Alan Cring Productions in association with the Emergent Light Studio presents
the Illinois State Collegiate Compendium, academic lectures in business and economics.
This is Business Finance, FIL 240 for spring semester 2024.
Today, ratio analysis. Now there will be a few resources that I will point you to that I've put in your Canvas files folder that will give you some help and I'll show you those after we look at the numbers for the day.
And we should be getting pretty good at this. Sir, is this a bull or a bear day?
A bull.
It's not a massive bull, but it's a decent bull. As you can see, the Dow is up half a percent and then as usual, the S&P 500 higher risk portfolio is up more at about.84 percent and the most riskiest is the NASDAQ, which would be up.93 percent today.
Now that is a very typical pattern. It just represents that risk return sort of relationship and we can sort of see that almost all the time. Once in a while it's not there and sometimes we can ask why it's not working the way it normally would.
But going on from there, now keep in mind, this would mean that investors are pulling money off the sidelines and they are buying stocks or as we say in a fancy way, they're going long equities.
You hear me use the word long? That means we're going long. That means we're buying as opposed to selling, which is going short, but that's a little bit trickier to use that term here.
I'll explain that later in another class. But the investors are going long. They're pulling money off the sidelines and going long equities.
And so if we run over here and see what's happening with the bonds, what we see is the bond is just bouncing around a little bit up on the yields, which would mean that the prices are down.
So there's a little bit of selling off in the bond market. Nothing major right now, but the bond yields are up a little bit. Only two basis points. That's hardly anything at all.
But anyway, going back over here, we'll get some stuff, physical stuff. Crude oil, as I have said before, it seems to like that 72 to 79 trading area and it's just sort of bounced around, went up a little bit,
but it's still near the lower end of that trading range at 73, 79. And we hope it's over the next couple of weeks, they'll be reflected in a little bit lower gas prices, but that's kind of hard to say.
I'll talk about that again later. Now you see that gold has done hardly anything at all. It's bounced around, but it's staying pretty much flat as a pancake.
So investors are not putting any money into the metals at all, which generally tends to indicate that there's pretty good confidence.
Most of what's happening is happening in the stock market, which when investors are putting money into stock, that means that they're bullish, not just on those stocks, but they're bullish overall on the economy.
And then going over here, just have a quick look, the Nikkei hardly did anything. By the end of the day there yesterday, which was last night, our time, it was down a little bit.
You can see there was a drop, the bears, but then the bulls came right back and put it near where it started.
By the end of the day it was a little bit down, but nothing hardly at all that you could talk about.
And then London had a day that just sort of trickled downward, just minor bad news through the day, and that just kept pushing the stocks down and down and down.
If you look ahead, I think there are, no, they may still, they're still maybe trading, I don't know. But as you can see, that did not come over to our side of the world.
We started out up and we had a little bit of a lull there, but in the last hour or so the bulls have picked up speed and they're pushing up again on equities.
Well, decent day. Looking at a few just to see what's happening here and there in the world.
My favorite whipping boy, Tesla, should be up a little bit today. Yeah, it's up actually pretty good today.
And moving over to, what else would be worth looking at today? One of the technology stocks, AMD.
Oh, it's up decent today too. Now, the one problem is getting involved in these stocks, you're buying, you're putting a pretty good chunk of change into buying even one share.
That's the price of a share over $170. And so these are those kinds of stocks that are maybe not the ones that you want to put your money into.
Although these days you can buy fractional shares of stocks if you want to. I think there's still a little bit of a fee for fractional shares.
But you could do it, if you had $50 you could buy about a third of a share if you wanted to do that.
But there are cheaper stocks that you can go into if you want to buy whole shares of stocks.
There are a lot of stocks out there that are good price. For example, I could look at Verizon.
Down a little bit today, but that's more in the price range that you might consider to be something you could afford.
Marathon Oil, MRO, $22. So there's plenty out there. Now, how much? Oh, stop it.
Now, it depends on, you're trying to make a nice round portfolio, a nice well-balanced portfolio.
You buy in the single share of one stock, it's not a good idea.
But if you're doing that so that you can accumulate different stocks over a period of time and you're doing it one stock at a time, well then, that's not so bad.
Let's look over here. Today we are going to be talking about U.S. Steel.
And I'm going to show you the links how you can get to the financial statements.
And at the end of the day, I'm going to upload the U.S. Steel, what I've done, to your spreadsheets folder in Canvas, in File, in Canvas,
so that you can bring that, download that one if you didn't keep up or check it against the one that you're doing.
I strongly recommend that you do this with me as we go along and make, if you can, make some notes about why I'm doing things as I'm doing them,
why I'm arranging my calculations in certain ways and all that.
But look at U.S. Steel right off the bat. We can see that it's, as we said on, saw on Monday, it's a risky stock.
Probably somewhat undervalued. It's profitable, pays a dividend.
Okay, those are all good signs. It means that, well, the risk is a little bit scary there.
But overall, it's not a bad place. Now let me show you something here.
In Canvas, this is your view of Canvas when you go in.
In Files, there are a couple of things I want to show you here.
First things first, this, we're going to be doing financial ratios here and today, and I'll spill this a little on Monday too, I suppose.
Well, where the heck is it? Oh, financial, huh, where are the financial analysis ratios? Is that it?
I can't, oh, I see, it's not, is that it? No. Huh, it's not showing. Well, I didn't, oh, well, anyway, links.
This one is the one that we want to start with anyway. I'll have to upload that and I'll send out an announcement that I've gotten it uploaded.
This is that site that I showed you earlier, that the SEC, this is how you link right over to the Edgar Filings filings.
And you might even want to put that as a bookmark because we'll be using that on a number of occasions through the rest of the semester.
But you're right there where you can get to your financial statements.
And again, I'm repeating what I did on Monday. You put in the ticker symbol of the company you want.
You'll get a drop-down menu and you'll choose the one that's what you're looking for and it's usually the one right at the top, United States Steel Corp.
Now from there, you've got these different forms the company files. You click on the plus sign by the 10K.
And then from there, don't click on the text hyperlink, click on the little box that says filing for that 10K right there.
Now you click on the filing and we're not going to go through all these paperwork.
We're just going to go over on the landing page on the left, just a little above center, there's a big, there's a blue button that says interactive data.
Click on that.
And from there, mercifully, we will get to this hyperlink that says view Excel document.
Now that's right on the left side, just a little above center, and it's above the bounded black box.
It says view Excel document and that will download your Excel financial statements for U.S. Steel Corporation.
And there they are. All there for you.
And this is what I did on Monday. I'm just getting a running start here so that you see everything as it happens.
Now a couple of things. The first thing you're going to do, you want to get the sheets that are what you need all together, one after the other.
Now we've got the consolidated statement of operations. That's a fancy name for the income statement.
So we'll leave that where it is. Now we're going to try to find the balance sheet. That's not it. There it is, consolidated balance sheet.
Now you click and hold it and then you can bring it over so that it's sitting right next to your income statement.
You'll see especially why this is important as I go on today.
Now we're going to find the statement of cash flows. There it is.
So now I'm going to click and hold that one and get that over there next to my balance sheet, just to the right of it.
See that little arrow that tells you you're going to land it? And there they all are.
Now I'm going to do something here. You don't need to know how to do this. But if I hold down the control key, I'll highlight the worksheets that I want.
And I'm going to, if you highlight more than one sheet, whatever you do to any one of those sheets, you do it to all of them.
So I'm just going to make them a little bigger so you can see them better.
And then you click somewhere else on another worksheet and they'll unhighlight.
And this is the part where this is essentially you're learning how to use a modern calculator, step by step.
And again, as I said in the last lecture, you should be using your keyboard and not your mouse to execute, to do things.
But because this is a teaching environment, you wouldn't be able to see me doing the keystrokes to do things. So that's why I use the mouse.
And partly also because I can't remember all the keystrokes myself anymore.
Okay, now one thing that you're probably going to want to do. Oops, I didn't mean to do that.
Right here, usually I do it between the income statement and the balance sheet. Just a little bit to the right of where the income statement moves over to the balance sheet.
I'm going to right click. I'm going to insert a worksheet.
And I'm going to call that worksheet calculations.
This is your scratch sheet. This is where you actually do the stuff that you have this Excel sheet loaded to do.
As I said in finance, the financial statements themselves really aren't our final product.
It's what we do with them and then what we interpret what we have done with them.
That's what matters here. So I got to expand this sheet.
Okay, so here we go. I'm just going to take you through the meat grinder with some of the things that we do.
The first one that we're going to do is calculate. Now this is a dirty calculation.
You can do it much more sophisticated with a lot more calculations.
But the truth be told, I mean, I do it this way unless I really want something unusual.
Here is how you calculate free cash flow. Free cash flow.
Now the first thing you're going to do is you're going to take revenues minus costs.
Now one thing you want to make sure is that those costs include depreciation.
Like I said, some companies don't tell you whether it includes it or not, but we're hoping it will.
Now on your financial statement itself, on the income statement, this should be called Earnings Before Interest in Taxes or Operating Income.
So we don't actually have to do those numbers. We should be able to pull that mess right off the financial statement as one number, I hope, I think.
Okay, so then we're going to take that times one minus the tax rate.
A quick side note. This number right here.
Over many, many decades, that top marginal tax bracket has changed. It started out as 90% over a century ago when taxes first started being collected.
It went down in the, I think it was during the Kennedy administration in the early 60s, it went down to 70%.
Then in the early 1980s, during the Reagan administration, it was brought all the way down to the top bracket being 39%.
Republican administration cut taxes and all that.
Interestingly enough though, just as a slight side warning, the actual tax rate by statute, by law or whatever, is for the largest companies possible,
isn't 39%, wasn't 39%, it was a little lower, and I believe it was 35%. The 39%, oddly enough, applied to companies that weren't quite the biggest.
That was just kind of an odd thing. There's all kinds of excuses you can find for why it was that way.
But we traditionally, most of the time that I taught, you just use a.39 there, one minus.39.
Then, however, in 2017, the top marginal tax bracket was dropped all the way down to 21%, almost cut in half the tax rate for corporations.
Hence why we are running insane budget deficits and the national debt is accumulating now at a staggering rate.
We essentially cut off one of the most important arteries for tax revenues into the federal government by half.
And that will be your problem to figure out how to make that up in the decades to come.
It will have to be made up, but that's your problem.
I'll be in my grave and you won't know where it is, so you won't come there and piss on it.
You've got all the problems we've left you.
But anyway, what you use, unless you're told differently, that T would be a.21.
Okay, now, we have something here.
This revenue minus cost quantity times the quantity one minus T is called NOPAT.
The Net Operating Profit After Taxes.
NOPAT.
Okay, so that is the first thing you do.
Now, with Excel, this is a joke.
And you'll see why I arrange the sheets the way I do, so that you can do these calculations just really rapidly.
It's really not hard at all.
You just have to know where to find each thing scrambling around a little bit.
But you don't even have to type in any numbers.
Pretty much, you don't have to type in any numbers.
Okay, now, this animal right here.
You'll notice on an income statement, you would have an intermediate line, the interest expense.
And we don't use that in finance because what we care about is operating.
Interest expense is not an operating expense.
It's not something that makes the product happen.
So interest expense is not something that we care about.
That will be something that we consider once we've seen the free cash flow.
We'll say, well, can they afford their interest payments and all that?
Can they afford a dividend? Can they do this?
It's not part of the operation, the blood that makes the company alive.
So we don't put that in there.
We jump right from operating income right down to taking out the taxes with that T there and getting what we want, which is called NOPAT.
We're not finished, though.
The next thing we'll have to do here is we're going to have to add back in the depreciation expense.
It was taken out here, but we don't want to fix it there because it actually reduces how much we pay in taxes.
It's called a tax shield.
Okay, so but we have to add it back in because it really didn't happen.
There wasn't any check written to depreciation expense.
It's just that over here it protects us from a little, it protects our revenue from a little taxes.
Okay, so now the next thing we're going to have to do, and then we're going to minus.
Now make sure that you put this in parenthesis.
There are two last pieces, and these two can be, one of them can be a whopper.
The other one can be pretty noticeable.
The first one is the capital expenditures of the company, the capital expenditures.
Now I'm going to have to say something about this.
There's something you have to remember and put this somewhere in Excel.
You have to do something with the financial statements, a little thing.
And then there's one more, plus the change in net operating working capital.
This looks more complicated than it actually is.
Excel makes this pretty straightforward.
Let me explain net operating working capital.
This is a change in net operating working capital.
Now first of all, net operating working capital is your current operating assets
minus your current operating liabilities.
You're saying, well William, why didn't you put the O in those?
It's because of this.
Almost everything that will be in current assets, in current liabilities on that financial statement will be operating.
If there's something that's not, it's going to be probably pretty trivial.
So we just do current assets minus current liabilities.
That's net operating working capital.
You notice that if current liabilities are more than current assets, this will be negative.
If current assets are bigger than current liabilities, it will be positive.
So the change in net operating working capital is the current net operating working capital,
Nowc sub-zero, minus the last periods, net operating working capital, Nowc sub-1.
You'll see how to do this.
I'm going to give you a moment to catch up.
I can't emphasize this enough.
This used to be kind of a pain in the butt, getting each of the numbers written down
and then taking out the calculator and doing this, that, and the other thing.
Now it's just knowing where to call the different numbers.
And that's why I have this nice calculation sheet here.
Now if I do go too fast, just shoot me with a tranquilizer dart and I'll slow down.
I'm trying to give you enough time so that you can absorb this.
But remember, we're still doing really lightweight Excel here.
It might look a little sophisticated, but it's just basic Excel stuff.
Okay, so here we go.
Now, I'm going to put a little title here at the top of this.
Free cash flow.
Okay, here we go.
Now, I'm going to do a couple of years here.
Let me check something here real quick.
Okay, I'm going to do 2023.
I'm going to put this on row three, starting in column B, 2023,
and then in column C, 2022, and then in column D, 2021.
Now, we're going to start doing some, we're going to build the model, as we say.
So we're going to need a few things along the way here.
Now, the first thing, if you look here, I need revenue minus costs.
That's nothing but operating income.
So operating income.
I'm just going to go over here and grab it.
I put operating income in cell A5.
In cell B5, I'm going to do the core calculation, equals.
And then I'm going to go here.
This stuff is on the income statement.
And I'm going to say, okay, where's operating income?
It's EBIT.
They call it EBIT.
Right there it is, $7.99.
I'm going to click on it.
There you go.
Now, the tax rate is 21%.
You can either put.21 or 21%.
I put the 21% because it's visually a little more elegant.
Okay, so, NOPAT.
Well, it says NOPAT is operating income equals operating income times,
open parenthesis, 1 minus the tax rate.
Close the parenthesis.
And there's your dinner, 631.21.
Now, I'm going to take that and drag it over my ass.
Oh, see what I did?
I forgot to make the 21% an absolute reference.
So I'll put it on the B6 and hit F4 and it's an absolute.
Okay.
Oh, I have to skid this one over too.
Sorry about that.
Not paying attention at all.
Skid this one over.
There you go.
So we got NOPAT for the three years.
Now, the next thing we're going to have to do is get the depreciation expense.
Depreciation expense.
And we'll go over equals.
And that one, now if it's not on the income statement,
the best place to get the depreciation expense is from the statement of cash flows.
Because it's right there near the top.
You see it?
And then hit Enter, 916.
Now, what I'm doing here is I am writing formulas that call references.
That's why I put those sheets so close to each other.
So I can jump between them and pull numbers from them
without running around looking for where the heck it is.
I could even drag that one over.
Is that real?
Is that right?
Huh, it was the same for two years.
Okay, so that's done.
Now, what else do we need?
Now, here's the one where you have to be careful.
Capital expenditures.
Now, the capital expenditures, now let me do something here.
Hang on here.
I want to go up here and do something real quick just for your benefit.
I'm going to type here where I got these.
Oh, there it is.
Catch up with me.
Capital expenditures.
I want you to look here for a minute.
You will find capital expenditures under investing activities right here.
Now, you'll notice that there could be other numbers in here.
And some would argue you use the net from investing activities.
But that's not really a good idea because some of those are not operating.
The capital expenditures is definitely operating.
Whatever is under it is probably pretty small anyway.
And it's probably not operating.
It was some financial thing or some investment in another company or something like that.
So now, however, you have to watch out for something here.
This number is put in as a negative in the accounting.
It always will be.
But you don't want that because you're going to subtract it anyway.
So that would mess up your calculation.
So the way we deal with this is with now all these calculations.
I'm going to key in equals and I'm going to type ABS open parenthesis.
That means take the absolute value of what you have in the sheet.
And then I'll go over here and I'll get that capital expenditure,
which is right there, 2576, negative.
Click on it, close the parenthesis and hit enter.
See how it brings it up into the calculation sheet as a positive?
That is the only place you have to remember to do that.
If I'm thinking correctly, there is no other place where you'll run into that little issue.
Now, scoot these over and you'll get all three years of them.
And again, that came from the statement of cash flows.
Now, we're going to have to do a side calculation here.
We're going to get the current assets,
the current liabilities.
Let's try this again. There you go.
And then we're going to get from that the net operating working capital.
So I'm going to get the current assets.
I'm going too fast. Get that in there.
For almost all of you, this is going to just be routine stuff in your lives in business.
Is creating these models, adding stuff to them, interpreting them, all that.
This is just the normal stuff.
And yes, I do recognize that for some of you, this is probably kind of boring,
but it gets to be pretty quick once you're good at Excel.
Okay, so the current assets equals.
We always get those off the balance sheet.
We get their current assets right here, and the current liabilities right here.
Where the heck are the current liabilities?
Oh, there they are.
Okay, and then let me put over here that you get those from the balance sheet.
Try that again.
And if you don't know how I did that, put it on the one you want to copy,
Control C, then put it where you want it to copy to, where you want to paste it,
Control V.
Okay, so the net operating working capital will equal the current assets
minus the current liabilities.
And then you want to take these three, and you're going to copy them over.
You notice that I didn't copy them over to 2021?
The reason is this.
The balance sheet we're working with had only two years.
I'd do it another year, and I'd have an error.
Now, if I were doing this on my own, I'd go and grab that third year, that 2021,
and fill that, the balance sheet in with that.
But for us, I'm not worried about it.
Now, I'll put here calculated.
And what's the name?
And so finally, we can put in the change in net operating working capital,
which will be the net operating capital in the current year
minus the net operating capital one year back.
And you can see that the overall change was negative $912 million.
It's negative, the change.
So in terms of net operating working capital,
did it change for the positive or for the negative?
Did it change for the good of free cash flow or for the bad?
Negative.
You said negative.
You're cheating.
Did it change for the good or for the bad?
For the bad.
I knew you were going to say that.
You were afraid to, but no, it was for the good.
Because net operating working capital went down.
So the net effect of current assets, accounts receivable,
inventories against wages payable, accruals, things like that,
was actually that net operating capital went down.
That freed up.
It's not tied into accounts receivable.
It's not tied to accounts to inventories.
It's actually going down, opens up cash.
Last year, you owed at the end of the year $5,000.
I know, right?
But this year, you owed $8,000 at the end of this year.
No better, because you didn't pay some of your bills, you scoundrel.
You kept some of your money in your pocket.
I did get $2 in the mail the other day.
Wait, what?
Where?
What?
I don't know why.
I just got $2 in the mail.
Dude, what exactly are you doing on this side hustle?
Me, you know, I do mail escort, but that's just me.
I don't make any money at it.
God knows why.
It will go to hell.
But you understand that when your change is negative,
that means that you didn't use some of your money that you had used the year before on net.
So if I...
Let me give you a good example.
Last year, my inventory was about $12,000.
But this year, it was only about $9,000.
What that meant was that I made money off selling some of my stuff, but I didn't replace it.
So I actually freed up money by doing that.
It takes a while to get this in your mind.
God knows I still get confused, but I'm going to copy this over one.
No, I can't because it would have used that year, so I'm stuck here.
Okay, now, end of the game.
We got all the numbers.
Now we can just use the formula.
Oh, let me write this here.
Free cash flow.
This is our holy grail.
This is what we consider not profit.
This is the number that we are looking for.
And it's...
Before I even calculate it, I will tell you that this is actually a number that has to be there.
If it's positive, that means actual cash was left over from all of our operations.
If it's negative, that means that we had to find that cash somewhere to cover our operations.
It had to happen.
This is real money in this one.
So we're going to say free cash flow on cell B14 equals following the formula, we need no pat.
That's right there.
And then we have to add back the depreciation expense right there.
And then we have to subtract, open parenthesis, the capital expenditures plus the change in net operating working capital.
And then we close the parenthesis.
That is all there is.
You see all that legwork I did up there, setting it all up?
That is very common.
You get everything into place, and then the end is just bringing together all the pieces of information that you brought in.
Okay, so I'm going to hit this.
Ouch.
Real negative, if I did my calculations right.
Negative 117 million.
Now again, that's not an abstract number.
The company had to get that.
117 million dollars from somewhere.
It had to.
Because the rest of the accounting numbers said this was spent in real life.
Once we fixed them up and took in things and put things out, the financial statements are saying this happened.
So how did it happen?
They're in the hole, 117 million dollars.
Now let's try it this way.
I'm trying to find someone.
Okay, madam, you.
You have to bring 117 million dollars together.
How are you going to do that?
You look in your pocket.
It's not there.
So what happens? What are you going to do?
Well, yeah, I'll call the parents, you know.
I got some friends up in Chicago who can lend you money, but their collection terms are rather aggressive.
Okay, first place that the company would go is to its retained earnings.
The real version.
In other words, it would go to its long-term.
What did it accumulate in bank accounts?
In its money markets, in its long-term investments, whatever.
It would dig there.
In other words, it would pull what we call internally generated equity.
It would pull out from where it had over many, many years.
U.S. Steel is an ancient company.
It's built up money in, well, capital.
It's built up into investments and into bank accounts, checking accounts, whatever.
That would be the first place it would go to see what to do.
And then the next thing that it would do is it would go to the capital markets.
It could issue bonds, borrow the money.
It could issue stock and bring in new owners.
Those are all places where it can bring in.
It issues new debt.
We will see that in the long-term liability section.
Now, if it draws from its retained earnings, we call that internally generated equity.
In other words, it was earned for the shareholders through its operations.
If it goes and brings in new stockholders by selling them stock,
that's called externally generated equity.
So equity, it can draw from what it has already earned for the shareholders
or it can bring in new shareholders.
That's externally generated.
I'll get into that a little later, but as I've told you before,
I pass through things, try to bring them up informally before I do them formally.
So don't sweat too much about that right now.
But one way or the other, it had to get that $117 million from somewhere
because otherwise it can't...
Okay, look at this $117 million.
There are a couple places where it can't just ignore that.
One thing that's clear, it would have to pay its wages and salaries.
Another thing is clear, it would have to pay its interest expense
because if it doesn't pay its interest expense,
then the debt holders simply liquidate the corporation.
So it's got to get that money together.
It's got to get it together.
And I want you to notice something.
I'm going to come back over here just for a second to Yahoo.
Here's something interesting too.
Let me go back to U.S. Steel here just for one quick little notice.
Do you see that U.S. Steel paid a dividend to its shareholders?
Well, that would have had to come from somewhere too.
Now, why...
Now, remember, if you don't pay your debt holders what you owe them,
interest and principal and all that, they will knock you down.
They'll just end your corporation.
They'll end it right there unless you run to bankruptcy court
and get protection under Chapter 11, which is what would probably happen.
Why would U.S. Steel, it's already in trouble with free cash flow,
it's negative, why would it pay a dividend...
Shareholders, all they can do is cry if you don't give them their dividend.
They can't do anything to you.
It's a bitch at you at the annual shareholders meeting.
Why would they put themselves even more in the hole by giving a dividend?
To encourage more investors.
Oh, very good.
And also...
Here's something.
Okay, sir, turns out you're my son.
Don't ask, okay?
It was a long night and it was Decatur.
Yeah, we'll do it.
Yeah, Travel America truck stop.
Okay.
Every year I give you a Christmas, no, on your birthday,
I give you a $10,000 check.
You've been getting it every year, right?
No, I'm down with you as dad.
Hey, dad.
No, I'm not giving you...
Okay, here.
The thing though is that this year I'm in trouble.
My salary went down the toilet and all of that.
But why would I still give you your $10,000 check?
I'd go to my retirement account, my savings account,
maybe borrow the money, do something,
but I want to make sure you get your $10,000.
Is it because I care about you?
Look at me.
Do I?
No.
But what I want to do is I want to keep your confidence.
That's important.
You're right.
With new investors, I damn well better give them confidence
that an investment in U.S. Steel is a good idea.
But I also want to give my existing shareholders confidence
in my ability to make their investment do well.
That's what dividends, the main purpose of dividends...
Dividends actually are kind of...
And we'll talk about this in the last half of the course.
They are actually kind of illogical.
Why would you give dividends?
We've come up in the last several decades
with the understanding that it's part of signaling theory.
It's a signal that we're in good shape.
The dividend is actually just a confidence measure.
I've seen this in corporate life in many ways
where they don't want trouble.
They don't want bad PR.
It's not so much that it's going to hurt them if the PR comes out,
as much as it is that they want to continue
to give positive signals at all times.
And dividends are a signal, especially to Wall Street.
Well, those Wall Street boys, if you don't give a dividend,
they're going to spank your buttocks.
They are going to sell off their stock
from their holdings in your company.
They're going to squeeze your board of directors.
So you want to make sure that they get their dividend.
And this is what that dividend is about.
That negative $117 million,
that includes that dividend of 20 cents per share
times the number of shares outstanding.
That's part of the problem.
But they are not going to solve that by cutting off the dividend.
They most definitely would not do that.
As a matter of fact, I would speculate
that that 20 cent of share dividend
times the number of shares US Steel has outstanding
is a pretty decent part of that negative $117 million.
But they're not going to cut the dividend.
That's like me not sending you your check.
If I do that, then you're going,
you're not my real dad anymore.
Okay? That's the point.
So anyway, I wanted to put that in there.
That what we're doing here is the real thing.
The net profit, net income, earnings,
whatever you want to call it, that's just a number on paper.
I can show you a number of corporations
have negative net earnings,
but they have positive free cash flow.
I can show you a number of companies.
On paper, they look like they're not doing so well.
Look at their free cash flow. It's doing fine.
I can also show you a lot of companies
that have positive profit, positive earnings,
but they have negative free cash flow.
As a matter of fact, I'll show you one right here.
I've got it on the screen.
Statement of operating income.
Well, look at that. Net earnings.
A positive $895 million.
U.S. Steel on paper is a profitable company for last year.
In real life, U.S. Steel...
What is that calculation?
Has a negative free cash flow.
That's why we care about that number
right there on your screen right now.
Not the profit, the net earnings,
because this one's the one that tells the real story of it.
You'd be surprised at how many people are walking around out there.
They look like they're multimillionaires, billionaires,
but if you look at their free cash flow,
they are in the hole insanely.
They can be in the hole for years and years
because their bankers will just keep propping them up,
and if those bankers say no,
they'll go to less reputable bankers who will say yes,
and they will just keep on rolling,
and everyone will think they're geniuses.
Not that there's any political implications of that, mind you,
but keep that in mind.
You're seeing it right here in real life.
Okay, well that was all kinds of fun.
Now we can go and we can look at these financial ratios.
These drill in on the different components of operations.
Most of these are operating ratios, and for heaven sakes,
the first thing is you've got a sheet.
You can bring it to quizzes with you.
You can bring it to the final, the midterm and the final with you,
as long as you don't write anything else on it.
You've got a note card for that.
Well, of course, and I pulled that up.
Access denied my ass.
Oh, sorry about that.
I get really hurt when I'm told I can't go someplace.
Files.
Let me see if I've got them here.
I know I uploaded them to one class.
Financial ratios.
I'll bet I didn't.
I'll have to go back out here.
I put them in the 190 class.
I'll get them from there.
Files.
Financial analysis.
This will be in yours by this evening with apologies for that.
Let me download that.
There we go.
Wait, what?
Okay.
These, now these are pretty much what the book gives you to.
You've got a page in there.
Now I have one or two in here that aren't in the book.
They're old school, but in just the last couple of years they've become very big again,
and the textbooks haven't caught up.
The one most important I'll point out that is not in the book is called the burn ratio.
You will also hear that called the cash ratio.
It's not in textbooks currently.
Back in the day it was really important,
and like I said in the last few years it's suddenly really big again
because cash management, short-term financial management has become so big these days.
And if you're interested in what can be a rather tediously boring subject,
I do teach an upper level course in cash management.
Your teaching assistant survived that, and he's still sane I think.
So it's, but it's huge.
Cash is king is one of those go-to things in corporate now.
But anyway, other than that, now when I go through these,
you can have, I don't care if you memorize the formulas or not.
That's not the thing.
For us in finance it's saying why did this happen?
Oh, here's a pretty number. Why?
What is this number compared to that same number for another corporation
or for the industry average?
Those are important.
And another thing is also most of these ratios,
it's not a question of whether they're too big or too small.
There are a few exceptions to that.
Most of them are relative, and that's where judgment comes in.
That's why a course like this, I don't probe your judgment too hard,
but I do ask you for a few, think your way through it.
So for example, if I see that a company's inventory turnover ratio has gone up,
okay, why did that happen?
Well, if inventory goes down,
that would tend to make inventory turnover ratio increase.
The denominator of inventory turnover is inventory.
So if inventory goes down, that will increase the inventory turnover ratio.
That's considered a good thing.
If you're turning over all your inventory more times every year,
well, that means that you're selling stuff faster,
you're not keeping as much inventory space, which has costs.
It's a wonderful thing, until it's not.
Here was what went on with that, and this is part of our thinking in these.
Over the past 20 years, getting that inventory ratio up,
you're selling off all your inventory more times every year,
that was considered an ideal thing to do.
Turn it over faster.
We need smaller warehouse space, all that, great stuff.
Until we got to the COVID lockdown, where the supply chains froze up.
With all these companies that were getting rid of inventory real fast,
well, once the supply chains broke, they had no inventory in their warehouses
to put on the shelves.
And suddenly, you were without toilet paper on the shelves of Wal-Mart and Kroger.
You were without other things that would have been there if they'd had larger inventories
as buffers against supply chain disruptions.
So that's the whole point.
Yeah, sometimes a number is the big thing, is get that number to go this way or that way.
Sometimes you can make it go too far.
I'll show you another one here.
This is one, there's a definite no-no number on this one, times interest earned.
This is your earnings before interest and taxes, divided by your interest expense.
So EBIT is how much money that you have first to pay your interest expense.
Well, what would happen if EBIT was a smaller number than what you owed in interest?
That would technically, times interest earned, would be below one.
Practically speaking, you'd be out of business,
because the debt holders would say you didn't pay an interest expense,
and so we're turning you off right now.
That's the end of you.
Real world example of that.
Have any of you ever eaten at a Steak and Shake?
They're overpriced, but they're okay.
They're decent burgers and all that.
Well, it was a couple of years ago.
We were watching that EBIT over interest expense, times interest earned,
and they were coming up on an interest payment, and times interest earned was below one.
Which means they couldn't pay it.
I think it was an interest payment.
They didn't have the money to pay it, according to the number.
Well, that would have meant they were gone.
And somehow they managed to find a way to get the money together to pay that expense,
that interest expense, so they didn't go under.
But that was a classic example.
We saw a train wreck coming at them, and we were all kind of surprised
that they were able to pull it out of the fire like they did.
But those are the kinds of things that we do.
That's a definite no-no.
You don't want times interest earned ever to be less than one.
And I will ask that on a quiz and or an exam.
That's one of those no-nos.
Some of the others, you know, they're here and there.
You have to kind of make your, take your positions on some of them.
But I'll bring up other ones as time goes along.
But let's just do a couple of calculations here.
We notice on this sheet, we break them down into categories.
Profitability ratios, just what they tell us.
Profit, they're related to the profitability, the profit of the earnings of the company.
And then the liquidity.
Remember liquidity?
We want liquidity.
A company needs cash on, needs quick ways to get money together.
But we don't want it to have so much, if you have liquidity too high,
that means you're not putting money into long-term investments
where you could make some extra money.
Money I have in my pocket, if I have a lot of money in my pocket, I'm highly liquid.
But that's also money that's not earning me anything like it would if I put it into stocks and bonds.
So liquidity can be too low, meaning you don't have enough money maybe to pay your bills.
But it can also be too high if you're keeping too much money
that you should be able to, that you should be investing in long-term high-yield assets.
Okay, and then we also have our debt ratios, debt to total assets.
That's called capital structure, but don't worry about that right now.
Asset activity.
How hard are the company's assets working?
Now there are, and so we want to keep an eye on those, obviously.
And then some market value ratios.
Now I won't get through all of these today, but I'll just sort of begin it here.
We can break these down.
The liquidity ratios.
The first one would be your current ratio.
The next one would be your quick ratio.
You'll hear me call this one its old name, the acid test.
And that last one, the burn ratio, otherwise called the cash ratio.
And I won't go too far, but I do want you to see it's just like I did above.
You just go and grab the numbers.
So with the liquidity ratios, current ratio is your current assets over your current liabilities.
Equals, and go over here to your balance sheet, your current assets divided by your current liabilities.
Total current liabilities.
There it is.
The quick ratio.
Now that takes all of your current assets.
Total current assets.
But it subtracts out the inventories.
Because inventories really aren't that liquid.
You might get 10 cents on the dollar with a factoring company for your inventories.
So we take it out.
Inventories.
And then divide the result by the current liabilities.
And then the burn ratio is nothing but your cash divided by your...
Because basically at the end of the day, if you really needed to cover all of your current liabilities immediately,
realistically all that would matter is your cash.
A little side note here.
These are multiples, multipliers.
So in other words, this is saying that their current liabilities, current assets,
can cover all of their current liabilities 1.76 times over.
The quick ratio is saying that excluding inventory, which really isn't that liquid,
they could cover their liabilities with their current assets 1.22 times over.
But if all they had was their cash and they had to pay all of their current liabilities,
they could do only about 0.32 of their current liabilities.
Now, are these good or bad?
This is where judgment comes in and I would certainly not ask you.
First thing I would do is I'd say, well, what's their industry average for these?
But aside from that, that's a surprisingly high liquidity.
That's a little bothersome.
And even if you don't count their inventory, they've got an awful lot of liquid assets.
Maybe they could be using some of that to put into long-term investments.
But what the heck is going on here?
As far as just pure cash is concerned, they're actually fairly illiquid.
So that's a little bit of a conundrum.
Now, the next thing that I probably would want to do, did I get all those current assets in there?
Where the heck?
Yeah, I guess, well, that's liquidity.
We usually do those first.
Now, profitability, I'll just do a couple of those real quick here for you.
Profitability, and I'll finish the rest next week.
Gross margin.
Operating margin.
And net margin, I'll just do those.
This is pretty simple to interpret.
You take your gross margin.
Whoops, I forgot.
Tell you what, this is going to take too long.
It's almost the end of the class.
I'll pick it back up on Monday.
That's all I have for you today.
I thank you.