During selection of an income opportunity, the financial documents should be evaluated by the investor in order to see the trends followed by prospective companies over their years of operation. Evaluating the last three years of a company gives the investor an insight of the expected future of his investment. In case the investor lacks the knowledge to calculate the required ratios that will assist him evaluate the company, the individual may seek professional assistance from accountants. The profitability of the business is determined by the amount of profit the organization makes and the dividend the company gives to the share holders (Aven, 2008).
Calculations
Industrial Company #1
(in millions)
2008 2009 2010
Sales $4,250 $4,500 $4,750
Operating Income $400 $445 $480
Net Income $200 $225 $250
Current Assets $2,500 $2,750 $2,850
Current Liabilities $2,300 $2,450 $2,500
Shares Outstanding 100 100 100
Average Stock Price $32 $39 $50
a) Operating income margin=400= 0.094
4250
Operating income margin=445= 0.099
4500
Operating income margin=480= 0.10
4750
b) Net income margin= 200= 0.05
4250
Net income margin=225= 0.05
4500
Net income margin= 250= 0.05
4750
c) Current ratio=2500=1.09
2300
Current ratio=2750=1.12
2450
Current ratio=2850=1.14
2500
d) EPS= 200=2
100
EPS= 225=2.25
100
EPS= 250=2.5
100
e) PE= 32=16
2
PE= 39=17.33
2.25
PE= 50=20
2.5
Industrial Company #2(in millions)
2008 2009 2010
Sale s $3,350 $3,750 $4,250
Operating Income $335 $395 $470
Net Income $168 $198 $240
Current Assets $1,750 $1,900 $2,100
Current Liabilities $1,350 $1,400 $1,500
Shares Outstanding 80 80 80
Av Stock Price $38 $46 $62
a) Operating income margin=335= 0.1
3350
Operating income margin=395= 0.11
3750
Operating income margin=168= 0.1
4250
b) Net income margin= 198= 0.06
3350
Net income margin=240= 0.06
3750
Net income margin= 250= 0.06
4250
c) Current ratio=1750=1.3
1350
Current ratio=1900=1.4
1400
Current ratio=2100=1.4
1500
d) EPS= 168=2.1
80
EPS= 198=2.5
80
EPS= 240=3
80
e) PE= 38=18.1
2.1
PE= 46=18.4
2. 5
PE= 62=20.7
3
The operating margin is a measure of the company’sf financial well being. The ratio measures the amount of income left over from the total sale when the operations necessary for adequate running of the business are factored in. Such expenses include the payments made for the electricity to workers and the rent of the business. A company having a high profit margin is a worth venture as the business will cover its expenses adequately and have sufficient money for payment of dividend. The ratio is deliberated by division of the operating expenses by net sales
Operating income margin=operating earnings
Net sales
Net income margin relates to the income from the business after factoring in the tax. It is a profitability ratio and it relates to the total revenue generated from the sales of the company, less the operating expenses less the tax charged by the government for the operations of the company. It’s calculated through the formulae
Net income margin= income after tax
Net sales
The other ratio that the investor should consider is the liquidity ratios of the company. The ratios determine the ability of the company to pay its debts. The current ratio is such a ratio and it evaluates the ability of the company to utilize current assets to cover the current liabilities. The ratio is calculated by dividing the current assets by the current liabilities.
Current ratio=current assets
Current liabilities
The company with a higher liquidity ratio caters for its debt and pays more money to the investors compared to the company with the smaller liquidity ratio. The company has enough assets to pay its share holders is the better option for the investor. The ratio for the second company is bigger thus the better company (Cox, 2002).
The measure of the profits of the company with regards to the total amount of shares is the earnings per share. The ratio is calculated by dividing the income for the company after before preference share divided and tax by the number of ordinary shares in the company. The ratio determines the worth of the shares of the company.
EPS=net profit after preference share divided
Number of ordinary shares
The earnings per share are proportional to the profitability of the company. The better the earnings for the investor the better profits derived from this investment.
The investor should also compare the market value of the shares to the earning per share to determine the value of the shares. The smaller the ratio the better the shares of a particular company, the price earning ration is calculated by dividing the market value per share by the earning per share (Connor, 2010).
PE=market value per share
EPS
Comparison with 2010 Industry Average
The industrial averages for operational margin for 1 is 9.8% that of company 2 is 10.3%, the industrial average is 10.5%, both companies are below this average but the second company has a better operating margin. For an investor, company 2 is the better investment option. For net margins, the first company has a net margin of 5% while the second company has a net margin of 6%. The industrial margin is 5.5% thus the second company makes more profit than the first thus the better investment option. Company one has a current ratio of 1.39; company two has a current ratio of 1.55. Both companies have average current ratios above the industrial average but company 2 has a higher average that industry one thus the better investment option. The EPS for first company is 2.25 while that of company 2 is 2.53. These averages are below the industrial average but the second share earns more than the first thus the better investment option. The PE ratio is 17.1 for the first company and 19.8 for the second. The average industrial
PE Ratio 20.0 which is high for both companies but the second company has a higher ratio thus the better company compared to the first. From the analysis, the second company is the better investment option.
References
Aven, T. Risk Analysis: Assessing Uncertainties Beyond Expected Values and Probabilities. Chichester, England: Wiley, 2008. Print.
Connor, G., Goldberg, L. R., & Korajczyk, R. A. (2010). Portfolio risk analysis. Princeton, N.J: Princeton University Press.
Cox, Louis A. Risk Analysis: Foundations, Models, and Methods. Boston: Kluwer Academic Publishers, 2002. Print.
