Analysis and Evaluation of Data

The densest unit on one sheet: financial statements, every ratio, the three valuation methods, and the deal-math gotchas the exam loves.

The One-Liners That Win Points

• Three analytical lenses: individual company analysis (standalone, from 10-K / 10-Q / 8-K), comparable company analysis (live trading multiples of public peers), industry sector analysis (sector growth, cycle, M&A activity).
• Comparable companies use live trading multiples; precedent transactions use past deal multiples. Different analyses, different numbers, both go on the football-field chart.
• Net income flows three places at once: bottom line of the income statement, top of the cash flow statement (Cash Flow from Operations (CFO) start), and an addition to retained earnings on the balance sheet.
• Cash on the balance sheet = beginning cash + total change in cash from the cash flow statement. That tie-out is the standard model check.
• Net debt subtracts cash: $5 billion debt with $4 billion cash = $1 billion net debt. Net debt lives inside the EV formula.
• Interest coverage uses Earnings Before Interest and Taxes (EBIT), not net income (net income already subtracts interest).
• Return on Invested Capital (ROIC) uses Net Operating Profit After Tax (NOPAT), not net income; NOPAT = EBIT x (1 minus tax rate).
• Enterprise Value (EV) adds debt, preferred, and minority interest and subtracts cash; equity value (market cap) ignores debt. M&A prices are quoted as EV.
• Precedent transactions usually produce HIGHER multiples than trading comps because deal prices include a control premium.
• Stock-funded deal is accretive when the target's Price-to-Earnings (P/E) is LOWER than the acquirer's P/E.
• Schedule 13D is for active investors (intent to influence control); Schedule 13G is for passive investors. Both are 5%+ filings.
• Going-private = Schedule 13E-3 plus a fairness opinion, even when shareholders get a premium.

Numbers to Lock In

Financial-Statement Models

• Balance sheet (snapshot): the identity is $\text{Assets} = \text{Liabilities} + \text{Stockholders' Equity}$. Equity is also called net worth or book value.
• Income statement (waterfall over a period): revenue, minus Cost of Goods Sold (COGS), minus Selling, General and Administrative (SG&A), minus Depreciation and Amortization (D&A), to operating income (equals EBIT), then interest, taxes, and net income.
• Cash flow statement = CFO + Cash Flow from Investing (CFI) + Cash Flow from Financing (CFF); the sum equals the change in cash for the period.
• Depreciation and Amortization (D&A) is non-cash: it lowers reported net income but not cash, so the cash flow statement adds it back to compute CFO.

Liquidity Metrics

• Current ratio (working capital ratio) = current assets / current liabilities.
• Quick ratio (acid test) = (current assets minus inventory) / current liabilities. The tougher test because inventory is the least liquid current asset.
• Working capital = current assets minus current liabilities (a dollar amount, not a ratio).
• Cash collection cycle = DIO + DSO - DPO (days inventory outstanding, days sales outstanding, days payables outstanding). Shorter recycles cash faster.
• Turnover ratios: receivables turnover = revenue / accounts receivable; inventory turnover = COGS / inventory; payables turnover = COGS / accounts payable. Receivables uses revenue; inventory and payables use COGS.
• Capital-structure liquidity: debt-to-capital = total debt / (debt plus equity); debt-to-equity = total debt / equity; free cash flow yield = free cash flow / market cap; net debt = total debt minus cash.

Profitability Metrics

• Earnings layers: EBIT (operating income); Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) = EBIT plus D&A; EBITDAR = EBITDA plus rent (leased-asset industries: restaurants, casinos, airlines, hotels, retail).
• Earnings Per Share (EPS) = net income (less preferred dividends) / weighted average shares outstanding.
• Earnings yield = EPS / price per share (the inverse of P/E).
• Margin stack: gross margin = (revenue minus COGS) / revenue; operating margin = operating income / revenue; pre-tax margin = pre-tax income / revenue; net margin = net income / revenue.
• Return metrics: Return on Assets (ROA) = net income / total assets; Return on Equity (ROE) = net income / stockholders' equity; Return on Investment (ROI) = gain / cost of investment; ROIC = NOPAT / invested capital (debt plus equity).
• ROA vs ROE differ by leverage: ROA and ROIC strip out leverage, ROE does not.
• EBITDA is NOT cash flow: it ignores working-capital changes, capital expenditures (CapEx), and interest and taxes actually paid.

Asset Turnover and Inventory Methods

• Asset turnover = revenue / total assets. Appears in the DuPont ROE decomposition (ROE = net margin x asset turnover x equity multiplier).
• During inflation, First-In, First-Out (FIFO) sends oldest (lowest-cost) inventory to COGS: lower COGS, higher earnings, higher taxes, newer inventory left on the balance sheet.
• During inflation, Last-In, First-Out (LIFO) sends newest (highest-cost) inventory to COGS: higher COGS, lower earnings, lower taxes (a tax-deferral strategy), older inventory left on the balance sheet.
• LIFO reserve = FIFO inventory minus LIFO inventory (not the other way). Comps often add it back to put both methods on one basis.

Valuation Metrics

• Equity value / market cap = price per share x fully diluted shares. Ignores debt.
• Enterprise Value (EV): $EV = \text{Market Cap} + \text{Total Debt} + \text{Preferred Stock} + \text{Minority Interest} - \text{Cash and Equivalents}$
• EV multiples: EV / EBITDA (workhorse, capital-structure-neutral); EV / Sales (when EBITDA is negative or distorted).
• Equity multiples: P/E = price / EPS; P/CF = price / CFO per share; P/FCF = price / free cash flow per share; P/S = price / revenue per share; P/B (stated vs tangible, tangible strips goodwill and intangibles); P/NAV (REITs, holding companies); PEG = P/E / earnings growth rate.
• Yield/payout: dividend yield = annual dividend / price; payout ratio = dividends / net income; earnings yield = EPS / price.
• Discounted Cash Flow (DCF) = present value of projected free cash flows discounted at WACC, plus terminal value. Dividend Discount Model (DDM) = present value of expected dividends (only for dividend payers). Net Present Value (NPV) = PV of inflows minus PV of outflows (accept if NPV greater than zero). Internal Rate of Return (IRR) = the discount rate that sets NPV to zero (accept if IRR exceeds the hurdle rate or WACC).
• Weighted Average Cost of Capital (WACC): $WACC = \frac{E}{V} \cdot R_e + \frac{D}{V} \cdot R_d \cdot (1 - T)$ where $E/V$ and $D/V$ are capital-structure weights, $R_e$ is cost of equity, $R_d$ is cost of debt, $T$ is the tax rate, and $(1 - T)$ is the tax-shield adjustment on debt only.
• Terminal value: Gordon Growth (perpetuity) = FCF in final year x (1 + g) / (WACC - g); exit multiple = terminal-year EBITDA x exit multiple (preferred in M&A practice).
• Risk inputs: stock volatility (standard deviation of returns) and beta (systematic risk, feeds cost of equity through the capital asset pricing model (CAPM)).
• Accretion/dilution: stock-funded deal is accretive when target P/E is lower than acquirer P/E; cash-funded deal is accretive when the target's after-tax earnings exceed the after-tax interest cost of the debt.

Precedent Transactions and Supporting Filings

• Categories tracked: capital restructurings, use of derivatives (convertibles, warrants), share repurchase programs, tender offers, rights offerings, debt issuance.
• Registration statements: S-1 for an initial public offering (IPO); S-3 for seasoned (already public) issuers; S-4 for M&A and exchange offers.
• DEF 14A (definitive proxy) carries the "Background of the Merger" section, the richest single source for M&A precedent (process, advisor work, board deliberations, competing bids).

Financing Alternatives

• Organizational structures: C corporation (double taxation); S corporation (pass-through, capped at 100 shareholders, one class); LLC; limited partnership; trust; master limited partnership (MLP); REIT (pass-through if 90%+ distributed); private equity fund; government issuers.
• Investor types: mutual funds, hedge funds, venture capital, private equity, QIBs ($100 million, $10 million for broker-dealers, unlock 144A resales), qualified purchasers ($5 million individual / $25 million institutional, unlock 3(c)(7) funds).
• Transaction dimensions: debt vs equity vs hybrid; public vs private; primary (new shares, cash to company, dilutive) vs secondary (existing shares, cash to seller, non-dilutive); IPO vs follow-on vs private investment in public equity (PIPE).
• Going-private/tender analysis: issuer-purchase restriction during a pending third-party tender offer; going-private disclosure (Schedule 13E-3 plus fairness opinion) when the deal drops the class below 300 holders of record or causes delisting; target board files Schedule 14D-9 within 10 business days.

Top Gotchas

• PP&E means property, plant and equipment, not "property, plant and earnings."
• Current ratio includes inventory; quick ratio strips it out. The quick ratio is the tougher liquidity test.
• Free cash flow yield uses market cap (equity), not EV.
• Interest coverage and ROIC both avoid net income: coverage uses EBIT, ROIC uses NOPAT, so financing choices don't distort operating performance.
• EV subtracts cash; net debt also subtracts cash. "EV = market cap + net debt + preferred + minority interest" is the same formula rearranged.
• Stated vs tangible book value (P/B): tangible strips goodwill and intangibles, the tougher number for acquisitive companies.
• The tax shield reduces the cost of debt, not the cost of equity; that is why WACC multiplies only the debt component by (1 minus tax rate).
• DDM only works for dividend payers; a high-growth company that retains all earnings needs a DCF on free cash flows.
• Risk arbitrage is merger arbitrage (long the target, short the acquirer in an announced deal), not general arbitrage.
• Broker-dealer QIB threshold is $10 million, not $100 million.
• 300 holders of record is the standard going-private threshold; the 500 threshold applies only in narrower fact patterns.
• The target board has four Schedule 14D-9 options, not three: recommend acceptance, recommend rejection, remain neutral, or unable to take a position.
• Going private (issuer or affiliate is the buyer, files Schedule 13E-3) vs issuer-purchase restriction during a third-party offer (a behavior restriction, not a schedule). Do not confuse them.

One-Breath Recap

This unit is the analytical engine of the 49% Function 1: build three linked financial statements (net income ties to all three, cash ties out to the cash flow statement), then run liquidity, profitability, and leverage ratios where the tested traps are which denominator strips out leverage (ROA and ROIC yes, ROE no) and which metric subtracts cash (net debt, and therefore EV). Value the company three ways: comparable companies on live trading multiples, precedent transactions on past deal multiples that carry a control premium (so they price higher), and a DCF where free cash flows discount at WACC (tax shield on debt only) plus a terminal value that is 60% to 80% of the answer. Nail accretion/dilution direction (stock-funded is accretive when target P/E is below the acquirer's) and Enterprise Value (add debt, preferred, minority interest, subtract cash), then wire in the ownership filings (13D active, 13G passive, 13F institutional), the financing menu (QIB $100 million, going-private below 300 holders, Schedule 14D-9 within 10 business days), and this fourteen-section beast answers itself.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Analysis and Evaluation of Data unit for the complete lesson.