Question

I need a recommendation on which stock i should recommend to investors based on companies’ financial reports, ratio and 10-k report. (A)Southwest Airline (B) American Airline=

All the ratio For Southwest Airlines:

Return on Equity (ROE): 2017=37.0% and 2016= 28.4%

Return on Assets (ROA): 2017=14.4% and 2016= 10.1%   

Net profit margin (PM); 2017=16.5% and 2016=11.0%

PPE Turn Over(PPET); 2017=1.19 and 2016=1.25

Total Asset Turnover (AT): 2017=0.87 and 2016=0.92

Gross Profit Margin(GPM); 2017= 100% and 2016 100%   

Currnet Ratio: 2017=0.69 and 2016=0.65

Quick Ratio: 2017=0.57 and 2016=0.56

Acoount Receivable Turnover: 2017=32.00 and 2016= 37.40

Times interest earned: 2017=30.83 and 2016=30.82

liability to Equity Ratio: 2017=1.41 and 2016=1.76   

Financial Leverage: 2017=2.56 and 2016=2.82

All the ratio For American Airlines:

Return on Equity (ROE): 2017=14.1% and 2016= 24.9%

Return on Assets (ROA): 2017=3.3% and 2016= 5.1%

Net profit margin (PM); 2017=4.6% and 2016=6.9%

PPE Turn Over(PPET); 2017=1.30 and 2016=1.38

Total Asset Turnover (AT): 2017=0.71 and 2016=0.74

Gross Profit Margin(GPM); 2017= 100% and 2016 100%

Currnet Ratio: 2017=1.25 and 2016=1.25

Quick Ratio: 2017=0.50 and 2016=0.63

Acoount Receivable Turnover: 2017=15.2 and 2016= 14.5

Times interest earned: 2017=4.08 and 2016=5.85

liability to Equity Ratio: 2017=3.11and 2016=3.59

Financial Leverage: 2017=4.34 and 2016=4.86

Answer 1

RECOMMENDATIONS TO BE MADE TO THE INVESTOR BASING ON THE RATIOS AND FINANCIAL REPORTS

*Statement showing the ratios of two companies from the information given

S.No.	RATIOS	SOUTHWEST AIRLINE		AMERICAN AIRLINE
		2017	2016	2017	2016
1.	Return on Equity (ROE)	37.00%	28.4%	14.1%	24.9%
2.	Return on Assets (ROA)	14.4%	10.1%	3.3%	5.1%
3.	Net Profit Margin (NPM)	16.5%	11%	4.6%	6.9%
4.	PPE Turnover (PPET)	1.19	1.25	1.30	1.38
5.	Total Assets Turnover (AT)	0.87	0.92	0.71	0.74
6.	Gross Profit Margin (GPM)	100%	100%	100%	100%
7.	Current Ratio	0.69	0.65	1.25	1.25
8.	Quick Ratio	0.57	0.56	0.50	0.63
9.	Account Receivable Turnover	32.00	37.40	15.2	14.5
10.	Times Interest Earned	30.83	30.82	4.08	5.85
11.	Liability to Equity Ratio	1.41	1.76	3.11	3.59
12.	Financial Leverage	2.56	2.82	4.34	4.86

Analysis and recommendations:-

• Return on Equity(ROE)

It is the measure of financial performance of a company. It is calculated by dividing `Net Income’ by `Shareholders Equity’. A higher ROE is considered good while comparing with other companies. Higher the percentage (%) of ROE greater the performance of the company.

[*ROE = Net Income/ Shareholders Equity]

In the given situation ROE of Southwest Airline is higher than American Airline and also there is a decrease in the ROE of American Airline from the year 2016 to 2017, which is not a good indicator. The ROE of Southwest Airline as increased from 2016 to 2017 which is good sign of progress.

• Return on Assets (ROA)

Return on Assets ratio indicates the company’s efficiency to gain profit from its assets deployed in the business. Higher Return on Assets Ratio indicates more asset efficiency.

[*ROA = Net Income / Total Assets]

In the given situation ROA of Southwest Airline is higher than American Airline and also there is a decrease in the ROA of American Airline from the year 2016 to 2017, which indicates inefficiency on the part of the company to make efficient use of its assets deployed into business for gaining income.

• Net Profit Margin (NPM)

It’s a ratio of Net Income to Revenue. It represents how much profit is gained from each dollar of sales of the company. A company which is able to increase its NPM ratio will have high growth in the share price. A higher NPM ratio is a good indicator of financial health of the company.

[*NPM = Net Income / Total Sales]

In the given situation NPM of Southwest Airline is higher than American Airline and also there is a increase in the NPM of Southwest Airline from the year 2016 to 2017, which indicates growth in the profitability of the company.

• PPE Turnover (PPET)

It is the fixed asset turnover ratio used to measure the operating performance of the company. It measures the company’s ability to generate sales from the fixed assets namely Property, Plant and Equipment (PPE). Higher ratio is an indicator of greater efficiency in managing fixed assets investments to generate sales.

[*PPE Turnover = Net Sales /Net Property, Plant and Equipment]

In the given situation PPET of American Airline is higher than Southwest Airline which indicates that American Airline is making an efficient use of its fixed assets to generate sales. However there is a decrease in the PPET from the year 2016 to 2017.

• Total Assets Turnover (AT)

It measures the value of the company’s sales with the total assets deployed in the business. A higher Total Assets Turnover indicates the efficiency of the organization to use its assets to generate revenues.

[*Total Assets Turnover = Total Sales /Average Total Assets]

In the given situation Total Assets Turnover of Southwest Airline is higher than American Airline, which indicates inefficiency on the part of the company to make efficient use of its assets deployed into business for generating sales.

However there is a decline in this turnover in both the companies from the previous year.

• Current Ratio

Current Ratio helps to analyze the liquidity position of a company and also its ability to convert its assets into cash in order to meet its short term liabilities. Ideally a Current Ratio of `2’ or more is considered good. Higher the Current Ratio greater the liquidity position of the company.

[*Current Ratio = Current Assets /Current Liabilities]

In the given situation Current Ratio of American Airline is higher than Southwest Airline which indicates good liquidity position. However the CR of American Airline remained constant, while the CR of Southwest Airline has increased when compared to the last year.

• Quick Ratio

Quick Ratio is an indicator of company’s short term liquidity position and measures a company’s ability to meet its short term liabilities with its most liquid assets. Ideally a Quick Ratio of `1’ or more is considered good.

[*Current Ratio = Quick Assets /Current Liabilities]

In the given situation Quick Ratio of Southwest Airline is higher than American Airline and also there is a major decrease in the Quick Ratio of American Airline from the year 2016 to 2017, which is not considered good.

• Accounts Receivable Turnover

It is a measure used to quantify company’s effectiveness in deciding the credit period to its customers collecting the debts within that period. It is the number of times per year that the company collects its average accounts receivable. A higher turnover indicates that the company’s credit policies are efficient.

[*Accounts Receivable Turnover

               = Net Credit Sales /Average Accounts Receivable]

In the given situation Accounts Receivable Turnover of Southwest Airline is higher than American Airline, which shows the efficiency of its credit policies and its ability to collect its debts.

• Times Interest Earned

It is used to measure the company’s ability to meet its debt obligations. A high ratio means the company is able to meet its debt obligations.

In the given situation Times Interest Earned ratio of Southwest Airline is very much higher than American Airline, which shows the efficiency on its part to meet its debt obligations.

• Liability to Equity Ratio

It is also known as the debt equity ratio. It is used to measure company’s financial leverage. In general high debt equity ratio means that the company may not generate sufficient cash to meet its debt obligations.

[*Debt Equity Ratio = Total Liabilities /Total Shareholders’ Equity]

In the given situation Debt Equity Ratio of American Airline is higher than Southwest Airline which is not a good indicator.

• Financial Leverage

It measures the financial risk on the part of shareholders caused by the capital structure of the company. The more debt financing the company uses higher will be the Financial Leverage. A financial leverage of 0.5 is considered ideal. That means not more than 50% of company’s assets to be financed by debt capital.

In the given situation Financial Leverage of American Airline is higher than Southwest Airline which indicates higher risk on the part of the shareholders.

Basing on the all the relevant ratios given for the past two years it is suggested to recommend Southwest Airlines to investors so that the investors receive good share growth a yeild good profits.