Apply Valuation Metrics - Series 7

1. What is the formula for the debt-to-equity ratio?

   $\text{Debt-to-equity} = \frac{\text{Total liabilities}}{\text{Total equity}}$. The debt-to-equity ratio illustrates the balance between debt financing and equity in the company's capital structure.

2. What is the formula for the current ratio?

   $\text{Current ratio} = \frac{\text{Current assets}}{\text{Current liabilities}}$. The current ratio assesses short-term liquidity by comparing assets convertible to cash within a year to upcoming liabilities.

3. State the formula for book value per common share.

   $\text{BVPS} = \frac{\text{Common equity}}{\text{Common shares outstanding}}$. Book value per share reflects the net asset value attributable to each outstanding common share from the balance sheet.

4. What is the formula for basic earnings per share (EPS)?

   $\text{EPS} = \frac{\text{Net income} - \text{Preferred dividends}}{\text{Weighted avg common shares}}$. This formula allocates net income available to common shareholders across the average shares outstanding during the period.

5. Identify the metric that is most directly used to compare valuation across firms with different capital structures.

   EV/EBITDA. EV/EBITDA normalizes for differences in debt and cash, facilitating cross-company valuation comparisons independent of financing.

6. Calculate P/E if the market price is $45 and EPS is $3.00.

   $15$. P/E is computed by dividing the current market price by earnings per share to assess relative value.

7. State a common simplified formula for EBITDA starting from net income.

   $\text{EBITDA} = \text{Net income} + \text{Interest} + \text{Taxes} + \text{D\&A}$. This bottom-up approach reconstructs EBITDA by adding back financing, tax, and non-cash expenses to net income.

8. What is the formula for the dividend payout ratio?

   $\text{Payout ratio} = \frac{\text{Dividends per share}}{\text{EPS}}$. The payout ratio indicates the proportion of earnings distributed to shareholders as dividends rather than retained.

9. State the formula for the price-to-earnings (P/E) ratio using current market price and EPS.

   $\text{P/E} = \frac{\text{Market price per share}}{\text{EPS}}$. The P/E ratio measures the market's valuation of a company's earnings, indicating investor willingness to pay for each dollar of profit.

10. What is the formula for the dividend yield?

    $\text{Dividend yield} = \frac{\text{Annual dividends per share}}{\text{Market price per share}}$. Dividend yield represents the annual return from dividends as a percentage of the current stock price.

11. What is the formula for the quick ratio (acid-test ratio)?

    $\text{Quick ratio} = \frac{\text{Current assets} - \text{Inventory}}{\text{Current liabilities}}$. The quick ratio provides a stricter measure of liquidity by excluding inventory, focusing on more liquid assets.

12. What is EBITDA (define the components included in the measure)?

    Earnings before interest, taxes, depreciation, and amortization. EBITDA approximates operating cash flow by excluding non-operating expenses and non-cash charges from earnings.

13. What is the formula for return on equity (ROE)?

    $\text{ROE} = \frac{\text{Net income}}{\text{Average common equity}}$. ROE evaluates how effectively a company generates profits from shareholders' equity investments.

14. State the formula for the earnings yield (E/P) using EPS and market price per share.

    $\text{E/P} = \frac{\text{EPS}}{\text{Market price per share}}$. Earnings yield quantifies the return on investment based on current earnings relative to the stock's market price.

15. What is the formula for the price-to-book (P/B) ratio?

    $\text{P/B} = \frac{\text{Market price per share}}{\text{Book value per share}}$. The P/B ratio compares market valuation to accounting book value, highlighting potential over- or undervaluation relative to assets.

16. What is the relationship between P/E and earnings yield (E/P)?

    $\text{E/P} = \frac{1}{\text{P/E}}$. Earnings yield is the inverse of the P/E ratio, offering a yield-based perspective on stock valuation.

17. What is the formula for return on assets (ROA)?

    $\text{ROA} = \frac{\text{Net income}}{\text{Average total assets}}$. ROA measures the efficiency of asset utilization in producing net income for the company.

18. Calculate EPS if net income is $\$120\text{M}$, preferred dividends $\$20\text{M}$, shares $50\text{M}$.

    $2.00. EPS is derived by subtracting preferred dividends from net income and dividing by shares outstanding.

19. What is the formula for the EBITDA margin?

    $\text{EBITDA margin} = \frac{\text{EBITDA}}{\text{Revenue}}$. EBITDA margin gauges operating profitability efficiency by relating EBITDA to total revenue generated.

20. What does a higher P/E generally imply about market expectations for a company?

    Higher expected growth and/or lower perceived risk. A higher P/E suggests market anticipation of stronger future performance or reduced risk profile for the company.

21. What is the formula for the retention ratio (plowback ratio)?

    $\text{Retention ratio} = 1 - \text{Payout ratio}$. The retention ratio shows the fraction of earnings kept by the company for reinvestment or other uses.

22. Calculate dividend yield if annual dividends are $2.00 and the stock price is $40.

    $5\%$. Dividend yield is found by dividing annual dividends by the stock price, expressed as a percentage.

23. Calculate the payout ratio if dividends per share are $1.50 and EPS is $3.00.

    $50\%$. The payout ratio is determined by dividing dividends per share by EPS to show earnings distribution.

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