Coke
I. INTRODUCTION AND PURPOSE
This article illustrates a systematic approach for teaching fundamental investment analysis.
Students analyze the investment potential of a publicly traded corporation. The semester project
consists of three parts: a complete ratio and DuPont analysis to determine the current financial
position of the company, a strategic analysis to determine the major strengths and weaknesses of
the company, and a forecast of the future performance and discounted future cash flow analysis
to determine the company's intrinsic investment value.
II. THE IMPORTANCE OF HISTORIC RATIO ANALYSIS
At the core of fundamental investment analysis is the ability to calculate, analyze, and
interpret the meaning of financial ratios to determine the financial position of the firm. Ratios
are used to discern changing patterns and potential trouble spots that may arise in the future
business life of a firm. They allow the analyst to standardize key financial variables from the
balance sheet and income statement for comparison to industry averages or those of a major
competitor. The semester project requires each student to obtain financial data on his or her target firm
from the SEC website (www.sec.gov) and, using integrative Excel spreadsheets supplied by the
professor, to calculate relevant ratios in the four financial management areas: liquidity, asset
utilization, employed leverage, and profitability.
III. ANALYSIS OF THE COCA COLA COMPANY
The Excel spreadsheet (Exhibit 1) is set up with logic statements to make assessments
regarding time-series trends and cross-sectional analysis. The cross-sectional analysis allows the
student to compare his/her selected company to the industry average, while the time-series
analysis allows for a trend comparison over the past three years.
Coca Cola's liquidity is substandard when compared with the industry. The current ratio for
1996 is below industry average. In addition, its quick ratio also indicates less liquidity than the
industry average with no discernable trend of improvement over the last three years. Therefore,
Coca Cola's liquidity position could be characterized as substandard.
The activity ratios reveal a second dimension of the Coca Cola Company. These ratios
indicate the relative efficiency with which the company uses investors' assets. The inventory
turnover ratio measures how rapidly the company "turns over" or uses dollars invested in
inventory. In the case of Coca Cola, there are positive values reported based on industry average
and cross-sectional comparisons. The inventory turnover for 1996 was 7.08 in comparison to an
industry average of 5. Likewise, the three-year trend indicates a continual improvement in
inventory turnover. Other activity ratios indicate similar positive results based on both cross-
sectional and time-series analysis.
The third group of ratios deals with the use of debt in the capital structure as well as the
ability to meet interest payments from operating income. Both the total debt ratio and the debt-
to-equity ratio indicate a favorable assessment based on cross-sectional and time-series analysis.
In addition, the times-interest-earned (TIE) ratio indicates that the company covers interest
charges over 16 times. This again compares favorably to the industry average of 15 times.
The fourth category ratios deal with profitability. Coca Cola's gross profit margin is clearly
superior in comparison with the industry average. It is also obvious that Coca Cola does a
superior job of cost cutting, resulting in higher operating profits when compared to the [next page]