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Lehrstuhl für Allgemeine Betriebswirtschaftslehre / Rechnungslegung Financial Statement Analysis and Valuation Prof. Dr. Bernd Hüfner Summer semester 2014

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Page 1: Financial Statement Analysis and Valuation - uni-jena.de · PDF fileFinancial Statement Analysis and Valuation ... • Penman, Financial Statement Analysis and ... Financial Statement

Lehrstuhl für Allgemeine Betriebswirtschaftslehre / Rechnungslegung

Financial Statement Analysis and Valuation

Prof. Dr. Bernd Hüfner

Summer semester 2014

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Financial Statement Analysis and Valuation 1 Prof. Dr. Bernd Hüfner

Course Content (I)

Objective: How to use financial statements and accounting information to value a company‘s equity or share prices respectively?

The course aims to answer the question by dealing with the following three topics: I. Framework for Business Analysis und Valuation II. Business and Accounting Analysis Tools III. Prospective Analysis with Valuation

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Financial Statement Analysis and Valuation 2

Course Content (II)

Chapters 1. Conceptual Basis 1.1 Introduction 1.2 Framework for Business Analysis und Valuation 2. Analysis Tools 2.1 Strategy Analysis 2.2 Accounting Analysis 2.3 Financial and Ratio Analysis 3. Prospective Analysis 3.1 Forecasting Methods 3.2 Valuation Methods

Prof. Dr. Bernd Hüfner

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Financial Statement Analysis and Valuation 3 Prof. Dr. Bernd Hüfner

Course Organisation (I)

Lecturer:

Prof. Dr. Bernd Hüfner Phone: 03641 / 943150 Internet: www.wiwi.uni-jena.de/rele

Assistant:

Dipl.-Kfm. Axel Eismann Phone: 03641 / 943154 Mail: [email protected]

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Financial Statement Analysis and Valuation 4 Prof. Dr. Bernd Hüfner

Course Organisation (II)

Wednesday, 12:00 – 14:00 Uhr, SR 3.07: lecture Thursday, 14:00 – 16:00 Uhr, SR 2.06: tutorial Test for Diploma-students • No test at the end of the lecture series/ no credit-point test! • Test as part of final diploma-exams

Test for Master-students • at the end of the lecture series Test for „AMUS“ • at the end of the lecture series Additional credits for successful working with case studies: up to 4 credits as bonus for the final test Test: tba.

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Financial Statement Analysis and Valuation 5 Prof. Dr. Bernd Hüfner

Course Organisation (III)

Teaching components

1. Lecture

Regular interactive control of comprehension • Clarification of open questions and quotations

2. Tutorial

Interactive exercises which take individual initiative for granted Dealing with few exercises from Palepu et al. (2010): • Control of comprehension and discussions of open questions • Doing exercises • Working with case studies

3. Self-study of recommended and further literature

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Financial Statement Analysis and Valuation 6 Prof. Dr. Bernd Hüfner

Literature

Key recommendations • Palepu / Healy / Peek, Business Analysis and Valuation - IFRS Edition, current

edition, London. • Penman, Financial Statement Analysis and Security Valuation, International

Edition, current edition, New York. • Easton, P. D. / McAnally, M. L. / Fairfield, P. / Zhang, X.-J. / Halsey, R. F., Financial

Statement Analysis & Valuation, Cambridge Business Publishers, current edition. Further reading • Baetge / Kirsch / Thiele, Bilanzanalyse, Current Edition, Düsseldorf. • Coenenberg, Jahresabschluss und Jahresabschlussanalyse,

Current Edition, Stuttgart. • Koller / Goedhart / Wessels, Valuation: Measuring and Managing the Value of

Companies, Current Edition, New York. • Cottle / Murray / Block, Graham and Dodd’s Security Analysis, Current Edition,

New York et al. • Ballwieser/Hachmeister, Unternehmensbewertung – Prozess, Methoden und

Probleme, aktuelle Auflage, Stuttgart. Additional literature will be presented within the particular chapter!

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Financial Statement Analysis and Valuation 7

Metacoon

• Log on at: http://metacoon.uni-jena.de (without www)

• Your username and password is the same as for „Friedolin“ resp. „URZ“

• Access the room: „Analyse der Rechnungslegung und Bewertung“

• Password for the room: announced separately

• Password for the documents: announced separately

Prof. Dr. Bernd Hüfner

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Financial Statement Analysis and Valuation 8 Prof. Dr. Bernd Hüfner

1 Contents

Introduction 1.1.1 Motivation

1.1.2 Fundamentals of Financial Accounting

1.1.3 Introduction to Company Examples

1.1.4 Approach of Fundamental Analysis Literature: Penman (2013), Financial Statement Analysis and Security Valuation, p. 3-16.

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Financial Statement Analysis and Valuation 9

1.1.1 Analyst Recommendation: Hennes & Mauritz ”Sell“ (I)

Prof. Dr. Bernd Hüfner

“We disagree with the market and expect H&M's gross margin to contract over time, given growing low end price competition in combination with cost inflation and unfavourable currency trends. Our EPS estimates are now 2%, 7% and 8% below consensus for 2012/14E and we cut our target price to SEK200 (220), reiterating our 3/UP rating. Fundamental Valuation: Underperformed Current Share Price: SEK 210 6-month Price Target: SEK 200” Daniel Ovin equity analysts at Cheuvreux (Nov. 19 2012) https://www.cheuvreux.com/dl.aspx?filter=172395

What is the current share price of H&M?

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Financial Statement Analysis and Valuation 10

1.1.1 Analyst Recommendation: Hennes & Mauritz ”Sell“ – Share price performance since recommendation

Prof. Dr. Bernd Hüfner

http://www.finanzen.net/chart/HennesMauritz_AB_%28HM,_H&M%29 (Zugriff: 25.02.2014)

Price Target: SEK 200

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Financial Statement Analysis and Valuation 11

1.1.1 Analyst Recommendation: Hennes & Mauritz (current)

Prof. Dr. Bernd Hüfner

Current analyst recommendations and revisions on H&M (08.05.2013)

http://www.reuters.com/finance/stocks/analyst?symbol=HMb.ST (25.02.2014)

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Financial Statement Analysis and Valuation 12 Prof. Dr. Bernd Hüfner

1.1.1 Motivational and Inspirational Quotes

“Millions of shares of business firms are traded every day on the world's stock markets. The investors who buy and sell these shares ask themselves: Am I trading at the right price? What are the shares really worth?“ Penman (2010), p. 3.

“How does one assess how much to pay for a stock and what is the role of accounting in that assessment?” Penman (1992), p. 465.

„Risk comes from not knowing what you’re doing.” Warren Buffet, American magnate, investor, and CEO of Berkshire Hathaway, in: Kaiser (2006), p. 144 „Risk comes from not understanding what you are reading in financial statements.” Kaiser (2006), p. 144

“How does one estimate the expected future payoffs to be valued?” Fama (1996), p. 247

"There is nothing so dangerous as the pursuit of a rational investment policy in an irrational world." John Maynard Keynes.

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Financial Statement Analysis and Valuation 13 Prof. Dr. Bernd Hüfner

1.1.1 Target Setting: At the End of the Course you should know…

• the role of financial statements in determining firms’ values

• what determines a firm’s value • how to pull apart the financial statements to get

at the relevant information • the relevance of cash flow and accrual

accounting information • how to assess the quality of the accounting • how to identify and adjust accounting distortions • how ratio analysis aids in valuation • how to do business forecasting • how to use different valuation models • how to calculate P/E and price-to-book ratios

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Financial Statement Analysis and Valuation 14 Prof. Dr. Bernd Hüfner

1.1.2 What is Financial Accounting?

In general: Conceptual design, environment and usage of corporate information systems

Provision of information-systems to external stakeholders • Financial statements • Other obligatory reports • Voluntary disclosure

Information-systems for internal users (e.g. management) • Capital budgeting • Cost and performance

accounting

Accounting

Financial Accounting Managerial Accounting

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Financial Statement Analysis and Valuation 15 Prof. Dr. Bernd Hüfner

1.1.2 What is Financial Accounting?

Financial accounting measures, classifies, and summarizes in report form business activities and that information which relate to the enterprise as a whole for use, primary by external parties.

Elements of financial statements: • Balance sheet

• Income statement

• Statement of owner´s equity

• Cash flow statement

• Segment reporting

• Notes

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Financial Statement Analysis and Valuation 16 Prof. Dr. Bernd Hüfner

1.1.2 Some Users of Firms’ Financial Information

• Equity Investors - Investment analysis - Management performance

evaluation • Debt Investors

- Probability of default - Determination of lending rates - Covenant violations

• Management - Strategic planning - Investment in operations - Evaluation of subordinates

• Employees - Security and remuneration

• Intermediaries - Investment analysis - Enhance credibility of financial

information • Litigants

- Disputes over value in the firm • Customers

- Security of supply • Governments

- Policy making - Regulation - Taxation - Government contracting

• Competitors

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Financial Statement Analysis and Valuation 17 Prof. Dr. Bernd Hüfner

1.1.2 Investors are supposed to be the primary users of financial statements on capital markets “The objective of general purpose financial reporting1 is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.” IFRS CF.OB7

Describe the decision-situations and the informational requirements to financial accounting of: • a fundamental free-float investor/shareholder • a debt capital provider (bank)!

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Financial Statement Analysis and Valuation 18 Prof. Dr. Bernd Hüfner

1.1.2 Financial Accounting as Informational Institution

Basic problem • Separation between creator and recipient of accounting

(agency-related frictions) • Problem of managerial influence on accounting information

(earnings management) • Requirement of institutional and/or contractual solution

Complementary relation between accounting and other information systems • Existence of alternative (real-time) information sources • Relative competitive advantage of accounting in disciplining other

available information through reliability (information hygiene)

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Financial Statement Analysis and Valuation 19 Prof. Dr. Bernd Hüfner

1.1.2 Institutional Frame of Accounting (I) C

orpo

rate

Gov

erna

nce

Business transactions

Transformation and aggregation based on accounting principles/rules

Management‘s (legal) discretion within the given accounting system

Financial Accounting Additional information (voluntary disclosure,

ad-hoc report, …)

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Financial Statement Analysis and Valuation 20 Prof. Dr. Bernd Hüfner

1.1.2 Institutional Frame of Accounting (II) C

orpo

rate

Gov

erna

nce

Release

Financial Accounting Additional information (voluntary disclosure,

ad-hoc report, …) Auditing

Audit Committee

Monitoring by committees and panels (e.g. courts, stock exchange)

Decision of recipient

Judiciary

External sources of information

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Financial Statement Analysis and Valuation 21 Prof. Dr. Bernd Hüfner

1.1.2 Dissatisfying Informational Situation

Despite financial accounting and voluntary disclosure, the informational requirements of recipients are usually not satisfied. The informational context is affected by: • Market frictions • Imperfect and incomplete markets • Uncertainty • Bounded rationality of creator and recipient of financial

accounting • Management’s opportunism • Transaction costs

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Financial Statement Analysis and Valuation 22 Prof. Dr. Bernd Hüfner

1.1.2 Business Analysis to Improve Information

Implications • Limited ability to use and understand published information • Imperfect accounting rules and principles • Discretion and forecasting errors • Problem of (legal) earnings management and transaction

structuring

“(…) it is difficult for outside users of financial statements to separate the true information from distortion and noise” Palepu et al. (2013), p. 13

Comprehensive analysis in order to overcome the dissatisfying information situation and to get at manager’s inside information! Note: cost/benefit constraint

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Financial Statement Analysis and Valuation 23

1.1.3 Introduction to company examples (I)

Prof. Dr. Bernd Hüfner

“The parent company H & M Hennes & Mauritz AB is a limited company domiciled in Stockholm, Sweden. The Group’s business consists mainly of sales of clothing, accessories, footwear, cosmetics and home textiles to consumers.” [GB (2012), S. 56.]

„Industria de Diseño Textil, S.A. domiciled in Spain. The principal activity of which consists of the distribution of fashion items, mainly clothing, footwear, accessories and household textile products. Inditex carries out its activity through various commercial formats such as Zara, Pull & Bear, Massimo Dutti, Bershka, Stradivarius,Oysho, Zara Home and Uterqüe.” [GB (2012), S. 137.]

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Financial Statement Analysis and Valuation 24

1.1.3 Introduction to company examples (II)

Prof. Dr. Bernd Hüfner

Hennes & Mauritz H & M AB • Headquarter in Stockholm (Sweden), first Hennes store 1947 in Västerås • Retailer, sells trendy, affordable products and is able to respond quickly to

changing trends by maintaining short production and lead times • Main competitor: Inditex • Key figures 2011/2012: 120 799 million SEK turnover, 23,4 million SEK EBITDA,

72.276 employees, listed at Stockholm Stock Exchange

Industria de Diseño Textil, S.A. • Headquarter in Arteixo (Spain), founder Amancio Ortega Gaoana started clothing

manufacture, 1975 first Zara store • Textile, design, manufacturing, distribution, different brands for different target

groups • Competition: H & M, GAP, Benetton • Key figures 2011: 13.793 million € turnover, 3.257 million EBITDA, 109.512

employees, listed on stock exchanges of Madrid, Barcelona, Bilbao and Valenci

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Financial Statement Analysis and Valuation 25

1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet – Assets (I)

Prof. Dr. Bernd Hüfner

production factors

Mitt

elve

rwen

dung

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Financial Statement Analysis and Valuation 26

1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet – Assets (II)

Prof. Dr. Bernd Hüfner

Total resources/ investing

Mitt

elve

rwen

dung

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Financial Statement Analysis and Valuation 27

1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet – Equity

Prof. Dr. Bernd Hüfner

Owner claim on resources M

ittel

herk

unft

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Financial Statement Analysis and Valuation 28

1.1.3 Annual Report 2011/12 of H&M in Detail Balance Sheet –Liabilities

Prof. Dr. Bernd Hüfner

Non-owner claims on resources

Total financing

Mitt

elhe

rkun

ft

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Financial Statement Analysis and Valuation 29

1.1.3 Annual Report 2011/12 of H&M in Detail Income Statement

Prof. Dr. Bernd Hüfner

Goods and services provided to customer

Costs incurred to generate revenues

Bottom line Net income

Profit generated by operations (EBIT)

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Financial Statement Analysis and Valuation 30

1.1.3 Annual Report 2011/12 of H&M in Detail Other Comprehensive Income

Prof. Dr. Bernd Hüfner

Bottom line Net income

Total non-owner change in equity

Gains and losses not recognized in the income statement

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Financial Statement Analysis and Valuation 31

1.1.3 Annual Report 2011/12 of H&M in Detail Cash Flow Statement (I)

Prof. Dr. Bernd Hüfner

Cash flows from operating activities

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Financial Statement Analysis and Valuation 32

1.1.3 Annual Report 2011/12 of H&M in Detail Cash Flow Statement (II)

Prof. Dr. Bernd Hüfner

Cash flows from investment activities

Total Cash

Cash flows from financing activities

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Financial Statement Analysis and Valuation 33

1.1.3 Annual Report 2011/12 of H&M in Detail Statement of Changes in Equity

Prof. Dr. Bernd Hüfner

Sources of equity change

Accounts under equity

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Financial Statement Analysis and Valuation 34

1.1.3 Articulation of Financial Statements (I)

Prof. Dr. Bernd Hüfner

Identify and explain the main financial statements and understand their links across time (articulation)! What relationships can be derived from the articulation of financial statements? How does information flow among financial statements?

Balance Sheet Beginning of period

Income Statement

OCI

Cash Flow Statement

Statement of Equity Changes

Balance Sheet End of period

Easton et al. (2010), S. 1-10

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Financial Statement Analysis and Valuation 35

1.1.3 Articulation of Financial Statements (II)

Prof. Dr. Bernd Hüfner

Easton et al. (2010), S. 2-20f

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Financial Statement Analysis and Valuation 36

1.1.4 Investment Styles and Fundamental Analysis

Prof. Dr. Bernd Hüfner

Investment style: Approach, mindset, or philosophy, under the influence of which investors frame their expectations

“Method of analyzing information, forecasting payoffs from that information, and arriving at a valuation based on those forecasts.” (Penman (2010), S. 84)

Relies on the “intrinsic value” of a stock and thus challenges stock market prices for a potential mispricing

Problem: laborious

Valuation on the basis of historical price movements and patterns Chart and statistical analysis

Fundamental Analysis Technical Analysis Others

• Passive • Intuitive

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Financial Statement Analysis and Valuation 37 Prof. Dr. Bernd Hüfner

1.1.4 Market Efficiency and its Implications for Investment Styles “A market in which prices always ‘fully reflect’ available information is called ‘efficient’.” Fama (1970), “Efficient Capital Markets: A Review of Theory and Empirical Work”, JoF, pp. 383-417.

• Market efficiency is related to a specific quantity of information

• Fama (1970) distinguishes between three different stages of market efficiency

Weak form efficiency: Past price information

Semi-strong efficiency: Public, available information

Strong efficiency: All information (public and private)

Discuss the investment styles within the context of market efficiency!

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Financial Statement Analysis and Valuation 38 Prof. Dr. Bernd Hüfner

1.1.4 The interrelated sequential Process of Fundamental Analysis (Penman 2010)

Industry Analysis

Business/ Strategy Analysis

Financial Statement Analysis

Fore- casting

Valuation + Decision

Valuation model

1.Know the firms products 2.Know the technology required to

bring the product to the market 3.Know the firm’s knowledge base 4.Know the competitiveness of the

industry 5.Know the political, legal, regu-

latory, and ethical environment

1.Reformulation/ adjustments to financial statements

2.Profitability and growth analysis

3.Assessment of accounting quality

1.Specify Payoffs

2.Forecast Payoffs

1.Reduction of forecasts to one number

2.Adjustment for time value of money and risk

Penman (2010), S. 85f.

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Financial Statement Analysis and Valuation 39 Prof. Dr. Bernd Hüfner

1.1.4 Questions that Fundamental Investors Ask

Coca-Cola had a price-to-book ratio of 6.5 in 2005. Why is its market value so much more than its book value?

Yahoo! had a market capitalization of 44 billion in 2005. What future sales and profits would support this valuation?

Dell Computer traded at 87.9 times earnings in 2000. Historically, P/E ratios have averaged about 14. Is Dell’s P/E ratio too high? Would one expect its price to drop?

What growth in earnings is required to justify a P/E of 87.9?

Ford Motor Co. traded at a P/E of 5.0 in 2000. Is this too low?

Google went public in 2004 and received a very high valuation in its IPO. How would analysts translate its business plans and strategies into a valuation?

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Financial Statement Analysis and Valuation 40 Prof. Dr. Bernd Hüfner

1.1.4 Tenets of Sound Fundamental Analysis

• One does not buy a stock, one buys a business • When buying a business, know the business • Value depends on the business model, the strategy • Good firms can be bad buys • Price is what you pay, value is what you get • Part of the risk in investing is the risk of paying too much for a stock • Beware of paying too much for growth • When calculating value to challenge price, beware of using price in the

calculation • Stick to your beliefs and be patient; prices gravitate to fundamentals,

but that can take some time

Penman (2010), S. 19.

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Financial Statement Analysis and Valuation 41

1.1.4 Example: Discounted Cash Flow Valuation for H&M

Prof. Dr. Bernd Hüfner

SEK (million) 2008e 2009e 2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017e

Sales 89.314 101.461 115.158 129.553 145.747 163.966 184.462 207.519 233.459 262.642

EBITmargin 23,8% 24,0% 24,1% 24,1% 24,0% 24,0% 24,0% 24,0% 24,0% 24,0%

NOPAT 15.436 17.654 20.121 22.636 25.360 28.530 32.096 36.108 40.622 45.700

Free Cash Flow

12.977 14.156 17.328 19.282 20.939 23.556 29.268 30.159 33.929 38.171

Discount Rate 10,6 %

Total PV to 2017

141.109

PV of Terminal Value

176.600

NV of Net Interest-Bearing Debt

19.041

Total DCF to Equity

336.482

Number of Shares

828

Value per Share

406,6 SEK Quelle: Equity Research Jyske Bank, Consumer Discretionaries, 28 March 2008,

https://jyskebank.com/wps/wcm/connect/d0197e804d0c48ac984a9af6968f215c/268990_280308HM1q08analyse.pdf?MOD=AJPERES&CACHEID=d0197e804d0c48ac984a9af6968f215c

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Financial Statement Analysis and Valuation 42 Prof. Dr. Bernd Hüfner

Check yourself

• Why do you see a need for financial accounting? • Explain how potential external users might use financial

statements in their decision making process! • What are the main financial statements and what

information is typically conveyed in each? • Decide the relative weights you would put on the different

statements while evaluating a company! • Which investment styles do you know? • How do financial statements support valuation? • What is market efficiency?