# Equity & Credit Analysis: Key Concepts and Techniques | CFA Level I FSA

In this article, we’ll delve into the world of equity and credit analysis. We’ll explore valuation ratios, segment reporting, and forecasting models to help you better understand the intricacies of financial analysis.

## Valuing Equities: Ratios and Quantities

Equity analysis evaluates a company’s performance and values its equity to assess its investment attractiveness. Analysts use various methods, including valuation ratios and per-share quantities, to achieve this goal.

### Valuation Ratios

Some popular valuation ratios are:

• Price-to-Earnings (P/E) ratio: Price per share divided by earnings per share (EPS). It indicates how much an investor pays for each dollar of earnings.
• Price-to-Cash Flow ratio: An alternative to P/E ratio, as net income can be more susceptible to manipulation.
• Price-to-Sales ratio: Useful when earnings or cash flow is negative; calculated by dividing price per share by sales per share.
• Price-to-Book (P/B) ratio: Indicates market judgment about the relationship between a company’s required rate of return and its actual rate of return.

### Per-Share Quantities

Per-share quantities include earnings per share (EPS), which can be expressed as Basic EPS and Diluted EPS. Other per-share measures include cash flow per share, EBITDA per share, and dividends per share.

## Dividend-Related Quantities

Dividend-related quantities help in valuing equities:

## Industry-Specific Ratios

Different industries have unique ratios that are considered important for analysis. For example:

• Retail industry: Growth in same-store sales, sales per square foot.
• Service companies: Revenue per employee, net income per employee.
• Regulated industries: Capital adequacy, cash reserve ratio, liquid asset ratio, net interest margin.

## Credit Analysis Ratios

Credit analysis assesses a company’s ability to service and repay its debt. Some key ratios used in credit analysis are:

## Segment Reporting

Segment reporting helps analysts evaluate conglomerates by breaking down financial data into individual business or geographic segments. Useful ratios that can be computed from segment data include segment margin, segment return on assets (ROA), segment turnover, and segment debt ratio.

## Financial Analysis Techniques: Integration and Forecasting

Analysts integrate the results of ratio and common-size analysis with other data to build models for forecasting future performance. Such data includes analyst assumptions and judgments, as well as economic and industry data.

### Pro Forma Financial Statements

Forecasts can be presented in the form of pro forma financial statements, which are widely used in financial forecasting and obtaining external financing.

### Examining Variability of Financial Outcomes

Analysts often use three methods to examine the variability of financial outcomes around point estimates:

1. Sensitivity Analysis: Also known as “what-if” analysis, it shows the range of possible outcomes as specific assumptions change.
2. Scenario Analysis: Based on specific scenarios, it yields a range of values for financial statement items.
3. Simulation: Uses computers to generate a distribution of values for outcomes based on repeated random selection of values for key variables. Monte Carlo simulation is a common technique.

And there you have it! We’ve covered equity and credit analysis, segment reporting, and various techniques for financial analysis. With this knowledge, you’re well-equipped to tackle the world of financial statement analysis.

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