This document provides an overview and table of contents for the book "Financial Statement Analysis and Security Valuation" by Stephen H. Penman. The book covers topics such as investment styles, fundamental analysis, the analysis of financial statements, valuation techniques, and applying analysis to active investing. It contains 12 chapters organized into two parts. Part one covers financial statements and valuation approaches like discounted cash flow valuation and residual earnings valuation. Part two focuses on analyzing specific financial statements such as the balance sheet, income statement, statement of cash flows, and statement of shareholders' equity. The book provides tools and frameworks for students and analysts to evaluate businesses and value securities.
This document provides an overview and table of contents for the book "Financial Statement Analysis and Security Valuation" by Stephen H. Penman. The book covers topics such as investment styles, fundamental analysis, the analysis of financial statements, valuation techniques, and applying analysis to active investing. It contains 12 chapters organized into two parts. Part one covers financial statements and valuation approaches like discounted cash flow valuation and residual earnings valuation. Part two focuses on analyzing specific financial statements such as the balance sheet, income statement, statement of cash flows, and statement of shareholders' equity. The book provides tools and frameworks for students and analysts to evaluate businesses and value securities.
This document provides an overview and table of contents for the book "Financial Statement Analysis and Security Valuation" by Stephen H. Penman. The book covers topics such as investment styles, fundamental analysis, the analysis of financial statements, valuation techniques, and applying analysis to active investing. It contains 12 chapters organized into two parts. Part one covers financial statements and valuation approaches like discounted cash flow valuation and residual earnings valuation. Part two focuses on analyzing specific financial statements such as the balance sheet, income statement, statement of cash flows, and statement of shareholders' equity. The book provides tools and frameworks for students and analysts to evaluate businesses and value securities.
This document provides an overview and table of contents for the book "Financial Statement Analysis and Security Valuation" by Stephen H. Penman. The book covers topics such as investment styles, fundamental analysis, the analysis of financial statements, valuation techniques, and applying analysis to active investing. It contains 12 chapters organized into two parts. Part one covers financial statements and valuation approaches like discounted cash flow valuation and residual earnings valuation. Part two focuses on analyzing specific financial statements such as the balance sheet, income statement, statement of cash flows, and statement of shareholders' equity. The book provides tools and frameworks for students and analysts to evaluate businesses and value securities.
Contents List of Cases xxv List of Accounting Clinics xxvi Chapter 1
Introduction to Investing and Valuation 2
Investment Styles and Fundamental Analysis Bubble, Bubble, Toil, and Trouble 6 How Bubbles Work 7 Analysts During the Bubble 8 More Toil and Trouble 8 Fundamental Analysis Anchors Investors
Measurement in the Financial Statements
The Setting: Investors, Firms, Securities,
and Capital Markets 10 The Business of Analysis: The Professional Analyst 12 Investing in Firms: The Outside Analyst 12 Investing Within Firms: The Inside Analyst 13
The Analysis of Business
14
Strategy and Valuation 15
Mastering the Details 16 The Key Question: Sustainability of Competitive Advantage 17 Financial Statements: The Lens on the Business 17
Choosing a Valuation Technology
18
Guiding Principles 18 Anchoring Value on the Financial Statements 20
How to Use This Book
21
An Outline of the Book
The Income Statement 36
The Cash Flow Statement 40 The Statement of Shareholders 'Equity 40 The Footnotes and Supplementary Information to Financial Statements 41 The Articulation of the Financial Statements: How the Statements Tell a Story 42
Summary 55 The Web Connection 55 Key Concepts 56 The Analyst's Toolkit 57 A Continuing Case: Kimberly-Clark Corporation 57 Concept Questions 63 Exercises 63 Minicase 69
PART ONE FINANCIAL STATEMENTS AND VALUATION 72 Chapter 3
The Analyst's Checklist 33 The Form of the Financial Statements Introducing Nike, Inc. 34 The Balance Sheet 34
xviii
44
The Price-to-Book Ratio 44
Measurement in the Balance Sheet 46 Measurement in the Income Statement 46 The Price-Earnings Ratio 50 Accounting as an Anchor: Don't Mix What You Know with Speculation 51 Tension in Accounting 53 Accounting Quality 54
34
The Analyst's Checklist
Multiple Analysis 76
75
The Method of Comparables 76
Screening on Multiples 79
The Process of Fundamental Analysis 85
Financial Statement Analysis, Pro Forma Analysis, and Fundamental Analysis 86
The Architecture of Fundamental Analysis:
The Valuation Model 87
Contents
Terminal Investments and Going-Concern
Investments 88 Valuation Models for Terminal Investments 89 Valuation Models for Going-Concern Investments 91 Criteria for a Practical Valuation Model 91 What Generates Value? 92 Valuation Models, the Required Return, and Asset Pricing Models 96
Summary 97 The Web Connection 97 Key Concepts 98 The Analyst's Toolkit 99 A Continuing Case: Kimberly-Clark Corporation 99 Concept Questions 100 Exercises 101 Minicases 104 Appendix The Required Return and Asset Pricing Models 106
Chapter 4
Cash Accounting, Accrual Accounting,
and Discounted Cash Flow Valuation 110 The Analyst's Checklist 111 The Dividend Discount Model 111 The Discounted Cash Flow Model 114 Free Cash Flow and Value Added
The Statement of Cash Flows
117
119
The Cash Flow Statement under IFRS
Forecasting Free Cash Flows 123
122
Cash Flow, Earnings, and Accrual Accounting
124
Earnings and Cash Flows 124
Accruals, Investments, and the Balance Sheet 127
Summary 129 The Web Connection 129 Key Concepts 130 The Analyst's Toolkit 130 A Continuing Case: Kimberly-Clark Corporation 131 Concept Questions 131 Exercises 132 Minicase 138
Chapter 5
142
Valuing a Project 142
Valuing a Savings Account 143 The Normal Price-to-Book Ratio 144
A Model for Anchoring Value on Book Value
145
Residual Earnings Drivers
and Value Creation 147 A Simple Demonstration and a Simple Valuation Model 150
Applying the Model to Equities
151
The Forecast Horizon and the
Continuing Value Calculation 152 Beware of Paying Too Much for Growth 155 Converting Analysts' Forecasts to a Valuation 156
Build Your Own Valuation Engine 157
Applying the Model to Projects and Strategies 159 Features of the Residual Earnings Valuation 161 Book Value Captures Value and Residual Earnings Captures Value Added to Book Value 161 Protection from Paying Too Much for Earnings Generated by Investment 162 Protection from Paying Too Much for Earnings Created by the Accounting 163 Capturing Value Not on the Balance Sheetfor All Accounting Methods 164 Residual Earnings Are Not Affected by Dividends, Share Issues, or Share Repurchases 165 What the Residual Earnings Model Misses 165
Pricing Earnings 178 The Analyst's Checklist 179 The Concept Behind the Price-Earnings Ratio
Accrual Accounting and Valuation:
Pricing Book Values 140 The Analyst's Checklist 141 The Concept Behind the Price-to-Book Ratio
Prototype Valuations
xix
Beware of Paying Too Much for Earnings
Growth 180 From Price-to-Book Valuation to P/E Valuation 180
179
XX
Contents
Prototype Valuation
181
A Continuing Case: Kimberly-Clark Corporation 223
Concept Questions 224 Exercises 225 Minicases 229
The Normal Forward P/E Ratio 183
The Normal Trailing P/E Ratio 184 A Poor P/E Model 185
A Model for Anchoring Value on Earnings
185
Measuring Abnormal Earnings Growth 187
A Simple Demonstration and a Simple Valuation Model 188 Anchoring Valuation on Current Earnings 189
Applying the Model to Equities
190
Converting Analysts 'Forecasts
to a Valuation 191
Chapter 8
Viewing the Business Through
the Financial Statements 234
Build Your Own Valuation Engine 192
Features of the Abnormal Earnings Growth Model 194 Buy Earnings 195 Abnormal Earnings Growth Valuation and Residual Earnings Valuation 195 Abnormal Earnings Growth Is Not Affected by Dividends, Share Issues, or Share Repurchases 196 Accounting Methods and Valuation 196
The Fed Model 197
PEG Ratios 199 Summary 200 The Web Connection 201 Key Concepts 201 The Analyst's Toolkit 201 A Continuing Case: Kimberly-Clark Corporation 202 Concept Questions 202 Exercises 203 Minicase 208
Chapter 7
Valuation and Active Investing 210
The Analyst's Checklist 211 ' How .the Fundamental Investor Operates /
211
Common Misconceptions About Valuation 211
Applying Fundamental Principles 213
Challenging Speculation in the Market Price
Reverse Engineering the S&P 500 215 Challenging the Price of a Stock 218 Reverse Engineering with the Abnormal Earnings Growth Model 221
Build Your Own Active Investing Tool
The Web Connection 222 Summary 222 Key Concepts 223 The Analyst's Toolkit 223
PART TWO THE ANALYSIS OF FINANCIAL STATEMENTS 232
222
213
The Analyst's Checklist 23 5
Business Activities: The Cash Flows
236
The Reformulated Cash Flow Statement
The Reformulated Balance Sheet 241
Business Activities: All Stocks and Flows
The Reformulated Income Statement
240
242 243
Accounting Relations That Govern
Reformulated Statements 243 The Sources of Free Cash Flow and the Disposition of Free Cash Flow 244 The Drivers of Dividends 244 The Drivers of Net Operating Assets and Net Indebtedness 245
Tying It Together for Shareholders:
What Generates Value? 246 Build Your Own Analysis Engine 248 Summary 250 The Web Connection 250 Key Concepts 251 The Analyst's Toolkit 251 A Continuing Case: Kimberly-Clark Corporation 252 Concept Questions 252 , Exercises 253
Chapter 9
The Analysis of the Statement
of Shareholders'Equity 258
The Analyst's Checklist 259
Reformulating the Statement of Owners' Equity Running with Nike 260 Reformulation Procedures
Dirty-Surplus Accounting
260
263
Comprehensive Income Reporting
Under U.S. GAAP andIFRS 265
259
Contents
Ratio Analysis
266
Chapter 11
Payout and Retention Ratios 266
Shareholder Profitability 267 Growth Ratios 267
Hidden Dirty Surplus
xxi
The Analysis of the Cash Flow Statement 342
268
Issue of Shares in Operations 268
Issue of Shares in Financing Activities 272 Handling Diluted Earnings per Share 2 72 Share Transactions in Inefficient Markets 274
The Eye of the Shareholder 275
Build Your Own Analysis Engine 276 Accounting Quality Watch 276 The Web Connection 278 Summary 278 Key Concepts 278 The Analyst's Toolkit 279 A Continuing Case: Kimberly-Clark Corporation 280 Concept Questions 281 Exercises 282 Minicase 288
The Analyst's Checklist 343
The Calculation of Free Cash Flow 343 GAAP Statement of Cash Flows and Reformulated Cash Flow Statements
345
Reclassifying Cash Transactions 346
Tying It Together 351
Cash Flow from Operations 353
Summary 355 The Web Connection 355 Key Concepts 356 The Analyst's Toolkit 356 A Continuing Case: Kimberly-Clark Corporation 356 Concept Questions 357 Exercises 357 Minicase 362
Chapter 12
The Analysis of Profitability 364
The Analyst's Checklist 365 The Analysis of Return on Common Equity 365 First-Level Breakdown: Distinguishing Financing and Operating Activities and the Effect of Leverage 366
Chapter 10
The Analysis of the Balance
Sheet and Income Statement
292
The Analyst's Checklist 293
Reformulation of the Balance Sheet
293
Issues in Reformulating Balance Sheets
Strategic Balance Sheets 301
Reformulation of the Income Statement
294
303
Tax Allocation 304
Issues in Reformulating Income Statements 308 Value Added to Strategic Balance Sheets Residual Income from Operations 312
312
Comparative Analysis of the Balance Sheet
and Income Statement 314 Common-Size Analysis Trend Analysis 316
315
Ratio Analysis 318
Build Your Own Analysis Engine 321 Summary 321 The Web Connection 322 Key Concepts 322 The Analyst's Toolkit 323 A Continuing Case: Kimberly-Clark Corporation 324 Concept Questions 325 Exercises 325 Minicases 334
Financial Leverage 366
Operating Liability Leverage 368 Summing Financial Leverage and Operating Liability Leverage Effects on Shareholder Profitability 370 Return on Net Operating Assets and Return on Assets 3 71 Financial Leverage and Debt-to-Equity Ratios 373
The Web Connection 382 Summary 382 Key Concepts 382 The Analyst's Toolkit 383 A Continuing Case: Kimberly-Clark Corporation 383 Concept Questions 384
xxii Contents
Exercises 385 Minicase 391
A Modification to Residual Earnings Forecasting:
Residual Operating Income 438
Chapter 13 The Analysis of Growth and Sustainable Earnings 392
A Modification to Abnormal Earnings
Growth Forecasting: Abnormal Growth in Operating Income 443
The Drivers of Residual Operating Income
The Analyst's Checklist
What Is Growth? 393
Abnormal Growth in Operating Income and
the "Dividend" from Operating Activities 443 Eye on the Future: Sustainable Income 445
393
The Cost of Capital and Valuation
Warnings About Growth 394
Cutting to the Core: Sustainable Earnings
396
Core Operating Income 396
Issues in Identifying Core Operating Income 397 Core Operating Profitability 404 Core Borrowing Cost 406
Analysis of Growth
407
Growth Through Profitability 407
Operating Leverage 408 Analysis of Changes in Financing 409 Analysis of Growth in Shareholders' Equity 409
Growth, Sustainable Earnings, and the Evaluation
of P/B Ratios and P/E Ratios 411 How Price-to-Book Ratios and Trailing P/E Ratios Articulate 411 Trailing Price-Earnings Ratios and Transitory Earnings 414 P/E Ratios and the Analysis of Sustainable Earnings 416 Price-to-Book and Growth 416
Summary 417 The Web Connection 417 Key Concepts 418 The Analyst's Toolkit 419 A Continuing Case: Kimberly-Clark Corporation 419 Concept Questions 420 Exercises 421 Minicases 425
PART THREE FORECASTING AND VALUATION ANALYSIS 434 Chapter 14 The Value of Operations and the Evaluation of Enterprise Price-to-Book Ratios and Price-Earnings Ratios 436 The Analyst's Checklist
437
441
445
The Cost of Capital for Operations 446
The Cost of Capital for Debt 44 7 Operating Risk, Financing Risk, and the Cost of Equity Capital 448
Financing Risk and Return and the
Valuation of Equity 450 Leverage and Residual Earnings Valuation 450 Leverage and Abnormal Earnings Growth Valuation 451 Leverage Creates Earnings Growth 456 Debt and Taxes 459
Mark-to-Market Accounting: A Tool for
Incorporating the Liability for Stock Options in Valuation 461 Enterprise Multiples 463 Enterprise Price-to-Book Ratios 463 Enterprise Price-Earnings Ratios 465
Summary 468 The Web Connection 468 Key Concepts 469 The Analyst's Toolkit 469 A Continuing Case: Kimberly-Clark Corporation 470 Concept Questions 471 Exercises 472 Minicase 477
Chapter 15 Anchoring on the Financial Statements: Simple Forecasting and Simple Valuation 480 The Analyst's Checklist 481 Simple Forecasts and Simple Valuations
482
Introducing PPE, Inc. 482
The No-Growth Forecast and Valuation 483 The Growth Forecast and Valuation 484
Simple Forecasting: Adding information to
Financial Statement Information 488 Weighed-Average Forecasts of Growth 488
Contents
Simple Valuations with Short-Term
and Long-Term Growth Rates 488 Growth in Sales as a Simple Forecast of Growth 489 Information in Analysts'Forecasts 490
Simple Valuation as an Analysis Tool
PART FOUR
ACCOUNTING ANALYSIS AND VALUATION 552 Chapter 17
491
Creating Accounting Value and
Economic Value 554
Sensitivity Analysis 491
Reverse Engineering to Challenge the Market Price 491
Summary 492 The Web Connection 493 Key Concepts 493 The Analyst's Toolkit 493 A Continuing Case: Kimberly-Clark Corporation 494 Concept Questions 494 Exercises 494 Minicases 500
Chapter 16
Full-Information Forecasting, Valuation,
and Business Strategy Analysis 504 The Analyst's Checklist 505 Financial Statement Analysis: Focusing the Lens on the Business 505 1. Focus on Residual Operating Income and Its Drivers 506 2. Focus on Change 507 3. Focus on Key Drivers 514 . 4. Focus on Choices Versus Conditions 515
Full-Information Forecasting and
Pro Forma Analysis 515
Mergers and Acquisitions 527
Share Repurchases and Buyouts
The Analyst's Checklist 555
Value Creation and the Creation of Residual Earnings 555 Accounting Methods, Price-to-Book Ratios, Price-Earnings Ratios, and the Valuation of Going Concerns 558 Accounting Methods with a Constant Level of Investment 558 Accounting Methods with a Changing Level of Investment 561 An Exception: LIFO Accounting 565
Hidden Reserves and the Creation of Earnings
Conservative and Liberal Accounting in Practice 570 LIFO Versus FIFO 571 Research and Development in the Pharmaceuticals Industry 572 Expensing Goodwill and Research and Development Expenditures 573 Liberal Accounting: Breweries and Hotels Profitability in the 1990s 574 Economic- Value-Added Measures 5 75
Accounting Methods and the Forecast Horizon
A Forecasting Template 520
Features of Accounting-Based Valuation 525
Value Generated in Share Transactions
526 528
Financial Statement Indicators and Red Flags
Business Strategy Analysis and Pro Forma Analysis 530
Discounted Cash Flow Analysis 576 Growth, Risk, and Valuation 577
Summary 578 The Web Connection 579 Key Concepts 579 The Analyst's Toolkit 5 80 Concept Questions 580 Exercises 581 Minicase 586
Chapter 18
Analysis of the Quality
of Financial Statements 590 The Analyst's Checklist 591 What Is Accounting Quality? 591 Accounting Quality Watch 592 Five Questions About Accounting Quality
593
xxiv
Contents
Cutting Through the Accounting:
Detecting Income Shifting 594 Separating What We Know from Speculation 597 Prelude to a Quality Analysis 598 Quality Diagnostics 600 Diagnostics to Detect Manipulated Sales 603 Diagnostics to Detect Manipulation of Core Expenses 604 Diagnostics to Detect Manipulation of Unusual Items 612 Detecting Transaction Manipulation 614 Core Revenue Timing 614 Core Revenue Structuring 614 Core Expense Timing 615 Releasing Hidden Reserves 615 Other Core Income Timing 616 Unusual Income Timing 616 Organizational Manipulation: Off-BalanceSheet Operations 616 Justifiable Manipulation? 617 Disclosure Quality 617 Quality Scoring 618 Abnormal Returns to Quality Analysis 620 Summary 621 The Web Connection 621 Key Concepts 621 The Analyst's Toolkit 622 Concept Questions 623 Exercises 624 Minicases 633
PART FIVE
THE ANALYSIS OF RISK
AND RETURN 640 Chapter 19
TheXnalysis of Equity Risk
and Return for Active Investing
642
The Analyst's Checklist 643
The Required Return and the Expected Return 643 The Nature of Risk 644 The Distribution of Returns 644 Diversification and Risk 648 Asset Pricing Models 649 Fundamental Risk 651 Risk to the Return on Common Equity 653 Growth Risk 654 Value-at-Risk Profiling 654 Adaptation Options and Growth Options 659
Strategy and Risk 660
Discounting for Risk 660 Price Risk 661 Market Inefficiency Risk 661 Liquidity Risk 664 Inferring Expected Returns for Active Investing 664 Growth-Return Profiles 666 Finessing the Required Return Problem 667 Evaluating Implied Expected Returns with Value-at-Risk Profiles 667 Investing Within Risk Classes 668 Beware of Paying for Risky Growth 668 Expected Returns in Uncertain Times 670 Summary 670 The Web Connection 671 Key Concepts 671 The Analyst's Toolkit 672 Concept Questions 672 Exercises 672 Minicase 678
Chapter 20
The Analysis of Credit Risk and Return 680
The Analyst's Checklist 681 The Suppliers of Credit 681 Financial Statement Analysis for Credit Evaluation 682 Reformulated Financial Statements 682 Short-Term Liquidity Ratios 684 Long-Term Solvency Ratios 686 Operating Ratios 687 Forecasting and Credit Analysis 687 Prelude to Forecasting: The Interpretive Background 687 Ratio Analysis and Credit-Scoring 688 Full-Information Forecasting 692 Required Return, Expected Return, and Active Debt Investing 695 Active Bond Investing 696 Liquidity Planning and Financial Strategy 696 The Web Connection 697 Summary 697
