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February 17, 1994 regulations.
Entity Accounting Analysis

8-39 Part 2 Business Analysis and Valuation Tools

The Company believes that maintaining an entre- subsidiaries and are classi¬ed as “Gain on issuance
preneurial atmosphere is essential to its continued of stock by subsidiaries” in the accompanying state-
growth and development. In order to preserve this ment of income. These gains have represented a
atmosphere, the Company adopted in 1983 a strat- substantial portion of the net income reported by
egy of spinning out certain of its businesses into the Company in recent years. Although the Com-
separate subsidiaries and having these subsidiaries pany expects to continue this strategy in the future,
Thermo Electron Corporation

sell a minority interest to outside investors. The its goal is to continue increasing segment income
Company believes that this strategy provides addi-
over the next few years so that gains generated by
tional motivation and incentives for the manage-
sales of stock by its subsidiaries will represent a
ment of the subsidiaries through the establishment
decreasing portion of net income. The size and tim-
of subsidiary-level stock option incentive programs,
ing of these transactions are dependent on market
as well as capital to support the subsidiaries™
and other conditions that are beyond the Com-
growth. As a result of the sale of stock by subsidiar-
pany™s control. Accordingly, there can be no assur-
ies, the issuance of shares by subsidiaries upon
ance that the Company will be able to generate
conversion of indebtedness, and similar transac-
gains from such transactions in the future.
tions, the Company records gains that represent the
increase in the Company™s net investment in the

(In thousands) 1993 1992 1991
Thermo Instrument Systems, Inc. $ 584,176 $ 423,199 $ 338,747
Thermo Fibertek Inc. 137,088 125,577 124,731
Thermedics Inc. (a) 80,220 45,778 32,295
Thermo Power Corporation 77,360 43,904 29,131
ThermoTrex Corporation 54,329 19,843 16,801
Thermo Process Systems Inc. (b) 53,839 47,082 50,632
987,012 705,383 592,337
Wholly and majority-owned nonpublic companies 262,706 243,589 213,147
$1,249,718 $ 948,972 $ 805,484

Segment Income(c):
Thermo Instrument Systems Inc. $ 96,786 $ 63,373 $ 49,742
Thermo Fibertek Inc. 15,902 15,716 14,652
Thermedics Inc. (a) 8,292 841 (3,048)
Thermo Power Corporation 2,707 715 (3,158)
ThermoTrex Corporation 485 (1,185) (113)
Thermo Process Systems Inc. (b) 1,338 371 (1,487)
125,510 79,831 56,588
Wholly and majority-owned nonpublic companies 17,122 7,237 7,315
142,632 87,068 63,903
Equity in Losses of Unconsolidated Subsidiaries (21,076) (3,948) (1,663)
Corporate 9,563 18,850 16,933
Income Before Income Taxes, Minority Interest, and
Cumulative Effect of Change in Accounting Principle $131,119 $101,970 $ 79,173

(a) Includes Thermo Cardiosystems Inc. and Thermo Voltek Corp.
(b) Includes Thermo Remediation Inc.
(c) Segment income is income before corporate general and administrative expenses, costs associated with divisional and product restructur-
ing, other income and expense, minority interest expense, and income taxes.
316 Entity Accounting Analysis

Entity Accounting Analysis

COMMON STOCK MARKET INFORMATION As of February 25, 1994, the Company had 6,406
holders of record of its common stock. This does not
include holdings in street or nominee names.
The following table shows the market range for the
Company™s common stock based on reported sales Common stock of the following majority-owned
prices on the New York Stock Exchange (symbol public subsidiaries is traded on the American Stock
TMO) for 1993 and 1992. Prices have been restated Exchange: Thermedics Inc. (TMD; Thermo Instru-

Thermo Electron Corporation
ment Systems Inc. (THI); Thermo Power Corporation
to re¬‚ect a three-for-two stock split distributed in
(THP); Thermo Process Systems Inc. (TPI); Thermo
October 1993.
Voltek Corp. (TVL); ThermoTrex Corporation (TKN);
Thermo Fibertek Inc. (TFT); and Thermo Remediation
1993 1992
Inc. (THN).
Quarter High Low High Low
$311„3 $312„3 $261„4
First $38
411„6 361„3 291„12 251„6
431„4 371„4 281„3
Third 25
381„8 311„2 261„2
Fourth 43

The closing market price on the New York Stock
Exchange for the Company™s common stock on Feb-
ruary 25, 1994, was 391„2 per share.

The Company has never paid cash dividends and
does not expect to pay cash dividends in the fore-
seeable future because its policy has been to use
earnings to ¬nance expansion and growth. Pay-
ments of dividends will rest within the discretion of
the Board of Directors and will depend upon,
among other factors, the Company™s earnings, cap-
ital requirements, and ¬nancial condition.
9 F ina n c ia l An a ly s is

T he goal of ¬nancial analysis is to assess the performance of a ¬rm in
the context of its stated goals and strategy. There are two principal tools of ¬nancial anal-
ysis: ratio analysis and cash ¬‚ow analysis. Ratio analysis involves assessing how various
line items in a ¬rm™s ¬nancial statements relate to one another. Cash ¬‚ow analysis allows
Business Analysis and 2
Valuation Tools
the analyst to examine the ¬rm™s liquidity, and how the ¬rm is managing its operating,
investment, and ¬nancing cash ¬‚ows.
Financial analysis is used in a variety of contexts. Ratio analysis of a company™s
present and past performance provides the foundation for making forecasts of future per-
formance. As we will discuss in later chapters, ¬nancial forecasting is useful in company
valuation, credit evaluation, ¬nancial distress prediction, security analysis, mergers and
acquisitions analysis, and corporate ¬nancial policy analysis.

The value of a ¬rm is determined by its pro¬tability and growth. As shown in Figure 9-1,
the ¬rm™s growth and pro¬tability are in¬‚uenced by its product market and ¬nancial
market strategies. The product market strategy is implemented through the ¬rm™s com-
petitive strategy, operating policies, and investment decisions. Financial market strate-
gies are implemented through ¬nancing and dividend policies.
Thus, the four levers managers can use to achieve their growth and pro¬t targets are:
(1) operating management, (2) investment management, (3) ¬nancing strategy, and (4)
dividend policies. The objective of ratio analysis is to evaluate the effectiveness of the
¬rm™s policies in each of these areas. Effective ratio analysis involves relating the ¬nan-
cial numbers to the underlying business factors in as much detail as possible. While ratio
analysis may not give all the answers to an analyst regarding the ¬rm™s performance, it
will help the analyst frame questions for further probing.
In ratio analysis, the analyst can (1) compare ratios for a ¬rm over several years (a
time-series comparison), (2) compare ratios for the ¬rm and other ¬rms in the industry
(cross-sectional comparison), and/or (3) compare ratios to some absolute benchmark. In
a time-series comparison, the analyst can hold ¬rm-speci¬c factors constant and exam-
ine the effectiveness of a ¬rm™s strategy over time. Cross-sectional comparison facili-
tates examining the relative performance of a ¬rm within its industry, holding industry-
level factors constant. For most ratios, there are no absolute benchmarks. The exceptions
are measures of rates of return, which can be compared to the cost of the capital associ-


318 Financial Analysis

Financial Analysis

Figure 9-1 Drivers of a Firm™s Profitability and Growth

Growth and

Product Market Financial Market
Strategies Policies

Operating Investment Financing Dividend
Management Management Decisions Policy

Managing Managing
Working Managing
Revenue and Liabilities and
Capital and Payout
Expenses Equity
Fixed Assets

ated with the investment. For example, subject to distortions caused by accounting, the
rate of return on equity (ROE) can be compared to the cost of equity capital.
In the discussion below, we will illustrate these approaches using the example of
Nordstrom, Inc., a prominent U.S. retailer. We will compare Nordstrom™s ratios for the
¬scal year ending January 31, 1999, with its own ratios for the ¬scal year ending
January 31, 1998, and with the ratios for TJX Companies, Inc., another U.S. retailer, for
the ¬scal year ending January 31, 1999.1
Nordstrom is a leading fashion specialty retailer, offering a wide variety of high-end
apparel, shoes, and accessories for men, women, and children. The company pursues a
strategy of high quality, extraordinary service, and premium price. Dissatis¬ed with the
inconsistent earnings performance in recent years, the company™s management has fo-
cused in the last two years on improving its pro¬t performance. We will use the ¬nancial
statements for the year ending January 31, 1999, to examine how successful the man-
agement has been in achieving this objective. TJX Companies pursues a strategy quite
different from Nordstrom™s: it operates off-price apparel and home fashions retail stores
through its T.J. Maxx and Marshalls stores. The company™s strategy is to offer brand-
name goods at 20“60 percent below department store regular prices. The company seeks
to accomplish this by buying opportunistically and by operating with a highly ef¬cient
Financial Analysis

9-3 Part 2 Business Analysis and Valuation Tools

distribution network and low cost structure. Nordstrom and TJX seem to follow different
investment and ¬nancing strategies as well. Nordstrom makes signi¬cant investment in
its stores whereas TJX leases its stores. Nordstrom has a credit card operation whereas
TJX does not. We will illustrate how these differences between the two companies affect
their ratios. We will also try to see which strategy is delivering better performance for

Measuring Overall Profitability
The starting point for a systematic analysis of a ¬rm™s performance is its return on equity
(ROE), de¬ned as:
Net income
= -------------------------------------------------


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