Uploaded by kevinbracker on 28.06.2012

Transcript:

This is the third and final video in our three part sequence on looking at

financial ratios

In the first video what we did is

took a look at

Pepsi's income statement, balance sheet, and statement of cash flows

from the guided tutorial handout

and again those financial statements are available online through Google docs

if you don't have the full handout

We gathered the necessary data to calculate our ratios

things from the balance sheet

income statement

statement cash flows

as well as a few extra items that we would need for some of our

ratios.

So in the second

video, we went through take a look at the liquidity ratios -- things like the current

and quick ratio;

asset management ratios such as inventory turnover or total asset turnover;

and then

the debt management ratios things like

total debt to total assets or times interest earned.

In this third video we're going to take a look at profitability ratios

as well has

market value ratios.

Let's go ahead and start with some of our profitability ratios. We've got

several different ratios that we're going to use to take a look at profitability.

The first looks at the gross profit margin.

Gross profit margin looks at just how much is left over

after paying for our cost of goods sold. So we take sales minus cost of goods

sold

divide by our sales

and record that as percentage.

So we go to our dataset.

We need that sales data

Sales are $66.504 billion

Remember all these values are in billions of dollars for Pepsi

and they come from the 2011 financial statements

So our gross profit margin

is equal to 66.504

Then we need to take out the cost of goods sold.

Cost of goods sold is $31.593 billion

and divide again by the sales which was $66.504 billion

So then we get our calculator

Go ahead and punch those values in 66.504

minus 31.593

five nine three

Divided by 66.504

and that gives us a gross profit margin of 52.49 percent.

And again, typically we don't want to write that down as a decimal, we want to write it down as a

percent

So 52.49%

as our gross profit margin

Gross profit margins like

all of our profit margins are going to vary quite a bit from industry to industry

In order to make comparisons such as is this a good number or is it a bad number

what we really need to do is evaluate it to you industry standard. So we can

compare it to the industry average,

compare it to some of the major competitors

Another way to look at it is see what's happened over time --

trend analysis.

Has it been declining over the last few years in which case it's not as good

Or has it been trending up over the last few years in which case that same number will

look a little bit better.

As with all our ratios, context is key. We have to think about what the number means

and what is the story behind it as much as the actual number itself.

Next up we have our operating profit margin,

which pulls out not only our cost of goods sold but also our operating

expenses

Let's go ahead and calculate that

Operating profit margin

We need our operating income

Now sometimes you'll just have earnings before interest in taxes

and use that is operating income but in Pepsi's case they have both in operating

income and and earnings before interest in taxes, so if we've got that operating

income let's go ahead and use it

$9.633 was our operating income

and remember that's in billions

and our sales again

were $66.504 billion

Again,

we want to express that value as a percent so we're going to take

9.633

divided by 66.504

and that gives us 14.48 percent

for our operating profit margin

Now notice that's quite a bit below our gross profit margin. That's going to be the

case you're operating profit margin, because it pulls out more expenses

should always be below the

gross profit margin

and again we need that same context comparing to industry average or looking at

trends over time

to determine if that 14.48% is a good or bad number.

Our next way to describe profit margins

is the net profit margin

and this is probably the most commonly cited way to measure profit margin,

sometimes people just refer to it as profit margin

and not even bother with the net

strictly talking about profit margin

but because we have a gross and operating profit margins here

I want to make sure we clarified here we're talking about net profit margin

This is just net income --

what's left over after all our expenses.

Not just our cost of goods sold or operating expenses but also pulling out any taxes,

interest, all the expenses. What's left over as the bottom line

So our net profit margin -- we need net income

and I just realized in my collecting the data that was one piece of information

that I forgot to capture

So let me go back to the income statement for Pepsi

I've still got that handy

The net income

was

down here -- net income applicable to to common shares

for Pepsi

And remember these numbers are in thousands so that is $6.443 billion

So let me go ahead and add that that to my

Gathering the Data sheet

Income for Pepsi

$6.443 billion

So now I can use that to

calculate my net profit margin

$6.443

over my sales

and we used that for our last couple ratios but just a reminder sales were

$66.504 billion

Do that calculation

6.443

divided by 66.504

gives us a net profit margin of 9.69%

Again, good or bad is all relative

the number itself doesn't tell us a whole lot. We've got to put it in the

context. Compare it to what Coca-Cola is doing; compared it to what Pepsi has done over

the last few years

Ideally we want to see that

trending up and better than the industry average. Now that's not going to happen all

the time, but that's the ideal situation we would like to see.

Different industries are going to have very different profit margins.

Retailers tend to have lower profit margins. Companies like software

companies often will have higher profit margins

That's going to vary a lot based on industry. That's why we really need

the context.

Then we've got return on assets

All these other

margins that we've been calculating and profitability ratios have been using sales as the

denominator.

Now we're going to change it assets.

How well are we doing at using our assets to generate profits or net income.

In a way this is kind of like our asset management ratios but now instead of

using sales in the numerator

we're focusing on our assets.

How well are we doing at generating profits are net income

from those assets?

So our ROA

is equal to our net income,

which remember was $6.443 billion

divided by our assets

total assets from the balance sheet

$72.882 billion

Go ahead and do the calculation

6.443

divided by 72.882

And again we want to express that as a percent

so Pepsi's return on assets is 8.84%

Now our last profitability ratio

is going to be return on equity

which looks at how well the company is doing at generating net income based

on owners' equity

We want to be a little bit careful there

(the focus is going in and out -- hopefully that will fix it)

We want to be a little bit careful here with return on equity

because

this is not necessarily what the equity costs the new shareholder. This is what

the equity is

based on the accounting statements, kind of a book value measure

of

owners equity instead of a market value measure.

So return on equity is definitely useful information of how well the company is using

the shareholders assets, but for a new shareholder

or even existing shareholders thats looking at

what is the value of my

investment right now,

this common equity doesn't capture it as well as the current stock price.

So let's go ahead and calculate the return on equity

Return on equity is just our

net income again

$6.443 billion

divided by our

common equity, sometimes referred to has shareholders equity or owners equity.

And that is $20.704 billion.

And do our calculations

6.443

divided by 20.704

and that gives us 31.12%.

Now I want to come back to our

return on assets

and talk about that relative to our return on equity.

Remember our return on assets was 8.84%

The return on equity is 31.12% -- quite a bit of difference.

What drives that difference between the return of on assets and return on equity?

And I just realized that I need to

write ROE there and not ROA.

But, the return on equity

is always going to be greater than or equal to the return on assets

The reason that

is true is because it comes from financial leverage.

The greater the amount of debt financing we use,

the greater this differential is going to be.

If you remember from our second video when we were talking about Pepsi's

total debt to total assets ratio, we mentioned that was quite high. They were using quite a bit

of leverage.

That's why we see that huge differential here

between Pepsi's return on equity of 31.12%

and the return on assets of 8.84%

That's why I said we don't want to think of

told that the high total assets as bad

instead think of it is a risk level and as we increase our risk

we increase the potential

return from that investment.

So Pepsi is using lots of financial leverage to magnify their potential

returns to shareholders.

That's a riskier strategy but for a company like Pepsi that's got a very

stable, predictable cash flow stream, it's not quite as risky as it would be for some

other companies such as auto manufacturers

or maybe a pharmaceutical company that's

trying to develop some new

medication streams, things like that.

That covers our profitability ratios. The next thing that we want to look at is our market

value ratios.

Market value ratios are a way to look at it from the investors' perspective.

How expensive are how cheap is the stock?

What am I I earning as far as the dividend yield? Things like that.

The first ratio we're going to look at is the price-earnings ratio

Or oftentimes just referred to as the PE ratio or PE multiple

That PE

is just the market price

divided by the earnings per share -- so what is the current stock price

divided by the earnings per share

Now you can get the stock price from any number of places Yahoo!Finance, CNBC.com,

your broker,

Wall Street Journal (online.wsj.com). There are tons of places that have that data.

I went ahead and used a historical price for this

from the end of 2011,

but you'd probably want to use whatever your current financial statements are and

a current stock price for this calculation.

Our market price is $66.35

and now we need the earnings per share

Now, we're not given the earnings per share in this calculation

instead we have the number of shares outstanding and our net income

So we have to calculate the earnings per share.

Earnings per share

is just the net income

divided by the

number of shares

Now a little side note --

technically it's a little more complex than that. We want to use the net income

available to common shareholders

and divide by a weighted average number of shares outstanding.

But for the purposes of our class we're just going to use a simple net income divided by

number of shares

So our net income was $6.443 billion

and the number of shares outstanding we had as 1.564 billion

Go ahead and calculate our earnings per share now

6.443 divided by 1.564

And that gives us an earnings per share of $4.12

So plug that into our

PE ratio formula

Stock price divided by earnings per share

Take the stock price of $66.35

divided by $4.12 earnings per share

And that gives us a PE ratio of 16.10

PE ratios are on of the more commonly cited ratios associated with stocks and stock

valuation

but it's a very difficult one to interpret. A lot of people

are a little bit

to lax with their PE ratio

and just say "Well high is expensive,

low is cheap."

But there are so many things that go into the price-earnings ratio

Is this last year's earnings or is it next year's forecast earnings?

How fast are earnings growing?

Lots of different things are going to affect that

And so we want to be really careful. Interest rates are going to affect that

PE ratio. The company's risk levels can affect that PE ratio.

So we want to be very careful when you're interpreting PE as to what the high or

expensive PE is or a low or cheap

PE is.

The next ratio we're going to look at is the market to book ratio

sometimes people refer to it as a market value-book value (MV/BV) ratio.

And again this is one that's going to

require us to take a couple intermediate steps

where you go ahead and start with the market price

which like we saw from our previous example is $66.35

But now we need the book value

Book value per share is just the owners equity or common equity

divided by the number of shares outstanding

So common equity divided by number of shares outstanding is going to give us our

book value

Go ahead and calculate

or go ahead and find our common equity

Common equity was given as 20.704 billion

and the number of shares outstanding

same as it was when we calculated our earnings per share

1.564 billion

shares outstanding

Go ahead and do that calculation

20.704

divided by 1.564

and that's going to give us a book value per share of $13.24.

That's the accounting value of the company

So from the balance sheet that's what the accountants are telling us each

share of stock is worth

Now that tends to understate the true value of the company. There are several reasons

for that.

One accounting does not do a great job of capturing the true value of intangible

assets

That's not necessarily a fault of accounting, its by design. They try to be a

little more conservative.

Also accounting is based on historical cost for assets

not necessarily the market value those assets. So in most cases

book value is going to be less than the financial value or market value of the

company.

So our market value to book value ratio will often be greater than one

How much greater is going to depend a lot on characteristics of the company.

So let's go ahead and calculate. We've got $66.35

divided by $13.24

gives us a market value

to book value ratio of 5.01

Again, does that mean the stock is cheap

or does that mean the stock is expensive?

It's hard to tell

That market value to book value ratio,

all else equal, the higher it is the more expensive the stock is.

The cheaper it is the more of a value the stock is. Sometimes you hear people refer

to value stocks versus growth stocks. Value stocks typically have a low

market value to book value ratio.

But just like the PE ratio there's lots of things that are going to

affect that.

Growth rates,

intangible assets, risk of the company -- all those things are going to determine

what that fair market value to book value should be

Lots of people use this ratio, but you want to be real careful in understanding

exactly what the ratio is telling us

and why you think that ratio is high or low

instead of just arbitrarily deciding well that's higher than the market

average

that's high

or that's lower the market average that's a cheap stock.

Our last ratio we're going to calculate is the dividend yield.

Dividend yield just looks at dividends per share divided by the market price.

Typically there are two ways investors turn rates of return from stocks. One is through

dividends and one is through capital gains.

Capital gains depends on the change in the stock price from when you purchase

it to when you sell it.

Well since we don't know what we're going to be able to sell it at, it's hard

to know exactly what our capital gains is

but our dividend yield is just based on what is the current value of the stock

and the dividends per share. How much are we making for owning the share divided

by its current value.

So when we calculate the dividend yield

we need to find the stock's dividends --

and here we had $2.03 on our dividends per share from

Pepsi

and our market price

$66.35

Go ahead and calculate our dividend yield

$2.03 dividend divided by the $66.35 stock price

gives us a dividend yield of 3.06%.

Again is that good or bad?

The answer is it depends

Some companies, typically older companies or more stable

cash cow type companies

like a Pepsi are going to be able to pay out higher dividends. They are going to have a

little bit higher dividend yields

Typically

faster growing companies that are reinvesting a lot of their money into

the company are going to have lower dividend yields

But it's also going to vary depending on management strategy. Some companies prefer to use

stock buybacks return money to investors instead of pay dividends.

Lots of different things are gonna affect that dividend yield.

3.06%, as of the time recording that, is a

reasonably good dividend yield. It's not at the highest end; it's not at the

lowest end. It's a little bit above the current market average

and that makes sense for a company like

Pepsi. Again this is not your total rate of return from owning the stock but just

one component. The capital gain, or potentially capital loss if stock price

goes down, is also going to

determine your rate of return.

This should give you an overview of some of the ratios out there; how to calculate

them as well as some interpretation of the ratios. How do we use those ratios.

Again this is not designed to be a

complex, overly-sophisticated look at financial statement analysis.

Ratios are hard to use because there's a lot that goes into it.

Context is everything a lot of times people take a very simplistic view of

ratios --

think "well I can calculate some numbers and determine whether or not this is a

good company or a bad company from management or an investment perspective."

It's not that simple.

We have to know the story behind the numbers.

Ratios provide us a starting point they don't really give us -- this is a good

company or this is a bad company

Instead they say "Hey, here's something that needs to be looked at in a little more

detail...does this make sense?"

And they give us a starting point

to begin our analysis

financial ratios

In the first video what we did is

took a look at

Pepsi's income statement, balance sheet, and statement of cash flows

from the guided tutorial handout

and again those financial statements are available online through Google docs

if you don't have the full handout

We gathered the necessary data to calculate our ratios

things from the balance sheet

income statement

statement cash flows

as well as a few extra items that we would need for some of our

ratios.

So in the second

video, we went through take a look at the liquidity ratios -- things like the current

and quick ratio;

asset management ratios such as inventory turnover or total asset turnover;

and then

the debt management ratios things like

total debt to total assets or times interest earned.

In this third video we're going to take a look at profitability ratios

as well has

market value ratios.

Let's go ahead and start with some of our profitability ratios. We've got

several different ratios that we're going to use to take a look at profitability.

The first looks at the gross profit margin.

Gross profit margin looks at just how much is left over

after paying for our cost of goods sold. So we take sales minus cost of goods

sold

divide by our sales

and record that as percentage.

So we go to our dataset.

We need that sales data

Sales are $66.504 billion

Remember all these values are in billions of dollars for Pepsi

and they come from the 2011 financial statements

So our gross profit margin

is equal to 66.504

Then we need to take out the cost of goods sold.

Cost of goods sold is $31.593 billion

and divide again by the sales which was $66.504 billion

So then we get our calculator

Go ahead and punch those values in 66.504

minus 31.593

five nine three

Divided by 66.504

and that gives us a gross profit margin of 52.49 percent.

And again, typically we don't want to write that down as a decimal, we want to write it down as a

percent

So 52.49%

as our gross profit margin

Gross profit margins like

all of our profit margins are going to vary quite a bit from industry to industry

In order to make comparisons such as is this a good number or is it a bad number

what we really need to do is evaluate it to you industry standard. So we can

compare it to the industry average,

compare it to some of the major competitors

Another way to look at it is see what's happened over time --

trend analysis.

Has it been declining over the last few years in which case it's not as good

Or has it been trending up over the last few years in which case that same number will

look a little bit better.

As with all our ratios, context is key. We have to think about what the number means

and what is the story behind it as much as the actual number itself.

Next up we have our operating profit margin,

which pulls out not only our cost of goods sold but also our operating

expenses

Let's go ahead and calculate that

Operating profit margin

We need our operating income

Now sometimes you'll just have earnings before interest in taxes

and use that is operating income but in Pepsi's case they have both in operating

income and and earnings before interest in taxes, so if we've got that operating

income let's go ahead and use it

$9.633 was our operating income

and remember that's in billions

and our sales again

were $66.504 billion

Again,

we want to express that value as a percent so we're going to take

9.633

divided by 66.504

and that gives us 14.48 percent

for our operating profit margin

Now notice that's quite a bit below our gross profit margin. That's going to be the

case you're operating profit margin, because it pulls out more expenses

should always be below the

gross profit margin

and again we need that same context comparing to industry average or looking at

trends over time

to determine if that 14.48% is a good or bad number.

Our next way to describe profit margins

is the net profit margin

and this is probably the most commonly cited way to measure profit margin,

sometimes people just refer to it as profit margin

and not even bother with the net

strictly talking about profit margin

but because we have a gross and operating profit margins here

I want to make sure we clarified here we're talking about net profit margin

This is just net income --

what's left over after all our expenses.

Not just our cost of goods sold or operating expenses but also pulling out any taxes,

interest, all the expenses. What's left over as the bottom line

So our net profit margin -- we need net income

and I just realized in my collecting the data that was one piece of information

that I forgot to capture

So let me go back to the income statement for Pepsi

I've still got that handy

The net income

was

down here -- net income applicable to to common shares

for Pepsi

And remember these numbers are in thousands so that is $6.443 billion

So let me go ahead and add that that to my

Gathering the Data sheet

Income for Pepsi

$6.443 billion

So now I can use that to

calculate my net profit margin

$6.443

over my sales

and we used that for our last couple ratios but just a reminder sales were

$66.504 billion

Do that calculation

6.443

divided by 66.504

gives us a net profit margin of 9.69%

Again, good or bad is all relative

the number itself doesn't tell us a whole lot. We've got to put it in the

context. Compare it to what Coca-Cola is doing; compared it to what Pepsi has done over

the last few years

Ideally we want to see that

trending up and better than the industry average. Now that's not going to happen all

the time, but that's the ideal situation we would like to see.

Different industries are going to have very different profit margins.

Retailers tend to have lower profit margins. Companies like software

companies often will have higher profit margins

That's going to vary a lot based on industry. That's why we really need

the context.

Then we've got return on assets

All these other

margins that we've been calculating and profitability ratios have been using sales as the

denominator.

Now we're going to change it assets.

How well are we doing at using our assets to generate profits or net income.

In a way this is kind of like our asset management ratios but now instead of

using sales in the numerator

we're focusing on our assets.

How well are we doing at generating profits are net income

from those assets?

So our ROA

is equal to our net income,

which remember was $6.443 billion

divided by our assets

total assets from the balance sheet

$72.882 billion

Go ahead and do the calculation

6.443

divided by 72.882

And again we want to express that as a percent

so Pepsi's return on assets is 8.84%

Now our last profitability ratio

is going to be return on equity

which looks at how well the company is doing at generating net income based

on owners' equity

We want to be a little bit careful there

(the focus is going in and out -- hopefully that will fix it)

We want to be a little bit careful here with return on equity

because

this is not necessarily what the equity costs the new shareholder. This is what

the equity is

based on the accounting statements, kind of a book value measure

of

owners equity instead of a market value measure.

So return on equity is definitely useful information of how well the company is using

the shareholders assets, but for a new shareholder

or even existing shareholders thats looking at

what is the value of my

investment right now,

this common equity doesn't capture it as well as the current stock price.

So let's go ahead and calculate the return on equity

Return on equity is just our

net income again

$6.443 billion

divided by our

common equity, sometimes referred to has shareholders equity or owners equity.

And that is $20.704 billion.

And do our calculations

6.443

divided by 20.704

and that gives us 31.12%.

Now I want to come back to our

return on assets

and talk about that relative to our return on equity.

Remember our return on assets was 8.84%

The return on equity is 31.12% -- quite a bit of difference.

What drives that difference between the return of on assets and return on equity?

And I just realized that I need to

write ROE there and not ROA.

But, the return on equity

is always going to be greater than or equal to the return on assets

The reason that

is true is because it comes from financial leverage.

The greater the amount of debt financing we use,

the greater this differential is going to be.

If you remember from our second video when we were talking about Pepsi's

total debt to total assets ratio, we mentioned that was quite high. They were using quite a bit

of leverage.

That's why we see that huge differential here

between Pepsi's return on equity of 31.12%

and the return on assets of 8.84%

That's why I said we don't want to think of

told that the high total assets as bad

instead think of it is a risk level and as we increase our risk

we increase the potential

return from that investment.

So Pepsi is using lots of financial leverage to magnify their potential

returns to shareholders.

That's a riskier strategy but for a company like Pepsi that's got a very

stable, predictable cash flow stream, it's not quite as risky as it would be for some

other companies such as auto manufacturers

or maybe a pharmaceutical company that's

trying to develop some new

medication streams, things like that.

That covers our profitability ratios. The next thing that we want to look at is our market

value ratios.

Market value ratios are a way to look at it from the investors' perspective.

How expensive are how cheap is the stock?

What am I I earning as far as the dividend yield? Things like that.

The first ratio we're going to look at is the price-earnings ratio

Or oftentimes just referred to as the PE ratio or PE multiple

That PE

is just the market price

divided by the earnings per share -- so what is the current stock price

divided by the earnings per share

Now you can get the stock price from any number of places Yahoo!Finance, CNBC.com,

your broker,

Wall Street Journal (online.wsj.com). There are tons of places that have that data.

I went ahead and used a historical price for this

from the end of 2011,

but you'd probably want to use whatever your current financial statements are and

a current stock price for this calculation.

Our market price is $66.35

and now we need the earnings per share

Now, we're not given the earnings per share in this calculation

instead we have the number of shares outstanding and our net income

So we have to calculate the earnings per share.

Earnings per share

is just the net income

divided by the

number of shares

Now a little side note --

technically it's a little more complex than that. We want to use the net income

available to common shareholders

and divide by a weighted average number of shares outstanding.

But for the purposes of our class we're just going to use a simple net income divided by

number of shares

So our net income was $6.443 billion

and the number of shares outstanding we had as 1.564 billion

Go ahead and calculate our earnings per share now

6.443 divided by 1.564

And that gives us an earnings per share of $4.12

So plug that into our

PE ratio formula

Stock price divided by earnings per share

Take the stock price of $66.35

divided by $4.12 earnings per share

And that gives us a PE ratio of 16.10

PE ratios are on of the more commonly cited ratios associated with stocks and stock

valuation

but it's a very difficult one to interpret. A lot of people

are a little bit

to lax with their PE ratio

and just say "Well high is expensive,

low is cheap."

But there are so many things that go into the price-earnings ratio

Is this last year's earnings or is it next year's forecast earnings?

How fast are earnings growing?

Lots of different things are going to affect that

And so we want to be really careful. Interest rates are going to affect that

PE ratio. The company's risk levels can affect that PE ratio.

So we want to be very careful when you're interpreting PE as to what the high or

expensive PE is or a low or cheap

PE is.

The next ratio we're going to look at is the market to book ratio

sometimes people refer to it as a market value-book value (MV/BV) ratio.

And again this is one that's going to

require us to take a couple intermediate steps

where you go ahead and start with the market price

which like we saw from our previous example is $66.35

But now we need the book value

Book value per share is just the owners equity or common equity

divided by the number of shares outstanding

So common equity divided by number of shares outstanding is going to give us our

book value

Go ahead and calculate

or go ahead and find our common equity

Common equity was given as 20.704 billion

and the number of shares outstanding

same as it was when we calculated our earnings per share

1.564 billion

shares outstanding

Go ahead and do that calculation

20.704

divided by 1.564

and that's going to give us a book value per share of $13.24.

That's the accounting value of the company

So from the balance sheet that's what the accountants are telling us each

share of stock is worth

Now that tends to understate the true value of the company. There are several reasons

for that.

One accounting does not do a great job of capturing the true value of intangible

assets

That's not necessarily a fault of accounting, its by design. They try to be a

little more conservative.

Also accounting is based on historical cost for assets

not necessarily the market value those assets. So in most cases

book value is going to be less than the financial value or market value of the

company.

So our market value to book value ratio will often be greater than one

How much greater is going to depend a lot on characteristics of the company.

So let's go ahead and calculate. We've got $66.35

divided by $13.24

gives us a market value

to book value ratio of 5.01

Again, does that mean the stock is cheap

or does that mean the stock is expensive?

It's hard to tell

That market value to book value ratio,

all else equal, the higher it is the more expensive the stock is.

The cheaper it is the more of a value the stock is. Sometimes you hear people refer

to value stocks versus growth stocks. Value stocks typically have a low

market value to book value ratio.

But just like the PE ratio there's lots of things that are going to

affect that.

Growth rates,

intangible assets, risk of the company -- all those things are going to determine

what that fair market value to book value should be

Lots of people use this ratio, but you want to be real careful in understanding

exactly what the ratio is telling us

and why you think that ratio is high or low

instead of just arbitrarily deciding well that's higher than the market

average

that's high

or that's lower the market average that's a cheap stock.

Our last ratio we're going to calculate is the dividend yield.

Dividend yield just looks at dividends per share divided by the market price.

Typically there are two ways investors turn rates of return from stocks. One is through

dividends and one is through capital gains.

Capital gains depends on the change in the stock price from when you purchase

it to when you sell it.

Well since we don't know what we're going to be able to sell it at, it's hard

to know exactly what our capital gains is

but our dividend yield is just based on what is the current value of the stock

and the dividends per share. How much are we making for owning the share divided

by its current value.

So when we calculate the dividend yield

we need to find the stock's dividends --

and here we had $2.03 on our dividends per share from

Pepsi

and our market price

$66.35

Go ahead and calculate our dividend yield

$2.03 dividend divided by the $66.35 stock price

gives us a dividend yield of 3.06%.

Again is that good or bad?

The answer is it depends

Some companies, typically older companies or more stable

cash cow type companies

like a Pepsi are going to be able to pay out higher dividends. They are going to have a

little bit higher dividend yields

Typically

faster growing companies that are reinvesting a lot of their money into

the company are going to have lower dividend yields

But it's also going to vary depending on management strategy. Some companies prefer to use

stock buybacks return money to investors instead of pay dividends.

Lots of different things are gonna affect that dividend yield.

3.06%, as of the time recording that, is a

reasonably good dividend yield. It's not at the highest end; it's not at the

lowest end. It's a little bit above the current market average

and that makes sense for a company like

Pepsi. Again this is not your total rate of return from owning the stock but just

one component. The capital gain, or potentially capital loss if stock price

goes down, is also going to

determine your rate of return.

This should give you an overview of some of the ratios out there; how to calculate

them as well as some interpretation of the ratios. How do we use those ratios.

Again this is not designed to be a

complex, overly-sophisticated look at financial statement analysis.

Ratios are hard to use because there's a lot that goes into it.

Context is everything a lot of times people take a very simplistic view of

ratios --

think "well I can calculate some numbers and determine whether or not this is a

good company or a bad company from management or an investment perspective."

It's not that simple.

We have to know the story behind the numbers.

Ratios provide us a starting point they don't really give us -- this is a good

company or this is a bad company

Instead they say "Hey, here's something that needs to be looked at in a little more

detail...does this make sense?"

And they give us a starting point

to begin our analysis