Q&A: Cash Flow, NIM & Spread, P/E, Management Analysis

Modified on July 13, 2018

The current article in this series provides responses related to:

  • Net interest margin & spread
  • Treatment of interest expense / finance charges in cash flow statement
  • Capex and Cash flow from Investing (CFI)
  • Factors that influence P/E ratio of a company
  • Usage of financial projections in assessment of companies
  • Stake sale by promoters
  • Assessing independence of independent directors
  • Operating & financial leverage
  • Tax payout ratio of a company

Query 

Hello Vijay,

Thank you for valuable time and support beginners like me.

I need your clarification about net interest margin (NIM) and interest spread. I try to understand from internet but I couldn’t. Please confirm my below understanding

  • NIM = (Interest Income – Interest Expense) / Interest earning assets

Spread, on the other hand, is the difference between yield and cost of borrowing, where yield is the interest income earned on interest earning assets and cost of borrowing is interest expense charged on interest bearing liabilities.

  • Spread = (Interest Income/ Interest earning assets) – (Interest Expense/ Interest bearing Liabilities)

E.g.

If Interest income = Rs. 150 crore

Interest expense = Rs. 80 crore

Interest earning assets = Rs. 2,250 crore

Interest bearing liabilities = Rs. 3,000 crore

NIM = (150 – 80) / 2250= 3.11%

Spread = (150 / 2,250) – (80 / 3,000)= 4%

Some websites explains spread = (interest earned – interest expenses)

E.g.: interest expenses= 8%, interest earned = 12% Spread= 4%

Thank you again for your support

Author’s Response:

Hi,

Thanks for writing to me!

I am happy that you are trying to understand different key concepts relevant to understanding stocks of different industries and referring to different resources for them.

Different resources would always define different ratios differently as per their preference. From you calculations, I find that you have understood the basic behind NIM/Spread.

Therefore, the first thing that you need to take care while using NIM &/or spread is that before taking the NIM/spread value mentioned on any website/source for granted, you should calculate it on your own from the annual report data and secondly, you should compare any two stocks for NIM/Spread by calculating their values by similar method.

Regards,

Vijay

 

Query

Read: Analysis – Premco Global Limited

Dear Dr. Vijay,

Thank you so much for all the wonderful analysis and in fact the whole website. I have learnt more in the last week reading your blog that I learnt (and apply) during MBA days. I have read most of the articles and have now feel much more confident on stock investing. My perspective has changed totally. For instance, Premco has been on my radar for many months now. I watch the stock price every week to see when I can buy. Now I have done a detailed analysis and feel much more confident on my decision.

I have one question on Premco Global.

I noticed in the cash flow statement, they have a line item called “Financial Expenses.” This particular line item appears both in CFO (as a positive figure) and CFF (as a negative figure). They have been consistently doing this from beginning. Mathematically, it seems like nullifying effect.

Just wanted to make sure this is not some accounting gimmick. I want to understand if this is “conceptually” correct. This reconciles correctly in the P&L as Finance expenses, though. So wanted to get your views.

Many thanks again for all your efforts.

Author’s Response:

Hi,

Thanks for your feedback & appreciation! I am happy that you found the articles useful!

Financial charges pertain to financial activities, therefore, these pertain to cash flow from financing activities (CFF). An investor would appreciate that companies need to deduct financial charges from profits before arriving at net profit after tax (PAT).

As a result, while calculating cash flow from operations (CFO) from PAT/PBT, financial charges are added back to PAT (positive entry) and are deducted from CFF (outflow/negative entry) to classify them correctly in the cash flow statement.

Read: Understanding the Annual Report Of A Company

Hope this clarifies your query!

Regards,

Vijay

 

Query

Thank you! Can we consider capex as close to “Cash from Investing Activity” from the cash flow statement?

Author’s Response:

Hi

Thanks for writing to me!

Capex is not equivalent to cash from investing activities (CFI). Capex is a part of CFI and CFI includes many other elements other than capex.

Regards,

Vijay

 

Query

a} sir, does market’s perception or market price of share increases with increase in eps or is there any other factors involved ?

and

b} can P/E ratio for a company be constant with increase in eps ?

Author’s Response:

Hi,

Thanks for writing to me!

P/E ratio measures how much market is willing to pay for a company. P/E will depend on many factors. Many of these factors are measurable like EPS growth, debt levels etc. how many are subjective like market perception. Therefore, there is no definite answer to your query.

P/E may increase or remain constant with increasing EPS depending upon other factors that influence a company’s performance.

Read: How to do Valuation Analysis of a Company

All the best for your investing journey!

Regards,

Vijay

 

Query

Hi Sir,

I am following your blogs which is very useful in to gain the knowledge in fundamental analysis, but you haven’t use the financial projection of financial data of company, so is it not useful to select the stock in right time ?

Author’s Response:

Hi,

Thanks for writing to me!

I do not rely on future projections. I believe in associating myself with a sound management running a fundamentally good company and riding the investing journey with them. I try not to project earnings 5-10 years down the road. Therefore, I do not use any parameter for analysis based on future values.

Read: How to Conduct Detailed Analysis of Companies

However, I believe that it is a personal choice of the investors to use any parameter she is comfortable. Therefore, if an investor believes that she can predict with reasonable certainty, the future, then she can always use future values for analysis. After all, it’s her own money and she is free to invest it as per her choice. As is said, many roads lead to Rome.

All the best for your investing journey!

Regards,

Vijay

 

Query

Read: How to do Management Analysis of Companies

Hi Sir,

Hope you are doing great. Very educative post. I kind of do not understand your point where you say that it might not always be a negative sign when a promoter sells her stake a little.

My argument is how these rich promoters have a need of a little money for personal reasons.

I would also love to hear your views on what you think of Siddhartha Lal family of reducing the stake in Eicher Motors by 4%.

Thanks!

Author’s Response:

Hi,

Thanks for writing to me!

It is usually not preferable to have the cash parked in bank accounts if an investor can find better productive uses/investment opportunities for it. The same is applicable for investors and promoters alike. Therefore, it is assumed that promoters of good businesses usually have most of their net worth invested in their company and any funds requirement which is more than normal day to day requirement needs to be me through company shares.

I do not track Eicher and therefore do not have any views on Eicher promoters’ stake sale.

All the best for your investing journey!

Regards,

Vijay

 

Query

Read: Analysis – National Fittings Limited

Thank you Dr Vijay,

But I have a doubt. In the management analysis of national fittings ltd, I don’t think that there is a big problem. Obviously, Muthuswami Lognatan (independent director) may not be an independent director in true sense. But the fact that he has stake in many other private co’s of promoters does not stop him from acting as a good director of national fittings ltd.

Moreover, 3 out of 4 directors being close to promoters is only good for the company as they will have an emotional attachment with the company i.e. they will feel that it’s their company.

Loans given as interest free is quite alarming but the company was able to purchase products from these entities for” competitive prices” which in a very small way is a MOAT.

Author’s Response:

Hi,

Thanks for writing to me and sharing your inputs!

I believe that if >=75% of directors are close to promoters/majority shareholder, then any decision/proposal being put forward by promoter would be passed irrespective of merit/suitability of minority shareholders. The decision to outsource the purchase of products might be one such decisions.

Read: Why Management Assessment is the Most Critical Factor in Stock Investing?

Markets have investors having opposite interpretations from same set of information inputs. That makes the market participants take opposite views on the future of the stock and makes the trade (buy and sell) possible at any point in time.

All the best for your investing journey!

Regards,

Vijay

 

Query

Dear Sir,

In the web portals, I find the formulas of Degree of operate leverage, degree of financial leverage of degree of total leverage. I simply want to know what is operating leverage and its, formula to compute. And what is financial leverage and its formula.

I also what to know from you on IRR.

IRR is the rate which makes NPV zero. If a project has IRR on 15% for 5 years means, Its NPV is zero or say the projects Initial cost is equivalent with discounted value of projected cash flow of first 5 years, isn’t it? If so, the future projected cash flow generated by the project from 6th year are the return for the investors of the project?

Please simply educate me or if you have any links of your article on such, please provide. I would be very grateful with you.

Sincerely

Author’s Response:

Hi,

Operating leverage: when fixed costs are high, then with increasing sales, profits increase faster than sales in % and vice versa.

Financial leverage: company boosts its assets by raising additional resources (debt) over its equity

Read: How to do Financial Analysis of Companies

IRR is compared to cost of funds or risk free rate. The higher is the IRR than cost of funds or risk free rate, the more rewarding is the project.

Regards,

Vijay

 

Query

Hi Vijay,

Thank you for the insightful article.

I had a doubt regarding the 30%+ tax rate for the past 4 years. How is that a good thing from an investor’s point of view?

Thanks,

Author’s Response:

Hi,

Thanks for your feedback! I am happy that you found the articles useful!

A company with good accounting and corporate governance standards would want to pay all legitimate taxes to the government. In India corporate tax rate is 30% for Indian companies and 40% for foreign companies.

There are many tax incentive schemes for different companies/industries/states etc, that provide many tax saving avenues that companies use to lower tax expense. Nevertheless, abnormally low tax payouts should raise red flags and must be analysed.

You may read my views about other financial parameters of any company in the following article:

Read: How to do Financial Analysis of a Company

All the best for your investing journey!

Regards,

Vijay

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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