Key Financial Metrics Revisited: Calculations and Applications Rod Feuer & Prof. Frank Howland July 13, 2004

Reviewing Key Concepts Revenue Operating Profit Margin Earnings Per Share Free Cash Flow Return on Equity (ROE)

Sales Growth Calculation Quarter 1 Quarter 2 Take the difference between 2Q sales and 1Q sales and divide it by 1Q sales… and multiply this number by 100.

Revenue Analysis Growth trends –Is revenue growth due to your product’s pricing, volume or a combination of both? –How does seasonality affect sales (holiday shopping in 4Q vs. summer doldrums in 2Q)? –If revenue growth is declining or decelerating, why? –Is your product gaining or losing market share?

Profit Margin Calculation Divide this line By this line

Profit Margin Trend Analysis Is your profit margin increasing or decreasing? Why? Examine trends in operating expense line items as a percentage of sales (e.g., selling expense/sales) Inventory cost changes Sales force type, ad spending Bigger factory, workforce change

Earnings Per Share Calculation

Earnings Per Share Analysis Is your company’s EPS growing or declining? Why? –Revenue –Operating Profit –Interest Expense EPS growth is an important metric that investors use to determine the value of your company – higher growth typically implies higher value EPS is used to determine a company’s price-to-earnings ratio (P/E), which we’ll discuss later in the presentation

Free Cash Flow Calculation Profit (Loss) After Taxes ($332,000) Plus: Depreciation ($500,000) Minus: Cash Spent for New Capacity ($0) Equals: Free Cash Flow ($832,000)

Free Cash Flow Analysis What to do with all that free cash flow? –Invest in new product development –Expand manufacturing capacity –Pay dividends to shareholders Free cash flow is also used by investors to determine the value of a company, something we’ll discuss later in the presentation

Calculating Return on Equity Notes 1) Shareholders’ Equity = Common Stock + Retained Earnings 2) Net Income must be annualized 3) Must use average value of Shareholders’ Equity Annualized Net Income Average Stockholders’ Equity

Return on Equity Analysis Why is your ROE increasing or decreasing? –Profit margin trends –More productive use of your company’s assets –Financing with debt vs. equity ROE is a way to measure investors’ return on investment Net Profit MarginAsset TurnoverLeverage Ratio This formula is for demonstration purposes only!!!

Proof These Metrics Matter From the Annual Reports of Corinthian Colleges and Career Education

Application: What Is Your Company Worth?

Two Ways to Value a Company Discounted Cash Flow Model –Based on the present value concept from the morning lecture –Too complicated for our purposes Price-to-Earnings ratio (P/E ratio) –Widely used –Easy to understand –Easy to calculate

Calculation of a P/E Ratio Eli Lilly P/E Ratio Calculation

What P/E Should You Use? Depends on several factors and trends –Revenue growth –Profit margin –Earnings growth –Cash flow generation –Return on investment The better these metrics, the higher a firm’s P/E should be resulting in a higher the stock price You should also look at the P/E ratios of other publicly traded companies in your industry

Financial Trends at Eli Lilly What trends do you see here? Any concerns?

Revenue Trends at Eli Lilly This chart shows Lilly’s sales from current and projected drug pipeline Prozac was the primary reason behind LLY’s revenue decline in 2002

Comparing Eli Lilly Against Peers * Estimates from Morgan Stanley and First Call Why does Lilly have a premium valuation?