complicated than they are] Stock optionsare a form of compensation that management often gives toexecutives managers and in some cases regular employeesThese options give the holder the right to buy a certain number ofshares by a specific date at a specific price If the shares areldquoexercisedrdquo the company issues new stock Likewise the other threecleavers have the same affect ndash the potential to increase thenumber of shares outstanding

This situation leaves Wall Street with the problem of how much toreport for the earnings per share figure In response they came upwith two sets of EPS numbers basic and diluted The basic figure isthe total earnings per share based on the number of sharesoutstanding at the time The diluted earnings per share figurereveals how much profit per-share a business would have made if all



stock options warrants convertibles etc were invoked and theadditional shares increased the total shares outstanding Thepercentage of a company that is represented by these possibleshare dilutions is called ldquohangrdquo

Although ABC may have 5 shares outstanding today it may actuallyhave the potential for 15 shares outstanding during the next yearValuation on a per-share basis should reflect the potential dilution toeach share Although it is unlikely all of the potential shares will beissued [the stock market may fall meaning a lot of executives wonrsquotexercise the stock options for example] it is important that youvalue the business assuming all possible dilution that can take placewill take place This practiced conservatism can mean the differencebetween mediocre and spectacular returns on your investment

Below is an excerpt from Intelrsquos 2001 income statement

IntelExcerpt ndash 2001 Annual Report

Earnings per share from continuing operations 2001 2000

Basic $19 $157

Diluted $19 $151

In 2000 the difference between Intelrsquos basic and diluted EPSamounted to around $006 If you consider the company has over65 billion shares outstanding you realize that dilution is takingmore than $390 million in value from current investors and giving itto management and employees

Clandestine Boarding on DishonestySome companies donrsquot include the possible share dilution fromoptions that are ldquounderwaterrdquo This occurs when an employee ownsoptions to buy shares at a certain price and due to a sudden drop in



stock market value the option is below the exercise price If [andthis is a big if] the stock does not rise over the exercise price theoption will expire worthless On the other hand if the stockadvances to higher levels these options will probably be exercisedincreasing the number of shares outstanding and dilution yourpercentage ownership in the business

The problem with not including these underwater options in thediluted figures is that options normally have extended life [in somecases around 10 years] In that time it is very likely if not certainthat some of those options will become valuable once the companyrsquosstock price rises

Herersquos an example from Abercrombie amp Fitchrsquos 10K

Options to purchase 5630000 9100000 and 5600000 shares ofClass A Common Stock were outstanding at year-end 2001 2000and 1999 respectively but were not included in the computation ofnet income per diluted share because the optionsrsquo exercise priceswere greater than the average market price of the underlyingshares

As you analyze companies you must keep your eye out for suchborder-line deceptive practices as they are widespread and commonoccurrence

Share Repurchase ProgramsJust as stock options warrants and convertible preferred issues candilute your ownership in a company share repurchase plans canincrease your ownership by reducing the number of sharesoutstanding Below is a reprint of an article I published on June 42001

Stock Buybacks ndash The Golden Egg of Shareholder ValueldquoOverall growth is not nearly as important as growth per sharehelliprdquo

All investors have no doubt heard of corporations authorizing sharebuyback programs Even if you dont know what they are or how



they work you at least understand that they are a good thing [inmost situations] Here are three important truths about theseprograms - and most importantly how they make your portfoliogrow

Principle 1 Overall Growth is not nearly as important as Growth perShare

Too often youll hear leading financial publications and broadcasttalking about the overall growth rate of a company While thisnumber is very important in the long run it is not the all-importantfactor in deciding how fast your equity in the company will growGrowth per share is

A simplified example may help Lets look at a fictional company

Eggshell Candies Inc$50 per share

100000 shares outstanding-------------------------------------------

Market Capitalization $5000000

This year the company made a profit of $1 million dollars==================================

In this example each share equals 001 of ownership in thecompany [100 divided by 100000 shares]

Management is upset by the companys performance because it soldthe exact same amount of candy this year as it did last year Thatmeans the growth rate is 0 The executives want to do somethingto make the shareholders money because of the disappointingperformance this year so one of them suggests a stock buybackprogram The others immediately agree the company will use the$1 million profit it made this year to buy stock in itself

The very next day the CEO goes and takes the $1 million dollarsout of the bank and buys 20000 shares of stock in his company



[Remember it is trading at $50 a share according to the informationabove] Immediately he takes them to the Board of Directors andthey vote to destroy those shares so that they no longer exist Thismeans that now there are only 80000 shares of Eggshell Candies inexistence [instead of the original 100000]

What does that mean to you Well each share you own no longerrepresents 001 of the company it represents 00125 of thecompany thats a 25 increase in value per share The next dayyou wake up and find out that your stock in Eggshell is now worth$6250 per share instead of $50 Even though the company didntgrow this year you still made a twenty five percent increase onyour investment This leads to the second principle

Principle 2 When a company reduces the amount of sharesoutstanding each of your shares becomes more valuable andrepresents a greater percentage of equity in the company

If a shareholder-friendly management such as this one is kept inplace it is possible that someday there may only be 5 shares of thecompany each worth one million dollars When putting togetheryour portfolio you should seek out businesses that engage in thesesort of pro-shareholder practices and hold on to them as long as thefundamentals remain sound One of the best examples is theWashington Post which was at one time only $5 to $10 a share Ithas traded as high as $650 in recent months That is long termvalue

Principle 3 Stock Buybacks are not good if the company paystoo much for its own stock

Even though buybacks can be huge sources of long-term profit forinvestors they are actually harmful if a company pays more for itsstock than it is worth In an overpriced market it would be foolishfor management to purchase equity at all [even in itself]Instead the company should put the money into assets that can beeasily converted back into cash This way when the market swung



the other way and is trading below its true value shares of thecompany can be bought back up at a discount - giving shareholdersmaximum benefit

Remember even the best investment in the world isnt a goodinvestment if you pay too much for it

Return on Equity ndash ROEOne of the most important profitability metrics is return on equity[or ROE for short] Return on equity reveals how much profit acompany earned in comparison to the total amount of shareholderequity found on the balance sheet If you think back to lesson threeyou will remember that shareholder equity is equal to total assetsminus total liabilities Itrsquos what the shareholders ldquoownrdquo Shareholderequity is a creation of accounting that represents the assets createdby the retained earnings of the business and the paid-in capital ofthe owners

A business that has a high return on equity is more likely to be onethat is capable of generating cash internally For the most part thehigher a companyrsquos return on equity compared to its industry thebetter This should be obvious to even the less-than-astute investorIf you owned a business that had a net worth [shareholderrsquos equity]of $100 million dollars and it made $5 million in profit it would beearning 5 on your equity [$5 $100 = 05 or 5] The higheryou can get the ldquoreturnrdquo on your equity in this case 5 the better

The formula for Return on Equity is

Net Profit----------(divided by)----------

Average Shareholder Equity for Period

Martha Stewart Living Omnimedia IncExcerpt ndash 2001 Consolidated Balance Sheet

(in thousands except per share data) 2001 2000



Total Shareholdersrsquo Equity 222192 196116

Total liabilities and shareholdersrsquo equity 311621 287414





Now that we have the income statement and balance sheet in frontof us our only job is to plug a the numbers into our equation Theearnings for 2001 were $21906000 [because the amounts are inthousands take the figure shown in this case $21906 and multiplyby 1000 Almost all publicly traded companies short-hand theirfinancial statements in thousands or millions to save space] Theaverage shareholder equity for the period is $209154000[$222192000 + 196116000 divided by 2]

Letrsquos plug the numbers into the formula

$21906000 earnings-------------(divided by) -------------

$209154000 average shareholder equity for period

The answer is 01047 or 1047 This 1047 is the return thatmanagement is earning on shareholder equity Is this good Formost of the twentieth century the SampP 500 [a measure of thebiggest and best public companies in America] averaged ROEs of 10to 15 In the 1990rsquos the average return on equity was in excessof 20 Obviously these twenty-plus percent figures probably wonrsquot



endure forever In the past two years alone small and largecorporations alike have issued repeated earnings revisions warninginvestors they will not meet analystsrsquo quarterly and or annualestimates

Return on equity is particularly important because it can help youcut through the garbage spieled out by most CEOrsquos in their annualreports about ldquoachieving record earningsrdquo Warren Buffett pointedout years ago that achieving higher earnings each year is an easytask Why Each year a successful company generates profits Ifmanagement did nothing more than retain those earnings and stickthem a simple passbook savings account yielding 4 annually theywould be able to report ldquorecord earningsrdquo because of the interestthey earned Were the shareholders better off Not at all theywould have enjoyed heftier returns had the earnings been paid outThis makes obvious that investors cannot look at rising per-shareearnings each year as a sign of success The return on equity figuretakes into account the retained earnings from previous years andtells investors how effectively their capital is being reinvestedThus it serves as a far better gauge of managementrsquos fiscaladeptness than the annual earnings per share

The return on equity calculation can be as detailed as you desireMost financial sites and resources calculate return on commonequity by taking the income available to the common stock holdersfor the trailing [most recent] twelve months and dividing it by theaverage shareholder equity for the most recent five quarters Someanalysts will actually ldquoannualizerdquo the recent quarter by simplytaking the current income and multiplying it by four The theory isthat this will equal the annual income of the business In manycases this can lead to disastrous and grossly incorrect results Takea retail store such as Lord amp Taylor or American Eagle for exampleIn some cases fifty-percent or more of the storersquos income andrevenue is generated in the fourth quarter during the traditionalChristmas shopping period An investor should be exceedingly



cautious not to annualize the earnings for seasonal businesses

Calculating Asset TurnoverThe asset turnover ratio calculates the total sales [revenue] forevery dollar of assets a company owns To calculate asset turnovertake the total revenue and divide it by the average assets for theperiod studied [Note you should know how to do this In lesson 3we took the average inventory and receivables for certainequations The process is the same take the beginning assets andaverage them with the ending assets If XYZ had $1 in assets in2000 and $10 in assets in 2001 the average asset value for theperiod is $5 because $1+$10 divided by 2 = $5] A quick exercisewould benefit your understanding

Asset Turnover

Total Revenue---------(divided by) ---------

Average assets for period

Alcoa2001 Income Statement Excerpt

Period Ending Dec 31 2001 Dec 31 2000 Dec 31 1999

Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000

Alcoa2001 Balance Sheet Excerpt

20012000

1999

Long Term Assets



Long Term Investments $1428000000$1072000000 $673000000

Property Plant and Equipment $11982000000$14323000000 $9133000000

Goodwill $9133000000$6003000000 $1328000000

Intangible Assets $674000000$821000000 $117000000

Accumulated Amortization NANA NA

Other Assets NANA NA

Deferred Long Term Asset Charges $1746000000$1894000000 $1015000000

Total Assets $28355000000$31691000000 $17066000000

In 2001 and 2000 Alcoa [Aluminum Company of America] had$28355000000 and $31691000000 in assets respectivelymeaning there were average assets of $30023000000 [$28355billion + $31691 billion divided by 2 = $30023 billion] In 2001the company generated revenue of $22859000000 When appliedto the asset turn formula we find that Alcoa had a turn rate of76138 That tells you that for every $1 in assets Alcoa ownedduring 2001 it sold $76 worth of goods and services

$22859000000 revenue---------(divided by) ---------

$30023000000 average assets for period

There are several general rules that should be kept in mind whencalculating asset turnover First asset turnover is meant to measurea companyrsquos efficiency in using its assets The higher the numberthe better [although investors must be sure compare a business toits industry It is fallacy to compare completely unrelatedbusinesses] The higher a companys asset turnover the lower itsprofit margin tends to be [and visa versa]

Return on AssetsWhere asset turnover tells an investor the total sales for each $1 ofassets return on assets [or ROA for short] tells an investor how



much profit a company generated for each $1 in assets The returnon assets figure is also a sure-fire way to gauge the asset intensityof a business Companies such as telecommunication providers carmanufacturers and railroads are very asset-intensive meaning theyrequire big expensive machinery or equipment to generate a profitAdvertising agencies and software companies on the other handare generally very asset-light (in the case of a software companiesonce a program has been developed employees simply copy it to afive-cent disk throw an instruction manual in the box and mail itout to stores)

Return on assets measures a companyrsquos earnings in relation to all ofthe resources it had at its disposal [the shareholdersrsquo capital plusshort and long-term borrowed funds] Thus it is the most stringentand excessive test of return to shareholders If a company has nodebt it the return on assets and return on equity figures will be thesame

There are two acceptable ways to calculate return on assets

Option 1Net Profit Margin x Asset Turnover

Option 2Net income

-----------(divided by) -----------Average Assets for the Period

The lower the profit per dollar of assets the more asset-intensive abusiness is The higher the profit per dollar of assets the less asset-intensive a business is All things being equal the more asset-intensive a business the more money must be reinvested into it tocontinue generating earnings This is a bad thing If a company hasa ROA of 20 it means that the company earned $020 for each $1in assets As a general rule anything below 5 is very asset-heavy[manufacturing railroads] anything above 20 is asset-light[advertising firms software companies]



Johnson Controls2001 Income Statement Excerpt

Period Ending Sep 30 2001 Sep 30 2000 Sep 30 1999

Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000

Preferred Stock and Other Adjustments ($8800000)($9800000) ($13000000)

Net Income Applicable to Common Shares $469500000 $462600000 $406600000

Johnson Controls2001 Balance Sheet Excerpt

20012000

1999

Long Term Assets

Long Term Investments $300500000 $254700000 $254700000

Property Plant and Equipment $2379800000 $2305000000 $1996000000

Goodwill $2247300000 $2133300000 $2096900000

Intangible Assets NA NA NA


Other Assets $439900000 $457800000 $457700000

Deferred Long Term Asset Charges NA NA NA

Total Assets $9911500000 $9428000000 $8614200000

Total Stockholder Equity $2985400000 $2576100000 $2270000000

Net Tangible Assets $738100000 $442800000 $173100000

The first option requires that we calculate net profit margin andasset turnover In most of your analyses you will have already



calculated these figures by the time you get around to return onassets For illustrative purposes wersquoll go through the entire processusing Johnson Controls as our sample business

Our first step is to calculate the net profit margin We divide$469500000 [the net income] by the total revenue of$18427200000 We come up with 0025 (or 25)

We now need to calculate asset turnover We average the$9911500000 total assets from 2001 and $9428000000 totalassets from 2000 together and come up with $9669750000average assets for the one-year period we are studying Divide thetotal revenue of $18427200000 by the average assets of$9660750000 The answer 190 is the total number of assetturns We now have both of the components of the equation tocalculate return on assets

025 [net profit margin] x 190[asset turn] = 00475 or 475return on assets

The second option for calculating ROA is much shorter Simply takethe net income of $469500000 divided by the average assets forthe period of $9660750000 You should come out with 004859 or485 [Note You may wonder why the ROA is different dependingon which of the two equations you used The first longer optioncame out to 475 while the second was 485 The difference isdue to the imprecision of our calculation we truncated the decimalplaces For example we came up with asset turns of 190 when inreality the asset turns were 1905654231 If you opt to use the firstexample it is good practice to carry out the decimal as far aspossible

Is a 475 ROA good for Johnson Controls A little research on MSNMoney Central shows that the average ROA for Johnsonrsquos industry is15 It appears Johnsonrsquos management is doing a much better jobthan the competitors This should be welcome news to investors



Projecting Future EarningsWe will save most of the discussion on future earnings for our laterlesson focusing exclusively on valuing a business As a caveat letrsquoscover some of the basic principles

1 The greatest indicator of the future is the past If a company hasgrown at 4 for the past ten years it is very unlikely it will startgrowing 6-7 in the future [short of some major catalysts] Youmust remember this and guard against optimism Your financialprojections should be slightly pessimistic at worst outrightdepressing at best Being masochistic in finance can be veryprofitable Itrsquos always the Pollyannarsquos that get creamed

2 Companies involved in cyclical industries such as steelconstruction and auto manufacturers are notorious for posting $5EPS one year and -$250 the next An investor must be careful notto base projections off the current year alone He she would bebest served by averaging the earnings over the past tens years andbasing coming up with a valuation based on that figure For moreinformation read Valuing Cyclical Stocks Assigning Intrinsic Valueto Businesses with Unsteady Earnings

Formulas Calculations and Ratios for the Income StatementYoursquove learned how to analyze an income statement In segmenttwo we are going to look at the income statements for threecompanies in the SampP 500 Below is a list of the equations we havecovered in this lesson You should memorize them as soon aspossible

Gross Margin gross profit divide revenueRampD to Sales RampD expense divide revenueOperating Margin operating income divide revenue [also known asoperating profit margin]Interest coverage ratio EBIT divide interest expenseNet Profit Margin net income [after taxes] divide revenueReturn on Equity (ROE) net profit divide average shareholder equity for



the periodAsset Turnover revenue divide average assets for periodReturn on Assets Net profit margin asset turnover or net incomedivide total average assets for the periodWorking Capital per Dollar of Sales Working Capital divide Total SalesReceivable Turnover Net Credit Sales divide Average Net Receivables

for the PeriodInventory Turnover Cost of Goods Sold divide Average Inventory for

the Period

These calculations were discussed in Investing Lesson 3 Analyzinga Balance Sheet They require both the balance sheet and theincome statement to calculate

Putting it all TogetherAt this point you should have the ability to understand the mostcommon entries on the income statement calculate and comparegross operating and profit margins examine depreciation policiesand put competitors in the same industry on a comparable basiscalculate ROE ROA and asset turnover have a respectableunderstanding of how businesses account for minority-owned stakesin other companies explain the difference between basic anddiluted earnings-per-share appreciate share repurchase programswhen stock prices are falling despise share dilution be able toexplain what ldquounderwaterrdquo options are and discuss why EBITDA is aworthless metric Congratulations I hope you feel it was time wellspent Although there is always more to learn you are further aheadthan a majority of people who own stocks mutual funds or bonds

In the future it may help to think of the income statement asfollowing this general outlineRevenue ndash Cost of Revenue = Gross ProfitGross Profit ndash All Operating Expenses = Operating ProfitOperating Profit ndash Interest Expense Income Taxes andDepreciation = Net Income fromContinuing Operations

11

1

1



Net Income from Continuing Operations ndash Nonrecurring events[extraordinary items discontinuedoperations etc] = net incomeNet income ndash preferred stock and other adjustments = net incomeapplicable to common shares

Abercrombie and Fitch - 2001 Annual Income StatementNow that you have come this far we are going to analyze threeincome statements First on our list is Abercrombie and Fitch aspecialty clothing retailer that has made a name for itself by sellingthe college experience As of February 2 2002 the companyoperated a total of 491 stores [309 Abercrombie amp Fitch stores 148abercrombie stores [tailored to a younger audience] and 34Hollister Co stores] Notice that Ive included a copy of the balancesheet so we can calculate return on equity return on assets etc All financials are taken from the companys 2001 annual reportpages 19 and 20

Abercrombie amp FitchConsolidated Statements of Income

(Thousands except per share amounts)

Fiscal year ended 20012000

1999

Net Sales $1364853$1237604

$1030858

Cost of Goods Sold Occupancy and Buying Costs 806816728229

580475

Gross Income 558034509375

450383

General Administrative and Store OperatingExpense

286576255723

209319

Operating Income 271458253652

242064

Interest Income Net (5064)(7801)

(7270)

Income Before Income Taxes 276522261453

249334

Provision for Income Taxes 107850103320

99730



Net Income $168672$158133

$149604

Net Income Per Share

Basic $170$158

$145

Diluted $165$155

$139

The accompanying Notes are an integral part of these ConsolidatedFinancial Statements

Abercrombie amp FitchConsolidated Balance Sheets

(Thousands)

February 2 2002February 3 2001

Assets

Current Assets Cash and Equivalents $167664 $137581Marketable Securities 71220 -Receivables 20456 15829Inventories 108876 120997Store Supplies 21524 17817Other 15455 11338Total Current Assets 405195 303562Property and Equipment Net 365112 278785Deferred Income Taxes - 6849Other Assets 239 381Total Assets $770546 $589577 Liabilities and Shareholders Equity Current Liabilities Accounts Payable $31897 $33942Accrued Expenses 109586 101302Income Taxes Payable 22096 21379Total Current Liabilities 163579 156623Deferred Income Taxes 1165 -Other Long-Term Liabilities 10368 10254Shareholders Equity Common Stock - $01 par value 1033 1033Paid-In Capital 141394 136490Retained Earnings 519540 350868 661967 488391Less Treasury Stock at Average Cost (66533) (65691)Total Shareholders Equity 595434 422700Total Liabilities and Shareholders Equity 770546 589577




Gross MarginThe first thing we do is calculate the companys gross margin Taking the gross profit of $558034 and dividing it by $1364853we come up with 40996 or almost 41 Applying the samecalculation to previous years we find that in 2002 companys grossmargin was 412 compared with 437 in 1999 As a potentialowner of the business you want to find out why the gross margin isfalling and if the trend is expected to continue If the industry ishit hard by economic conditions calculate the gross margins overthe past three years for Abercrombies competitors [such as PacificSunwear Gap or American Eagle] to see if they are experiencingthe same problem

Operating MarginWe calculate the operating margin as 199 during 2001 205 in2000 and 235 in 1999

Interest Coverage RatioYou will notice that the interest income is recorded as net If youthink back to the lesson you should remember that this means thetotal interest expense and interest income were added together tooffset one another and the resulting figure recorded InAbercrombies case the company recorded -5064 in interest

Using this information to calculate the interest coverage ratio wetake the earnings before interest and taxes [EBIT] of $271458 anddivide it by the total interest expense of $5064 The answer is5360 What does this mean The company can afford to make itsinterest payments 53+ times Obviously it is going to have noproblem making its relatively miniscule payments

Net Profit MarginIn 2001 Abercrombie had a profit margin of 124 In 2000 theprofit margin was 128 while in 1999 it stood at 145 Onceagain this doesnt mean much unless you compare it to the profitmargins of competitors Even then it may be inaccurate because of



pricing strategy [for instance Neiman Marcus may have a slightlyhigher profit margin than Wal-Mart but that is because of the tworetailers have different pricing strategies and business models]

Return on Equity - ROEHeres where we get to the juice To quickly calculateAbercrombies return on equity take the average shareholdersequity [$595434+422700 divide 2] of $509067 and divide it into thenet profit of $168672 The answer 3313 or 3313 is the returnthat management is earning on the retained profits Obviouslyyour pocketbook will be much faster enriched if you allow thecompany to retain all of the profits instead of paying them out asdividends [can you reinvest the earnings at 33 Probably not]

If both Abercrombie and a competitor were selling for ridiculouslycheap [say 3 times earnings] you would want to go with thebusiness that was generating the highest return on shareholderequity Considering the average corporation earns between 10 and15 on its equity Abercrombies high ROE should make your mouthwater

Asset TurnoverTaking Abercrombies average assets of $6800615[$770546+$589577 divide 2] and dividing it into the total revenue of$1364853 we find the company has an asset turn of 20 Thereare several general rules that should be kept in mind whencalculating asset turnover First asset turn is meant to measure acompanyrsquos efficiency in using its assets The higher the number thebetter [although investors must be sure compare a business to itsindustry It is fallacy to compare completely unrelated businesses]The higher a companys asset turnover the lower its profit margintends to be [and visa versa]

Return on AssetsMultiplying the 124 net profit margin by the 20 asset turn weget 248 or 248 return on assets Using the second formula we



divide the net income of $168672 by the $6800615 averageassets which we discover is 248 or 248

Share dilutionAs a conservative investor you should base your valuation on thediluted earnings per share Unfortunately if you remember back toour discussion on share dilution you havent forgotten theclandestine tactics Abercrombie took by not including all possiblestock option dilution in the diluted EPS figure

From Abercrombie amp Fitchrsquos 10K


If you believe that Abercrombie is undervalued at the currentmarket price and therefore expect the stock to rise some of theseunderwater options may become exercisable reducing the EPS evenfurther You would be wise to make a provision for these in yourvaluation [for instance if you take the net income of $168672000and divide it by the diluted EPS of $165 you can see thatmanagement estimates the possibility of a total of 102225454+shares outstanding You may want to add the 5630000underwater shares to this figure making the fully dilutedoutstanding shares stand at around 107855454 Now taking thenet income of $168672000 and dividing it by the true fully dilutedfigure you would get diluted EPS of $156 instead of $165]

Although there is a possibility of these shares not being exercisedpracticed conservatism can make a big difference to yourpocketbook over time

Final Thoughts on the Company



A quick look at the income statement shows that sales gross profitoperating profit and the basic and diluted EPS have increasedsteadily for the past few years even though the gross operatingand profit margins have fallen slightly These factors combinedwith the high return on shareholders equity should leave aninvestor fully satisfied with the business Management has clearlycreated shareholder value by increasing the amount of equity on thebalance sheet and reinvesting profits at a high rate of return If thecompanys shares were to ever trade low enough an enterprisinginvestor should have no problem holding Abercrombie in theirportfolio if the current conditions persists

Brown SafetyBrown Safety [a fictional company] is the manufacturer of safetyproducts such as chemical goggles fire extinguishers safety ropesand scaffolding for construction jobs In 2001 the companyreported record EPS of $279 up from just $003 the year before

Brown SafetyConsolidated Statements of Income



1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000

Interest Income Net 00

0

Income from Continuing Operations BeforeIncome Taxes

15004000

9000



Investment Income $350000 0 0

Provision for Income Taxes 70510 600 1350

Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008

The accompanying Notes are an integral part of these ConsolidatedFinancial Statements100000 shares outstanding

Those of you who looked closely at Browns income statement mayhave caught on to my trick Excellent job If you didnt let meexplain

Deteriorating Core OperationsIn 1999 Brown had a 3825 profit margin In 2000 Brown had a340 profit margin In 2002 Brown had a 255 profit margin Dont believe me Look close at the income statement You willsee that each year the total profit and revenues have been cut inhalf while SGampA expenses remained at a steady $1000 [whichcaused the decreasing profit margin] In the most recent yearBrown only made $1500 pre-tax from its continuing operations Assuming a 15 tax rate the net profit would have worked out to$1275 had it not been for investment income

In the most recent year Brown realized $350000 in investmentincome Without this one-time boost to earnings the companywould have reported EPS of just over $001 To drive home whatthese means assume Brown is trading at $5 per share [any numberwill do this is solely for illustrative purposes] A well-meaning butless-than-astute investor may scan the stock tables one morningand see that Brown is trading at a a pe ratio of 18 [$5 per share divide



$279 EPS] He gets excited throws up his hands and calls hisbroker to buy as many shares as possible At this rate hed beearning 558 on his investment

Unfortunately in a year or so the investor will have a veryunpleasant surprise If the current decline in the core businesspersists the company will report earnings of $0005 [thats half apenny] per share This makes the pe ratio 1000 Instead of a558 return on his investment in 2002 the shareholder will earn apathetic 001 He is going to lose a major portion if not all of hisinvestment unless the business has a large portfolio of stocks andbonds that it can distribute to shareholders or continue selling forcash [as was the case of the Northern Pipe Line an oiltransportation company managed by the Rockefellers The stockwas trading at $65 per share when Benjamin Graham studied thebalance sheet and realized the company had bond holdings worth$95 for each share The value investor tried to convincemanagement to sell the portfolio off but they refused Shortlythereafter he waged a proxy war and secured a spot on the Boardof Directors The company sold its bonds off and paid a dividend inthe amount of $70 per share]

The MoralWhy the over-simplified example There will come a day when youare analyzing a business and on the surface it will seem thatearnings are increasing and management is doing a splendid job Upon closer examination you may find that the core business isactually losing money and all of the reported profits come fromone-time events such as the sale of a business unit real estateintellectual property marketable securities or any other number ofassets Unless you are buying a company because you believe itsliquidation value is higher than its current market price you couldbe in for a rude awakening when management suddenly doesnthave anything left to sell or the losses in the core business havespiraled out of control





begin working through it In the end I think yoursquoll be surprised byhow much yoursquove learned As always there will be quiz followingthe lesson you should be able to pass without missing more thantwo questions

Below is a sample income statement taken from Walt Disneyrsquos 2001annual report

Itrsquos important to note that not all income statements look alikealthough they necessarily contain much of the same information Aswe work our way through various income statements you willinevitably find they are much simpler and comparable than mayappear at first glance

Total Revenue or Total SalesThe first line on any income statement is an entry called total







9 2001 Annual Report



Net Revenues

Retail $2229594 $1823607

Specialty 419386 354007
















Total Revenue






Cost of Sales $243125 $189000

Gross Profit $162084 $126000















































Total revenue













Interest Expense




















































Straight Line$1600

$1600 $1600



Sum of the Years $2400 $159984 $80016


$1600 $0






























$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008


















Page 29 2001 Annual Report



Net Revenues

Retail $2229594 $1823607

Specialty 419386 354007
















Total Revenue






Cost of Sales $243125 $189000

Gross Profit $162084 $126000















































Total revenue













Interest Expense




















































Straight Line$1600

$1600 $1600



Sum of the Years $2400 $159984 $80016


$1600 $0






























$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008

























Total Revenue






Cost of Sales $243125 $189000

Gross Profit $162084 $126000















































Total revenue













Interest Expense




















































Straight Line$1600

$1600 $1600



Sum of the Years $2400 $159984 $80016


$1600 $0






























$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008























































Total revenue













Interest Expense




















































Straight Line$1600

$1600 $1600



Sum of the Years $2400 $159984 $80016


$1600 $0






























$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008



















Interest Expense




















































Straight Line$1600

$1600 $1600



Sum of the Years $2400 $159984 $80016


$1600 $0






























$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008





























































Straight Line$1600

$1600 $1600



Sum of the Years $2400 $159984 $80016


$1600 $0






























$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008














Sum of the Years $2400 $159984 $80016


$1600 $0






























$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008




































$ 0 $ 50000 15 50000 75000 25 75000 100000 34 100000 335000 39 335000 10000000 34



10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008














10000000 15000000 35 15000000 18333333 38 18333333 35










































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008
















































Revenue


Revenue









$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008



















$500000 revenue
















Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008

























Basic $19 $157

Diluted $19 $151



































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008












































































Asset Turnover





Total Revenue $22859000000$23090000000 $16447000000

Cost Of Revenue $17857000000$17342000000 $12536000000

Gross Profit $5002000000$5748000000 $3911000000


20012000

1999

Long Term Assets





Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008
















Goodwill $9133000000$6003000000 $1328000000





Total Assets $28355000000$31691000000 $17066000000












Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008


















Option 2Net income







Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008
















Total Revenue $18427200000 $17154600000$16139400000

Cost Of Revenue $478300000 $472400000 $419600000




20012000

1999

Long Term Assets



Goodwill $2247300000 $2133300000 $2096900000



Other Assets $439900000 $457800000 $457700000


Total Assets $9911500000 $9428000000 $8614200000























the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008































the Period




11

1

1








1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008



















1999

Net Sales $1364853$1237604

$1030858


580475


450383


286576255723

209319


242064


(7270)


249334


99730



Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008














Net Income $168672$158133

$149604


Basic $170$158

$145

Diluted $165$155

$139



(Thousands)


Assets

































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008










































1999

Net Sales $5000$10000

$20000


10000


10000


10001000

1000


9000


0


15004000

9000





Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008
















Net Income $279490 3400 7650


Basic $279 $003 $008

Diluted $279 $003 $008














investing lesson 4 - printable version

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