Question

The Elite Mutual Fund associate director intends to invest in the stock of ABC Company. ABC Company is a merchandiser buying and selling mobile phones. ABC Company also provides mobile phones repairing services. Around 50% of the company’s revenues come from the sale of mobile phones. The remaining company’s revenues come from mobile phones repairing services.

The following are financial ratios for ABC Company and comparative ratios for ABC Company’s industry. Computations of the financial ratios for ABC Company are based on the information from ABC Company’s financial statements.

Aspect of financial ratios	Industry average	ABC Company
(i) Market measures
Price-to-book	9.1	8.9
Dividend payout rate	2.1%	0%
Dividend yield	0.6%	0%
Earnings yield	8%	8.2%
Price-to-earnings ratio	29.1	27.9
(ii) Asset utilization
Total assets turnover	4	3.95
Fixed asset turnover	15.65	15.4
Working capital turnover	9.81	8.6
Sales to inventory	28.8	30
Accounts receivable turnover	8.25	7
Cash turnover	39	40.9
(iii) Operating performance
Net profit margin	8.1%	8.3%
Pre-tax profit margin	14.55%	15%
Operating profit margin	16%	16.8%
Gross profit margin	34.4%	36.1%
(iv) Return on investment
Return on common equity	50.1%	52.7%
Return on assets	30.1%	31.5%

(v) Capital structure and solvency
Times interest earned	9.99	9.3
Long-term debt to equity	0.401	0.369
Total debt to equity	0.691	0.675
(vi) Liquidity ratios
Days to sell inventory	18.39	18.48
Collection period	36.7	42.29
Acid-test ratio	1.95	2.68
Current ratio	3.2	3.55

Required:

1. You are required to interpret the ratios of ABC Company. From your interpretation, draw relevant inferences regarding ABC Company’s financial condition and financial performance. (Note: Ignore the industry average ratios.)

2. You are required to repeat the analysis in (a) with full knowledge and understanding of the industry average ratios.

3. Show which financial ratios you may consider to deviate from the industry average norms. For each of the ABC Company’s financial ratio that deviates from the industry average norms, give suggestions for two possible explanations.

Answer 1

Aspect of financial ratios	Industry average	ABC Company		a) ABC Stand alone	B) ABC and Industry comparative
(i) Market measures
Price-to-book	9.1	8.9		being investor the Market Measures counts a lot...and for the long term point of view other ratios such as assets utilization,	Price to Book is near the industry average
Dividend payout rate	2.10%	0.00%		matters a lot.	the company does not pay any dividend whereas from investors point of view dividend income
Dividend yield	0.60%	0.00%		ABC company does pay any dividend to its shareholders	is one of the factor which influence the investment decision
Earnings yield	8.00%	8.20%		high P/E earning indicates that the sock has potential to grow in future.	Earning yield is sightly above the industry average
Price-to-earnings ratio	29.1	27.9			Price to earning ratio is much below the industry average
(ii) Asset utilization
Total assets turnover	4	3.95		Assets utiliazation ratios are indicate the revenue earned against the investments in assets.	asserts utilization ratios shows that the company is using its assets very efficiently .
Fixed asset turnover	15.65	15.4		total asset turn over is 3.95 ie around 4 times , which is a healthy sign
Working capital turnover	9.81	8.6		Working Capital Turnover is 8.60 , which means approx 31 days working capital cycle
Sales to inventory	28.8	30		all and all indicates very good good recovery ratio
Accounts receivable turnover	8.25	7
Cash turnover	39	40.9
(iii) Operating performance				the company shows good potiential as it invests its profit in assets
Net profit margin	8.10%	8.30%		all and all the company earns 8.30 % of net profit which can be available to pough back in business or to share with shareholders	the operating performance shows that the company stand in competition with others in revenue generations
Pre-tax profit margin	14.55%	15.00%		other admin and sales expenses are 1.80% of the sales	the company will have to outperform if they are will to attract more investors
Operating profit margin	16.00%	16.80%		other operating expenses are 20% of the sales
Gross profit margin	34.40%	36.10%		gross profit 36.10 % indicates that the company has approx 64 % of manufacturing expenses.
(iv) Return on investment					ABC gives returns on investment at par ...the company will have to show upward movement
Return on common equity	50.10%	52.70%		return on common equity 52.70% indicates that of the profit is available for distribution	in order to attract more investors and boost market value
Return on assets	30.10%	31.50%		return on assets indicates how much an asset can generate revenue ..here it s 31.50 % seems good
(v) Capital structure and solvency					comparatively less levered company thus carries less burden of interest and thus
Times interest earned	9.99	9.3		EBIT / TOTAL INTEREST EXPENSES....Indicates how many times the earning before interest can serve the interest ..here its 9.30 times	more available profit to shareholders
Long-term debt to equity	0.401	0.369		the company is marginally levered company..its has mostly funded its business from capital rather than debt.
Total debt to equity	0.691	0.675
(vi) Liquidity ratios					In case of any emergency the company has much better liquidity as compared to it industry
Days to sell inventory	18.39	18.48		liquidity ratios shows that days to sell inventory are 18 to 19 days, collection period is 42.29
Collection period	36.7	42.29
Acid-test ratio	1.95	2.68		acid test considers the highly liquid assets and liabilities , there the ratio is 2.68 which is much more above the mathematical average of 1.
Current ratio	3.2	3.55		current assets considers ability to pay current liability by current assets, mathematically its assumed better if its 1.50, there as the company
				Has 3.55 which is indicates a good ratio