Library/CFA (Chartered Financial Analyst)/JuiceNotes 2024: Equity (CFA Level I)/Company Analysis: Past and Present

Company Analysis: Past and Present

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Company Analysis Framework and Reporting5 min

The analysis process begins with examining the company's past and present performance, which serves as the foundation for understanding industry context and forecasting future performance. The initial research report is a comprehensive document that communicates the analyst's recommendation (Buy/Sell/Hold) and the rationale behind it. Key sections include the business model description, competitive positioning (using frameworks like Porter’s Five Forces), financial analysis of historical data, valuation estimates, ESG considerations, and material risks.

Key Points

Company analysis is the base of the forecasting pyramid.
Reports include recommendations, business descriptions, and risk factors.
ESG considerations include ownership structure and compensation.

Business Models and Revenue Analysis6 min

Analysts must deconstruct a firm's business model into components such as products/services, customer base, sales channels, and pricing strategies. Revenue analysis leans heavily on determining a firm's pricing power. Companies with high pricing power can raise prices without losing sales volume and can pass on cost increases to customers. This is typical of differentiated products, whereas companies in purely competitive markets are price-takers. A top-down revenue analysis moves from identifying the total market to specific valuation integration.

Key Points

Business model components: Products, Customers, Channels, Pricing, Resources.
Pricing power is evidenced by stable margins despite rising costs.
Top-down analysis involves market identification and segmentation.

Operating Profitability and Cost Structures7 min

Costs are categorized by nature (investing, financing, operating) and by behavior (fixed vs. variable). Operating costs are the primary focus, often split into Cost of Goods Sold (COGS) and SG&A. Economies of scale occur when unit costs drop as output rises, while economies of scope arise from sharing resources across multiple products. The Degree of Operating Leverage (DOL) measures the sensitivity of operating profit (EBIT) to sales changes. A higher proportion of fixed costs leads to a higher DOL, meaning profits are more volatile relative to sales.

Key Points

Fixed costs generally remain constant; variable costs change with output.
Economies of scale lower unit costs through increased volume.
DOL = Contribution Margin / EBIT.

Leverage and Working Capital8 min

Financial leverage (DFL) introduces the impact of debt; it measures how EBIT changes translate into Net Income (or EPS) changes. High interest expenses increase DFL. Combined leverage (DTL or DCL) multiplies DOL and DFL to show the total impact of sales changes on Net Income. Working capital management is assessed via the Cash Conversion Cycle and the Net Working Capital to Sales ratio. Sources of capital include operations and issuances, while uses include CapEx, dividends, and debt reduction.

Key Points

DFL = EBIT / EBT.
DTL = DOL x DFL.
Cash Conversion Cycle measures the time to convert investments into cash.
Negative working capital implies suppliers are funding operations.

Questions

Question 1

In the FinTree Company and Industry Analysis Framework, which component serves as the foundational layer?

Company Analysis: Past and Present

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