Question

1) Outline 3 different comparisons an analyst may include when evaluating the performance of a company. (Not asking for specific ratios)

2) You have been asked to evaluate investment options for a large private investment fund; identify some drawbacks to a purely fundamental (Ratio) analysis.

3) Consider companies in the following industries: Technology, Financial, Manufacturing. Name 2 companies within each industry, and identify 3-4 Ratios that you think would be most important within that industry (and why) and 2 Ratios that would not be important considerations (and why).

4) Define the following and provide examples of Financial ratio outcomes which would be positive indicators of a company’s : 1) Solvency 2) Liquidity

Answer 1

1) Ans Three differrent comparisions an analyst may include when evaluating the performance of a company are:

a) Comparision through ratios: using ratio analysis can be a great way to evaluate the way a company is performing and then compare it with its own performance of the past years or the performance of some other companies.

b) Comparison of net profit: Net profit is the amount of profit a firm retains after deduction of all its expences, and losses. Hence comparing companies using the net profit the earned over the financial year can be great way to evaluate the performance of the firm. higher net profit as compared to companies in the market would indicate better earning.

c) comparison through Comparitive size statements: Comaprative statements makes a horizontal comparison of a firm's performance with some other firm or itself by calculating deviation in their respective values of items and finding their proportion to total value of that item. Comapritive size statements brings out difference in proportion of each and every item in the "financial statement" values. this helps to have a wider overview of the performance of the firm.

2) Ans Some drawbacks of a purely ( fundamental) ratio analysis are:

a) ratio analysis is useful only for quantitative values. It is not possible to calculate ratio for qualitative aspects of the firm like customer satisfaction, trustworthiness etc.

b) Ratio analysis ignores the price level changes taking place in the market due to inflation or deflation. Ratios are calculated using historical cost and thus ignore changes of prices during that period. therfeore they do not reflect correct financial position.

c) There is no standard definition of ratios. different firms may be using different ratios as per their convenience. Thus, their is no universal applicability of a ratio. Due to this comaprision using ratios sometimes becomes difficult.

d) Ratios are are subject to window dressing.

e) Ratio are only are signal of firm's performance. They are not the actual solutions.

3) Ans 2 companies under TECHNOLOGY industry are:

a) Tata Consultany services.

Ratios most important here are:

I) Current ratio: to evaluate the status of its current assets and liabilities that indicates its liquidity position.

ii) Return on capital employed- to evaluate if the capital of the company is generating enough returns

b) Google

Ratios tmost imporatant here are:

I) Operating margin- to measure how profitable the company is from its actual operations and core business.

ii) Price to earnings ratio- to compare company's share price to its earnings per share. high price to earning ratio showsoptimism of investors about the shares or that the shares are overpriced.

2 companies under FINANCIAL industry are:

a) HDFC

Ratios most important here are:

I) Net interest margin ratio- to find the excess of interest earned to interest expended by the company that shows the profit margin.

ii) Return on Assets ratio- to know the percentage of every rupee invested in the business that returned as profits and how effective the firm is using those assets.

b) Bajaj Capital market

Ratios most important here are:

I) Sales by fixed assets ratio- to know the proportion of sales outcome from the assets of the company.

ii) Total debt/ equity ratio- to evaluate the proportion of debt in comaprision to its equity in order to know its leverage proportion.

2 companies under MANUFACTURING industry are:

a) Asian Paints

Ratios most important here are:

I) Debtors turnover ratio- to analyse how effective the company is in extending credit and collecting debts.

ii) Return on Capital empoyed- used to understand how efficient the company is in generating profits from its capital

b) TVS motors

Ratios most important here are:

i) Earning per share- used to analyse how much the company earn's from one share .

ii) Sales by fixed assets ratio- used to measure how well company generates sales from its fixed assets.

4) Ans

1) Solvency ratio: A key metric that measures an enterprise's ability to meet its long term debt obligations is known as Solvency ratio.

Example of solvency ratio outcome that would be positive indiacor of the company are:

a) Dent to equity ratio= Total debt/ total shareholder's equity

A high debt to equity ratio indicates higher risk for the firm as it means more debt.whereas lower debt to equity ratio indicates less risk of debt default and that the business is stable

b) Interest coverage ratio= Earning before interest and tax/ interest due on debts.

A higher interest coverage ratio shows that company is efficient in paying its debt interest whereas lower interest coverage ratio indicates debt burden on the business.

2) Liquidity ratio: A financial metric that measures an enterprise's ability to meet its short term and very short term debt obligations is known as liquidity ratio.

Example of liquidity ratio outcome that would be positive indiacor of the company are:

a) Current ratio= Current assets/ current liabilities

A higher current ratio between 1:2 to 2 means business has 2 times or more current assets to cover its current liabilities, whereas a lower ratio below 1 means the company does not has enough current asstes to meet short term liabilities.

b) Quick ratio= Cureent assets - inventory- prepaid expences/current liabilities

A liquid ratio of 1;1 is a good ratio. a ratio of higher than 1 is suitable as it sows a firm and very easily pay off its short term lianlities. but ratio of less than 1 is not good as here the firm may face difficulties to payoff the current liabilities switch the available quick asstes.