Data in the Financial notes

Financial Notes are an Integral Part of the Financial Statements. It provide a complete and adequate discussion relating to the balance in various accounts.

Some examples of appropriate footnote data are:-

• Description of the company's policies -disclosure of the company's policies for depreciation, amortization, consolidation, foreign currency translation, EPS, etc.
• Inventory valuation method - how to determine COGS - LIFO, FIFO or Avg Cost.
• Asset impairment - details about impaired assets or disposed assets
• Investments - debt\equity securities classified as "trading", "available for sale" or "held to maturity"
• Income tax provision - breakdown by current and deferred taxes, accompanied by a reconcilation from the statutory income tax rate to the effective tax rate for the company.
• Change in accounting policy - descripe the change - due to new accounting rules.
• Non Recurring Items - e.g. pension plan terminations, acquisitions/dispositions of significant business units.
• Employment and Retirement programs - employment contracts, profit-sharing, pension and retirement plans and postreitrement and postemployment benefits other than pensions
• Stock options - granted to officers and employees
• Long-term leases - lease obligations on assets and facilities on a per-year basis for the next several years and total lease obligations over the remaining lease period.
• Long-term debt - issuance and maturities of long term debt.
• Contigent liabilities - potential or pending claims or lawsuits that might affect the company.
• Future contractual commitments - terms of contract in force that will affect future periods.
• Regulations / Restrictions - regulatory requirements and dividend or other restrictions.
• Off-balance sheet credit and market risks - Potential for loss over and above the amount recorded on the balance sheet's financial instruments, e.g. interest rate swaps, forward and futures contracts and options contracts (derrivatives).
• Fair value of financial instruments carried at costs - e.g. long term debt, off-balance-sheet instruments - swaps and options.
• Segment sales, operating profits and identifiable assets - information on each industry segment that accounts for more than 10% of a company's sales, operating profits and/or assets. Multinational corporations must also show sales and identifiable assets for each significant geographic area where sales or assets exceed 10% of the related consolidated amounts.

The footnote reveal many critical and fascinating sidelights to the financial story.

References:-

• How to Read a Financial Report, Merrill Lynch

Financial Statement Analysis - APOLLO

I have performed financial statement analysis on APOLLO based on the latest financial statement analysis excel template.

Below is the summary of the analysis and you can click here for the detail analysis.

Income Statement Analysis

[1] To check the revenue, cogs, profit margin growth based on horizontal analysis.
 

APOLLO's revenue grew by 86.44% from 2004 to 2013 (CAGR of 7.17%).  And, the cost of sale grew at slight lower rate (82.31%) resulting in higher growth in gross profit (97.92%).  The more important operating profit and net profit grew at a higher rate of 118.63% and 98.04% respectively.  The profit growth is in tandem with revenue growth and the quality of growth is hence considered good.

[2]    To check how the revenues and the spending on different types of expenses change from one year to the next based on vertical analysis.




The profit margin (gross, operating, and net) was reduce dractically in year 2008 (due to economic crisis), and it have been recovered since 2010 and now it is on a steady up trend.
The management’s ability to contain the total operating expenses to about 10% each year. 
The growth in profit margin is in tandem with the revenue growth. On the latest financial year, the gross profit margin, operating profit margin and net profit margin is 28.11%,  18.30% and 14.40% respectively. 
The good result here give us more confident on APPOLO's growth quality.

Balance Sheet Analysis

[1]    Does business generate cash?  
                                                                  
APOLLO's cash and cash equivalent grew by 41.38% on 10 years, or a CAGR of 5.35%.
This indicate that the business is generating cash.
This is despite it have been giving reasonable good dividends (> 4% D.Y.) every year.

[2]    Does business increase equity value?
APOLLO's equity increases by 55.99%, or a CAGR of 5.38%. Including the 6% dividend  yield, the total value created in term of book value and dividend yield is 11% a year since 10 years ago.

[3]    Revenue vs Inventory
APOLLO’s inventory increased 93.79%% (CAGR 7.27%), while the revenue increase 86.44% (CAGR 6.80%). However, the inventory is 7.76% of the total assets and it is align with its previous years records. In view of the revenue is growing up, I believe the inventory increased is due to higher anticipated sales. Anywhere, investor need to monitor closely on the revenue growth and inventory level on next financial result to confirm the assumption.

[4]    Revenue vs Trade Receivables
APOLLO’s Trade receivables on year 2013 is 12.31% of total asset is slightly higher compare to its historical range. It may mean its customers are taking a little bit longer to pay. However, the  growth in trade receivables at 80.50% (CAGR 7.85%) and is lower than the revenue growth rate of 86.44% (CAGR 6.80%). This show us the sales proceeds are collected and converted to cash, as evidence from the increase in cash and cash equivalent.

[5]    Core Business Asset
The Core Business Asset is increasing on 38.52% with  a CAGR of 3.60% and the growth rate is much lower than the revenue growth rate of 86.44% (CAGR 6.80%).
It show that the the company need lower CAPEX to increase sales, and it able to turn the net profit to free cash flow easily. 

And, the CAPEX was funded by Opg Cash Flow in view of the positive free cash flow in 10/10 on the pass 10 years.

[6] Owner's Capital & Debt
APOLLO’s share capital is constant and thus, there is no dilution of its earnings per share. And, there is no long term debt on APOLLO, it show that APOLLO is using it’s own generated fund to sponsor the growth.  This shows there is little risk in  investing in its stock.

APOLLO experience net cash (to) owners on the pass 10 years indicate that the Company's owner have been collecting net income in the form of dividend each year.

[7] Asset breakdown

Above pie chart depicts the breakdown of the total assets of APOLLO.
It is made up of 28.00% cash & short term investment, 13.17% of Short Term Receivables, 7.37% of inventories, 43.72% of Core Business Assets and 7.19% of Long Term Investment.
The quality of asset is good in view of 28% of asset is hard cash.

[8] Liquidity Risk
APOLLO has excellent liquidity ratios with current ratio 13.77 times and a quick ratio 11.48 times

It has no problem at all to pay its short term obligations.

[9] Long Term Financial Strength

APOLLO debt/equity ratio is 0 (< 2) and financial leverage ratio is 1.11(< 3), and in fact APOLLO has no short-term nor long-term loan at all. APOLLO hence will have no trouble paying creditors as well as obtaining additional long-term funding when needed. Instead it has excess cash of about 56m, or 70 sen per share which can be distributed to shareholders without any significant adverse effect on its operations.

Cash Flow Statement Analysis

[1] Net Income vs Operating Cash Flow
OCF is above NP in 8 out of 10 years. This is a good sign as the net income was able to convert to the cash most of the times.

In 2013, OCF of 31,595 is about the same of net income, 32,083. This shows the good quality of its earnings which is translated to hard cash, rather than consumed in the build up of inventories and receivables.

[2] Capital Allocation and Earning Quality
The revenue was growing from 119.47M to 222.75M and it is equivalent to a 86.44% growth rate. The growth was achieved by a total of 115.56M of capex  and the CAPEX has been modest, average at about 7.15% of revenue for the last few years and the trend is decreasing. This results in more of the OCF, after deducting capex, translating to free cash flow (FCF) for the equity shareholders.

For example last year, after utilizing 6.4m in buying and upgrading PPE, FCF was at 25.2m. This FCF is equivalent to 11.30% and 15.36% of revenue and invested capital respectively, way above the benchmark of 5%. This again shows the good quality of its earnings.

[3] How the company being financed?
From the pass 10 years, the CAPEX is lesser than the OCF and the firm able to generate Free Cash Flow from 10/10 years. It mean that the firm  able to generate enough cash from its operating activities to meet its capex requirement. Owing to this, we can see the firm not only need not to acquire cash from owners or creditors, but it able to pay dividends to owners with the free cash flow.

The CAPEX provides a good yield to its shareholder in view of the average FCF/Revenue and FCDF/IC is very high which is  11.30% and 15.36% respectively.

Analysis of Return on Capital

[1] ROE DuPont Analysis
The ROE is above the WACC (13.94% vs 12.00%) and it have been grew in 26.96% with a CAGR of 2.88%.
The ROE was achieved with a net profit margin of 14.40% and this is the most desirable way to achieve a higher ROE.
The sales turnover is verly low and APOLLO should able to achieve a higher ROE if he able to increase the sales turnover.
Furthermore, it have a very low equity multiplier - 1.1133 and it can increase the financial leverage and improves its ROE. However, financial leverage is a double edge sword it can hurt ROE badly in the bad times. And, high leverage can make a company’s balance sheet unhealthy and become risky during economy downturn.

[2] ROIC Analysis
APOLLO Invester Capital grew by a CAGR of 4.00% while the NOPAT growth at a much higher rate at CAGR of 8.77%.
And, owing to this the ROIC was improving from 14.03% to 18.81% with a CAGR of 4.00%. And this is above the WACC of 12%.

[3] ROCE and CROIC
ROCE and CROIC is above WACC.

Valuations

[1] Price to Book Ratio
We evaluate APOLLO based on earning power.

[2]    Price to Earning Ratio
The P/E is increasing. Let's examine PEG                                                                       

[3]    Earning Yield
Earning Yield (Joel Greenblatt) 13.50% > 10 % - Pass.

For the pass 10 FY, the EBIT grew with a CAGR of 8.76% while EV grew with CAGR of 6.26%, owing to this the Earning Yield was improved from 15.59% to 19.22%.
If we look at the T4Q result, the EY was dropped to 14.39%, and this might indicate that the stock valuation is relatively expensive in view of the share price have been increased from 3.810 to 4.980

[4]    PE/Growth Ratio
 PEG of 1.81 is way above of 1.00. It indicate that the price is on the high range.

[5]    Price to Free Cash Flow
P/FCF = 12.112 < 20  is reasonalbe    

[6]    Price to Sales Ratio
Not Applicable                                                         

 


References:-

• APOLLO Annual Result
• APOLLO Quarter Result
• Financial Statement Analysis 
• Income Statement Analysis 
• Income Statement - Common Size Analysis 
• Profit Margin 
• Balance Sheet Analysis 
• Balance Sheet - Comparative Analysis 
• DuPont Analysis - Dissecting ROE 
• Issues and Pitfalls of ROE 
• Return in Invested Capital (ROIC) 
• Total Enterprise Value (TEV) and Earning Yields (EY)
• Cash Flow Statement Analysis 
• Cold Eye’s 5 yardsticks for investment
• Simple Valuation Techniques from kcchongnz

Five Habits of Highly Successful Investors - #2: Know basic accounting

Habit #2: Know basic accounting

Accounting is the language of business.

You need to understand basic accounting to identify good companies from the bad ones based on their past financial performance.

You have no right to invest in the stock markets if you not able to read the financial statement.

Yes, I totally agree with this points. By reading the financial statement and dissect the numbers, give retail investor like us able to find out a good companies, gauge the intrinsic value, and buy it when there is a satisfied margin of safety.

"In the business world, the rearview mirror is always clearer than the windshield." - WarrenBuffett

Every companies listed in bursa, provide the quarter and annual financial statement. And each financial statement, consits of 3 main components, i.e. Income Statement, Balance Sheet and Cash Flow Statement. Do take a look on it and check out how's the company performance.  

There is no free lunch in the investment world. And, it is a expensive lesson if a retailer buying into a stock without looking on its financial statement. Do always check out the latest result released for your companies and keep an eye on when is the next quarter result release.

"If you don't study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards. " - Peter Lynch

"An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative. " - Benjamin Graham

 
 
Refences:-

• Five Habits of Highly Successful Investors, Safal Niveshak
• Financial Statement Analysis 
• Income Statement Analysis
• Balance Sheet Analysis
• Cash Flow Statement Analysis 
• Latest Quarter Result for Bursa listed companies
• Upcoming Quarter Result for Bursa listed companies 

Cash Flow Statement Analysis

• It tells you how much cash went into and out of a company (how much cash generated?) during a specific time frame like a quarter or a year. 
• A +ve change in cash is good, what really matter is how the cash was increased and spent.
• Income statement present the income and expeses based on accural accounting concept (when transactions occur - expenses must match the revenues those expenses created whenever possible, not when cash is exchanged). This method of accounting introduces many interpretations and estimates from management that can vary from firm to firm. 
• Higher sales might not translate into higher cash flow if AR rise.
• Cash maybe used to build up inventories - may depreciate in value or even become obsolete (if not sold in timely manner). The expenses of inventory if not recorded until produts are actually sold. Invenory recognization may vary - e,g, FIFO, LIFO
•  
• Cash Flow Statement strips out all the abstract, non-cash revenues and expenses that are included in the income statement. Some companies have a good profits in the income statement but insufficient cash flows. It is a linkage between the balance sheet and income statement.
• Companies can generate cash in several ways - (1) from operating activities, (2) from investing activities, and (3) from financing activities.
• Cash Flows from Operating Activities
• How much cash company generated from its core business (as opposed to peripheral activies - investing or borrowing). 
• It is vital. -ve OCF lead companies to seek funding from outside source -
1. Increase debt load - increase interest payment, hinders growth, more vulnurable to business downturn.
2. Issuing stock - dilutes ownership.
• A growing company may have -ve OCF (expands its inventory and pays its increasing bills), OCF must eventually turn +ve for the firm to survive
• A contracting company may exhibit po +ve OCF for a period of time, as spending falls at a faster rate than sales and earnings. 
• 2 ways to determine OCF
1. Direct - reconciliation reports major sources of cash receipts and payments
1. Cash receipts from customers
2. Cash payments for inventory purchases and operating expenses
2. Indirect - start with net income and adjust non cash expenditures
• Net Income - the starting point of how much cash a company provides from its operations. But, some items on income statement affect income but don't affect cash flow, so adjustment is required.
• Depreciation and Amortization - record the wear and tear on company asset. This expenses is not a cash charge. Added back to net income.
• Change in Working Capital  - firm may provide a single line item or breakdown
• Increase AR, increase Net Income, but cash not receive -- subtract it
• Increase AP, decrease Net Income, but cash not pay yet -- add back
• Increase Inventory -- subtract it
• Other Non Cash items
• prepaid expenses - not reduce net income, but reduce cash -- subtract it
• unearned revnue (for future service) - not affect net income, but it increase cash - add back
• deferred tax expenses (pay alrge tax bill upfront and slowly deduct the expenses from earnings) - for 1st year, subtract the cash, subsequent year only affect net income but no cash outflow - added back.
• Net Cash provided by Operating Activities - this is the figure we can get after we perform all adjustments to the net income. It provide a great summary of how much cash a company's core business generated.
• For most firm, +ve OCF is crucial.
• Cash Flows from Investing Activities
•  It  shows the amount of cash firms spend on investments. There are 2 types of invesments.
1. Capital expenditures - to upkeep the current busienss operations. 
1. -ve - if company spends money on fixed assets (mainly PPE)
2. +ve - selling more of its assets than it is buying
3. It can be very large & long term in nature. Companies typically expenses a CAPEX over the course of its useful life (via depreciation) in Income Statement. But, the cash is used in the initial purchase year.
4. A -ve CAPEX can be a good sign for company - spending $ to expand business (be sure to ascertain the company is making wise investments and has good growth prospectes).
5. CAPEX figure should growting at a clip relatively similar to revenue. Spending cash on CAPEX while revenue are stalling can be problematic (if sale decline due to competitive threats and poor management decisions, instead of economic and industry cycles).
6. CAPEX vary by industry. Manufacturing firms required large CAPEX (it need large plants); IT firm need IP and Intangible assets. 
2. Monetary investments - e.g. purchase or sale of government bonds, equity funds, commodity hedges, currency hedge, investing in an associates or joint venture etc. 
1. Keep the company's industry in mind when examining investment cash flow - e.g. financial companies make significant investments in marketable securities.
•  We should pay attention on the capex items and the line item of other business acquisitions.
•  Net cash from investing activities for most healthy firms will be -ve  -- drive cash from operations back into the firm for expansion to generate future profits.
• Cash used for Acquisitions - take note on the figure as companies tend to overpay for acquisitions. And, it will show company achive growth? Internal sources vs acquisitions.
• Cash Flows from Financiang Activities
• It includes any activities that involve the company's owners or creditors.
• Owners - issuance or purchase of common stock, dividend pay to investors
• Creditors - issuance or repayment of debt.
• Should take note on how much stock a company is issuing or repurchasing. 
• Newer companies \ rapidly growing companies need issues lots of new stock to fund their growth. However, it will dilutes existing shareholders' ownership. It  is not necessarily a bad sign, as long as the firm is expanding at an acceptable rate.
• Mature companies that have ample free cash will buy back their own stock - it will increase the value of existing shares (SH own a bigger piece of the pie). Share buyback and dividend are typically the only tow ways a company can enrich its SH with cash flows.
• Issuance Debt - interest will be charged. Ineterest not a financing activity but include in operating activities since these expenses are considered part of normal business operations.
• Dividend
• It should increase (become more negative on the cash flow statement) in subsequent periods. 
• A decrease in dividends - a sign that a company is experiencing difficulties 9take note if the decrease > NOSH reduction)
• A firm with no dividends should be experiencing significant growth.
• It is important to study how the firm is raising cash or repaying cash.
• Free Cash Flow = Net cash from operating activies - Capex.  
• It measures how much cash was generated that can be spent at management's discretion. 
• This excess cash can be used to enrich SH or invest in new opportunities for business without hurting the existing operations.  
• It is one of the most important figures to determine the company capability to enrich its shareholders.
• It can be put to several uses: retire debt, repurchase shares, pay additional dividends and create new products or expand current offerings.
• There are companies with extremely long and expensive product cycles, such as Boeing Co. (BA) and Airbus SAS. As new planes are conceptualized, developed, manufactured and delivered, cash flows devoted to those to projects may be negative for years before profits are realized and net cash flows become positive.  
• Currency Translation
•  Multinational firms with operations in several different countries will generate revenues in several different currencies.
•  There are accounting rules written to supervise how currency is translated.
•  “cumulative effect of exchange rate changes” details the effect of the currency exchange rate changes on the company’s cash flow.
• Net Change in Cash
• Net Change in Cash = OCF + ICF + FCF = Cash at begining of reported period - Cash at the period's end. 
• It can be +ve or -ve. What matters is how cash is increased and spent. We want cash generated from business operations
• Increasing +ve OCF is a good sign
• A few periods of decresing total cash is not worrisome if a firms is spending on worthwile projects, paying high dividend, paying down debt, or repurchasing shares.
• Excess cash does not provide a return to shareholdres. Firms run the risk of management making risky decision with a stockpile of cash, e.g. investing in questionable acquisitions or pet projects.
• Analysis of Cash Flows
• Net Income vs OCF - each figure has its strengths and weknesses. 
• Net income is derived using the principles of accrual accounting, ignoring the effect of non-cash items (increasingly tax credit standards and aggresive revenue recognition can all be mised). 
• Non cash items are dependent on management estimates and discretion, and treatment may vary slightly from firm to firm.
• OCF fails to account for unearned revenue or accrued liabilties.
• The figure is difficult to evaluate for young, rapidly growth firm - increasing inventory, increasing current assets and extending credit to new customers to drive revenue growth. 
• This leads to -ve OCF that are supported by debt and issuance of stock.
• Questions to answer based on CF statements
1. With reference to the net profit, What do you think about the net cash flow generated from operations?
• Is the profit converted to cash?
• Has the company generated adequate CFFO to cover all operating expenses?
•  More specifically is the quality of earnings good?
• Explain why the difference, if any.
2. What do you think about the management’s capital allocation in its investing activities?
• How is the growth of capex in relation to revenue and net profit?
• What do you think is the results of the management’s investing in associate and subsidiary companies?
3. What is your though about its financing activities?
•  How do you view the company’s financing in equity and debt?
• Do you see the financing yields positive result for shareholders?
4. Calculate the free cash flow for the equity shareholders and for the firm for all the years.
• Explain what your understanding on free cash flow
• What is FCF used for? Give 4 examples.
• Are FCF of the company  good. And why?
• Can the company use its FCF to do what it suppose to do in 4a above?
• If not, how have the company been doing things in 4a above?

Profit is a matter of opinion. Cash is a matter of fact.

Revenue is vanity, cash flow is sanity, but cash is king.

References:-

• The Statement of Cash Flows, Morningstar
• The Cash Flow Statement: Tracing the Sources and Uses of Cash, By Z. Joe Lan