14. Company Analysis

Explore the fundamentals of company analysis in financial securities, including the evaluation of financial statements, financial ratios, and the assessment of preferred shares investment quality.

Company Analysis

Chapter Overview

In the previous chapter, we examined fundamental analysis from macroeconomic and industrial perspectives. In this chapter, we delve into company analysis, which fundamental analysts use to measure the actual or expected profitability of a securities issuer. You’ll learn how to examine financial statements and use various financial ratios to determine whether a company is a good prospect for investment.

Learning Objectives


  1. Identify the Factors Involved in Performing Company Analysis: Learn the criteria necessary to evaluate a company’s investment potential.
  2. Interpreting Financial Statements: Understand how to analyze a company’s financial statements using trend analysis and external comparisons.
  3. Analyzing Financial Ratios: Assess company performance by using key financial ratios.
  4. Assessing Investment Quality of Preferred Shares: Distinguish the criteria used in evaluating the quality of preferred share investments.

Key Terms

Key terms are defined in the Glossary and appear in bold text in the chapter.

  • Asset Coverage Ratio: Metrics evaluating a company’s ability to cover its debt with assets.
  • Inventory Turnover Ratio: A measure of how efficiently inventory is managed.
  • Capital Structure: The mix of different sources of finance used by a company.
  • Liquidity Ratios: Ratios measuring a company’s ability to meet short-term obligations.
  • Cash Flow: The net amount of cash being transferred in and out of a company.
  • Net Current Assets: Current assets minus current liabilities.
  • Cash Flow-to-Total Debt Outstanding Ratio: A measure of a firm’s ability to cover its total debt with its cash flow.
  • Net Profit Margin Ratio: A metric that shows the percentage of profit a company produces from its total revenue.
  • Operating Performance Ratios: Ratios that measure a company’s operational efficiency.
  • Debt-to-Equity Ratio: Indicates the relative proportion of shareholders’ equity and debt used to finance a company’s assets.
  • Preferred Dividend Coverage Ratio: Ratio measuring ability to pay preferred dividends out of net income.
  • Dividend Discount Model: A method to value a company’s stock price based on predicted dividends.
  • Dividend Payout Ratio: The proportion of earnings paid out as dividends to shareholders.
  • Dividend Yield: Measures the economic return on a stock based on its dividends.
  • Earnings Per Common Share: Earnings divided by the number of common shares outstanding.
  • Equity Value Per Common Share Ratio: Represents the value attributed to each share of common stock.
  • Interest Coverage Ratio: Determines how easily a company can pay interest on its outstanding debt.
  • Price-to-Earnings Ratio: Ratio for valuing a company by measuring its current share price relative to its per-share earnings.
  • Quick Ratio: Measures a company’s ability to meet short-term obligations with its most liquid assets.
  • Return on Common Equity Ratio: Shows the return on investment for equity shareholders.
  • Risk Analysis Ratios: Ratios that assess the risk of a company or an investment.
  • Trend Ratios: Analyze the pattern of various financial metrics over time.
  • Value Ratios: Ratios evaluating a company’s valuation metrics.
  • Working Capital: A measure of a company’s short-term financial health.
  • Working Capital Ratio: Also known as the current ratio, it’s a liquidity ratio that measures a company’s ability to pay off its current liabilities with its current assets.

Key Takeaways

  1. Importance of Company Analysis: Crucial for evaluating the potential of a company’s securities.
  2. Financial Ratios: Key metrics used in assessing various aspects of a company’s performance.
  3. Comparisons: External comparisons and trend analysis add depth to the evaluation process.
  4. Preferred Shares: Understanding the unique aspects of preferred shares is essential for a thorough investment analysis.

Frequently Asked Questions (FAQs)

Q1: Why is company analysis important?

A1: Company analysis helps investors evaluate the potential of a company’s securities by examining its financial health and profitability.

Q2: What are the key financial ratios used in company analysis?

A2: Some key ratios include the debt-to-equity ratio, liquidity ratios, net profit margin, and earnings per share.

Q3: How do trend analysis and external comparisons contribute to company analysis?

A3: These methods help track performance over time and compare it with industry standards, adding context to the company’s financial metrics.

Glossary and Definitions

  • Asset Coverage Ratio: Measures a company’s ability to repay its debt obligations with its assets.
  • Inventory Turnover Ratio: The number of times inventory is sold and replaced over a period.
  • Capital Structure: The mix of debt, equity, and other financial securities in a firm’s total capital.
  • Liquidity Ratios: Metric used to determine a company’s ability to pay off its short-term debts.

Explore further details in the coming sections where we will cover these concepts comprehensively with examples and real-world applications. Stay tuned!

📚✨ Quiz Time! ✨📚

🧐 Assess and Solidify Your Understanding

Welcome to the Knowledge Checkpoint! You’ll find 10 carefully curated quizzes designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you’re on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck! 🍀💪

## What is the primary focus of company analysis in fundamental analysis? - [ ] Assessing macroeconomic trends - [ ] Evaluating industrial performance - [x] Measuring the actual or expected profitability of the securities issuer - [ ] Examining global market conditions > **Explanation:** Company analysis aims to measure the issuer's profitability to determine if the company is a good investment prospect. ## What is utilized to determine whether a company is a good investment? - [ ] Interest rate trends - [x] Financial statements and financial ratios - [ ] Foreign exchange rates - [ ] Commodity prices > **Explanation:** Fundamental analysts examine financial statements and use financial ratios to assess whether a company is a good investment. ## Which financial ratio measures the liquidity of a company? - [ ] Price-to-earnings ratio - [x] Current ratio - [ ] Debt-to-equity ratio - [ ] Dividend yield > **Explanation:** The current ratio is one of the liquidity ratios used to assess a company's ability to cover its short-term liabilities with its short-term assets. ## What is the purpose of trend analysis in company analysis? - [ ] To compare a company's performance with macroeconomic indicators - [x] To analyze a company's performance over time - [ ] To evaluate competitors' performance - [ ] To assess the potential of new markets > **Explanation:** Trend analysis helps in understanding how a company’s financial performance changes over time. ## How is the net profit margin ratio calculated? - [ ] Net profit / Total assets - [x] Net profit / Revenue - [ ] Total equity / Net profit - [ ] Revenue / Total debt > **Explanation:** The net profit margin ratio is calculated by dividing net profit by revenue, indicating the percentage of revenue that constitutes profit. ## What does a liquidity ratio primarily assess? - [ ] Long-term profitability - [ ] Investment quality of preferred shares - [ ] Capital structure - [x] A company's ability to meet short-term obligations > **Explanation:** Liquidity ratios assess whether a company can meet its short-term liabilities with its short-term assets. ## Which financial ratio is specifically used to evaluate the performance of common equity? - [ ] Current ratio - [x] Return on common equity ratio - [ ] Debt-to-equity ratio - [ ] Quick ratio > **Explanation:** The return on common equity ratio helps assess the profitability and efficiency with which a company uses its common equity to generate profit. ## What does the debt-to-equity ratio indicate about a company? - [ ] Liquidity - [ ] Profit margin - [ ] Cash flow - [x] Financial leverage and capital structure > **Explanation:** The debt-to-equity ratio measures the relative proportion of shareholders' equity and debt used to finance a company's assets, indicating financial leverage. ## What is one of the key assessments in analyzing the investment quality of preferred shares? - [ ] Liquidity ratios - [x] Preferred dividend coverage ratio - [ ] Gross profit margin ratio - [ ] Inventory turnover ratio > **Explanation:** The preferred dividend coverage ratio evaluates the ability of a company to pay dividends on its preferred shares from its net income. ## Which term refers to the measure of how quickly a company can sell its inventory? - [ ] Net current assets - [x] Inventory turnover ratio - [ ] Operating performance ratios - [ ] Risk analysis ratios > **Explanation:** The inventory turnover ratio indicates how quickly a company can convert its inventory into sales within a period, reflecting operational efficiency.

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In this section

  • 14.1 Introduction
    Learn the fundamentals of conducting company analysis for determining investment potential in this chapter. This guide offers tools and insights into assessing a company’s financial statements and identifying risks and opportunities.
  • 14.2 Performing Company Analysis
    Explore the essential factors involved in performing a thorough company analysis to identify lucrative investment opportunities, utilizing fundamental analysis and financial statements.
    • 14.2.1 Statement Of Comprehensive Income Analysis
      A comprehensive guide on Statement Of Comprehensive Income Analysis, understanding its components, performing in-depth financial ratio analysis, trend analysis, external comparisons, and their implications on company’s performance.
Saturday, July 13, 2024