Company Analysis: Past and Present

An insightful and well-written company research report helps investors understand a company and make better investment decisions about the company’s securities. T his module is the first of three that will provide a framework to prepare a company research report by applying methods covered in previous modules to assess a company’s business model, financial performance, and financial position.

• Company research reports analyze a company’s past and present financials, its industry and competitors, and forecast its future financial statements. Reports end with a valuation, an investment recommendation, and investment risks.
• The first step of company analysis requires an understanding of the issuer’s business model, for which analysts rely on both issuer and third-party information sources.
• An understanding of the issuer’s business model and analysis of historical financial statements will allow the analyst to identify key drivers of revenues, profitability, cash flows, and financial position.
• Revenue analysis can be done using a bottom-up or top-down approach. A bottom-up approach breaks down revenues into drivers such as sales volumes and prices, by product line or segment. A top-down approach expresses revenue as a function of drivers such as market share, market size, and GDP growth.
• While a company can change its prices at will, its ability to do so successfully (i.e., not causing a loss of volume) and relative to costs is driven by the company’s pricing power. Pricing power is primarily a function of industry structure and competitive strategy.
• Cost analysis assesses a company’s profitability and working capital management. Analysts calculate and interpret several cost and profitability measures, including gross, operating, and net margins.
• While a fixed versus variable cost analysis is useful, the analysis is often limited by issuer disclosures and accounting standards that emphasize cost reporting by function or nature.
• The degree of operating leverage measures the sensitivity of operating profit to changes in sales. Operating leverage is primarily driven by the f ixed and variable cost composition of the issuer’s operating expenses.
• The degree of financial leverage measures the sensitivity of net income to changes in operating income. Financial leverage is primarily driven by the issuer’s capital structure.