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I. INTRODUCTION AND PURPOSE
This article illustrates a systematic approach for teaching fundamental investment analysis.
Students analyze the investment potential of a publicly traded corporation. The semester project
consists of three parts a complete ratio and DuPont analysis to determine the current financial
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position of the company, a strategic analysis to determine the major strengths and weaknesses of
the company, and a forecast of the future performance and discounted future cash flow analysis
to determine the companys intrinsic investment value.
II. THE IMPORTANCE OF HISTORIC RATIO ANALYSIS
At the core of fundamental investment analysis is the ability to calculate, analyze, and
interpret the meaning of financial ratios to determine the financial position of the firm. Ratios
are used to discern changing patterns and potential trouble spots that may arise in the future
business life of a firm. They allow the analyst to standardize key financial variables from the
balance sheet and income statement for comparison to industry averages or those of a major
competitor. The semester project requires each student to obtain financial data on his or her target firm
from the SEC website (www.sec.gov) and, using integrative Excel spreadsheets supplied by the
professor, to calculate relevant ratios in the four financial management areas liquidity, asset
utilization, employed leverage, and profitability.
III. ANALYSIS OF THE COCA COLA COMPANY
The Excel spreadsheet (Exhibit 1) is set up with logic statements to make assessments
regarding time-series trends and cross-sectional analysis. The cross-sectional analysis allows the
student to compare his/her selected company to the industry average, while the time-series
analysis allows for a trend comparison over the past three years.
Coca Colas liquidity is substandard when compared with the industry. The current ratio for
16 is below industry average. In addition, its quick ratio also indicates less liquidity than the
industry average with no discernable trend of improvement over the last three years. Therefore,
Coca Colas liquidity position could be characterized as substandard.
The activity ratios reveal a second dimension of the Coca Cola Company. These ratios
indicate the relative efficiency with which the company uses investors assets. The inventory
turnover ratio measures how rapidly the company turns over or uses dollars invested in
inventory. In the case of Coca Cola, there are positive values reported based on industry average
and cross-sectional comparisons. The inventory turnover for 16 was 7.08 in comparison to an
industry average of 5. Likewise, the three-year trend indicates a continual improvement in
inventory turnover. Other activity ratios indicate similar positive results based on both cross-
sectional and time-series analysis.
The third group of ratios deals with the use of debt in the capital structure as well as the
ability to meet interest payments from operating income. Both the total debt ratio and the debt-
to-equity ratio indicate a favorable assessment based on cross-sectional and time-series analysis.
In addition, the times-interest-earned (TIE) ratio indicates that the company covers interest
charges over 16 times. This again compares favorably to the industry average of 15 times.
The fourth category ratios deal with profitability. Coca Colas gross profit margin is clearly
superior in comparison with the industry average. It is also obvious that Coca Cola does a
superior job of cost cutting, resulting in higher operating profits when compared to the industry.
In addition, the net profit margin of 18.8 percent net return on sales compares well to only 15
percent for the industry.
Next, return on total assets also indicates favorable performance. Coca Colas 16 return
on total assets is percent compared to 16 percent for the industry. Further, the return on
equity for 16 was 57 percent, more than twice that of the industry average of percent.
The DuPont analysis for Coca Cola (Exhibit ) allows the students to consider all the parts
that affect the stockholders return on equity. The 16 return on equity of 56.7 percent is a
function of three triggers the financial manager has to control the performance of the firm the
net profit margin, total asset turnover, and the financial leverage multiplier. The strength of the
DuPont system is its ability to dissect the balance sheet and income statement and isolate
financial areas of low performance or concern. A comparison of the firms net profit margin,
total asset turnover, and financial leverage multiplier to the industry averages can pinpoint
area(s) of substandard performance that led to a low average return on equity.
Exhibit
DuPont Analysis 1
14 15 16
Return on Equity 48% 55% 57%
Net Profit Margin 16% 17% 1%
Total Asset Turnover 1.x 1.x 1.x
Financial Leverage Multiplier .7x .8x .6x
1 numbers are rounded
In summary, the ratio analysis suggests superior performance over the last three years. Coca
Cola is an excellent example of a fundamentally sound, long-term growth company that
continues to return to its shareholders in excess of 40 percent return on investment per year. It
meets the criteria of a franchise product company, one whose product is unique with few
substitutes, has a high demand, and has little or no government regulation. In addition, Coca
Cola continues to be an aggressive cost cutter as reflected by a continual increase in the
operating profit margin.
IV. STRATEGIC ANALYSIS
The strategic analysis includes an assessment of the companys strengths, weaknesses,
opportunities, and threats. In addition, the student is required to do an environmental scan of the
industry in order to determine who the competition is, what the relative market share is and could
be, and the degree to which the company has a competitive advantage in both domestic and
international markets.
The Coca Cola Company has many strengths and opportunities and only minor weaknesses
and threats to face. First, the companys product is clearly a franchise-that is its major strength.
Second, its ability to get the product to the customer at the least cost, when they want it, is a
strength that is surpassed only by its advertising prowess. Coca Cola recently entered both the
Chinese and Indian markets with distribution networks that have been in place for a number of
years. Its relative success in these markets will ultimately determine if sales will double every
three years, according to the companys CEO.
The strategic analysis requires the student to consider the non-quantitative factors that
contribute to the overall fundamental soundness of the company. The student is required to
consider these non-quantitative factors in the final analysis of whether the company should be a
prospective investment.
V. FORECASTS OF FUTURE PERFORMANCE
In the final phase of the semester project the student determines the intrinsic investment
value of Coca Colas stock. The intrinsic value is based on the present value of the annual cash
flows the stockholders receive over the next 10 years. Exhibit uses historic data for the last six
years to determine the stockholders cash flow, the annual growth rate of stockholders cash
flow, and the six-year average past growth rate of stockholders cash flow.
EXHIBIT
Return on Equity Calculations
Calculations
11 1 1 14 15 16
Price Per Share 14.884 0.664 1.084 .75 1.8 4
Owners Cash Flow
(NI + Dep - Capl Exp) 1085.4 11.147 175.7 06.75 507.77 40
Annual CF Growth Rate 0.04117 0.5748 0.176 0.116 0.1755
5-Year Average CF Growth .10%
Annual Sales Growth 10% 0.101 0.0686 0.1581 0.1104 0.015
5-Yr Average Sales Growth
Value Added 7.674 0.18 0.8440 7.715 6.4856
Average Value Added $4.7
Owners CF Per Share
0.40848 0.4158 0.6687 0.811056 1.00166 1.187878
Using the 16 shareholders cash flow ($.4 billion) the cash flow to the shareholders is
projected to grow at the six-year average past growth rate (Exhibit 4) over the next 10 years.
Next, using the dividend valuation model, the capital asset pricing model, and the bond
yield-plus-risk-premium model, the investors required rate of return for investing in Coca Cola
is estimated to be approximately 15 percent. This rate is used to discount the stockholders
future cash flows to their present value. Finally the terminal value of Coca Colas stock 10 years
from now is estimated using the dividend valuation model (P 10 = D 11 k s g) and also
discounted to the present value at the investors required rate of return. The sum of the present
value of each of the next 10 years cash flows to the stockholders and the present value of Coca
Colas stock 10 years from now represents the intrinsic investment value of Coca Colas stock.
Finally, the student compares Coca Colas intrinsic value to its actual stock price to make an
investment decision.
VI. CONCLUSIONS
This paper presents a systematic approach, using Excel spreadsheets, to teach fundamental
analysis. The student semester project consists of three major parts, a complete ratio analysis
based on historic financial statements, a strategic analysis that identifies the companys strengths,
weaknesses, opportunities, and threats, and a present value analysis of stockholders future
expected cash flows. The discounted future cash flows to the stockholders represent the intrinsic
value of Coca Colas stock and is compared to the actual stock price.
While the project appears to be extensive, the Excel spreadsheets tend to make short work of
the analysis. Students have found the experience quite rewarding.
V. REFERENCES
Copeland, Tom, Koller, Tim, and Jack Murrin, McKinsey & Company, Inc.,
000, Valuation,
Measuring and Managing the Value of Companies
, John Wiley & Sons, Inc.
Fraser, Lyn M., and Aileen Ormiston,
000, Understanding Financial Statements
, Prentice Hall,
Inc.
Higgins, Robert C., 15,
Analysis for Financial Management
, Richard D. Irwin, Inc.
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