Agenda 14 December 2002
• 9:30 Call to Order • 10:10 Education
• 9:35 Minutes • 10:30 Medical
• 9:40 Treasurer’s Services Industry
Report • 11:20 Portfolio Review
• 9:45 Old Business • 11:20 Investments
– Value Line Review
• 10:00 New Business • 11:30 Adjourn
INVESTIGATING RED FLAGS
in Section 2B of the SSG
Education Segment
Cincinnati Investment Model Club
Section 2B Return on Equity
• Section 2B tells us how good
management is at spending money;
that is, spending money in a way that
increases the value of the company.
• As the value of the company increases,
the value of our share of the company
increases.
The Problem
The trend in Section 2B is down.
Don’t ignore the problem.
Do find out what has happened
The Return on Equity is decreasing
• A company can increase the ROE in three
ways:
– increase the net profit margin
– increase the financial leverage
– increase the asset turnover rate
• If any one of these drops, the ROE could go
down
Net Profit Margin
Net profit margin is the amount of profit
generated for every dollar of sales.
The net profit can either be given to the owners
as a dividend or kept by management to
continue growing the company.
To find the net profit margin divide the net
profit by the sales.
The numbers are found in the Income
Statement
Net Profit Margin
The Net Profit
Margin for the
last 3 years was
15%, 16%, &
17%.
The Net Profit
margin is not
creating the
problem in ROE.
Net Profit Margin
• The net profit margin restates all the
conclusions made about management in
Section 2A.
• If there were a problem with the net profit
margin you would check the cost of goods
sold and the operating expenses in the
MD & A section of the annual report or 10K
to find out what happened.
Financial Leverage
(Borrowed Money)
• A company can increase its ROE by
borrowing money. The trade off is that
increased debt brings with it higher risk.
• To determine the financial leverage divide
the Total Assets by the Equity.
• These numbers are found on the Balance
Sheet.
Financial Leverage
The Financial Leverage ratio decreased a small amount from 2.71 in
2000 to 2.3 in 2001. This is not the problem in ROE.
Financial Leverage
• If the problem were caused by a change in
the financial leverage you would check the
MD & A section and the Notes to Finances
and Cash Flow Statement to find out what
the borrowed funds were used for.
• Borrowed money should increase the value
of the company.
Asset Turnover Rate
• Asset Turnover is the amount of sales
generated per dollar of assets (sales
divided by assets).
• Sales number is found on the Income
Statement.
• Total Assets is found on the Balance Sheet
in the Annual Report or 10K.
Asset Turnover Rate
Asset Turnover Rate
in 2000 was 1.03. In
2001 it was .76.
The total value of the
assets grew much
faster than the sales.
The company was
generating less sales
for the amount of
their assets.
This is one cause in
the decrease in ROE.
Asset Turnover Rate
• Higher numbers are better
• Compare with other companies in their
industry. The company generating more
sales with each $ of assets is making their
money work the hardest.
Now we know the problem. The
decrease in the ROE was caused
by a decrease in the asset turnover
ratio.
Let’s take a closer look at Assets and
see why they grew faster than sales.
Sales grew 17% from
2000 to 2001 so we
would expect assets
to grow about that
much also
Grew 32%
Grew 18.5%
Grew 17%
Let’s take a closer look at the current assets
Cash decreased 40.5%.
Short term investments grew 18%.
Accounts receivables grew 38%.
Deferred taxes grew 66% These are tax payments that are postponed from
this year to a later year (not withheld payroll taxes)
Other current assets grew 44%.
Cash went down while accounts receivable and deferred taxes went up
significantly.
Wrap Up
• When the arrow for ROE (Row 2B) is down,
do not reject the company but find out why:
– A decrease in the net profit margin
– A decrease in the financial leverage
– A decrease in the asset turnover rate
• Then decide if this is a major or long term
problem or just a short term problem.