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Company Analysis

Company Analysis

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1 Mojtaba Salem, Jafar Kazemiyan, Ramazan Barbari, Jafar Mahmoodi Final Paper Financial Accounting Dr.

Rod Monger May 18, 2011 The US Software Industry: A Ratio Analysis of HP, IBM, and Microsoft Introduction In this paper, we study the financial performance of three major software companies: Hewlett-Packard (HP) Company, International Business Machines (IBM), and Microsoft Corporation. Using their financial statements, we analyze the companies¶ levels of profitability and liquidity, assets and debt utilization, and dividend policy. Our analysis is comparative in that it compares the performance of three companies with each other and with the industry over three consecutive years of 2008, 2009, and 2010. We only attempt to identify where financial problems are. It should be noted that the interpretation of financial problems is beyond the scope of the current study. The first section of the paper is devoted to the ratio analysis of each company per se. We have three case studies in which profitability ratios, liquidity ratios, efficiency ratios, shareholder ratios, and capital structure ratios are calculated and briefly explained. Following the case studies, we have calculated ³industry norms´ for all categories of ratios. This is where we provide a comparative ratio analysis of the US software industry and its three major players.

2 Case Study 1: Hewlett-Packard (HP) Company I. The History of the Company In 1939, Hewlett-Packard Company, hereafter referred to as HP, was founded by two graduates of Stanford University: Bill Hewlett and Dave Packard. A decade after becoming a true corporation in 1947, HP went public and had its initial public offering of ordinary shares. It was not until the 1980s that HP took an active role in the mass production of personal computers and printers, which ³set the direction in which printers would evolve in the future´ (Dodge). Another crucial milestone in HP¶s history is the 2002 merger with Compaq Computer, which turned HP into one of the largest software companies in the world, operating in 160 countries and having around 150,000 employees. HP¶s corporate strategy is concentrated on ³market share growth and company profitability throughout the future of the business´ (Dodge). The executive management of the company attempts to operationalize the corporate strategy through employee empowerment and integration into the global market. The success with which the executive management could implement its corporate strategy has turned HP into a relatively safe investment. Standard and Poor¶s has given HP an A credit rating and an A-1 commercial paper rating (Dodge). Yet, from the perspective of the firm¶s executive managers, it is crucial to consistently watch the performance of the company as if they were potential investors. In this sense, the fundamental analysis of financial statements must be conducted. It must be noted that all financial data used in our calculations are taken from the annual reports available in HP¶s website. For further information, please visit http://h30261.www3.hp.com/phoenix.zhtml?c=71087&p=irol-reportsAnnual.

Ratio Analysis Profitability Ratios: Before delving into the profitability analysis of HP. paid-in capital. Capital means common stock + reserves including retained earnings + preference shares + loan notes and long-term loans. long-term debts. Shareholder Funds means the book value of all things in the balance sheet that describe the owner¶s capital and reserves. it is important to shed light on the method with which Return on Shareholders¶ Funds (ROSF) and Return on Capital Employed (ROCE) are calculated. . In this case.´        ROSF = X 100 ii. Return on Shareholders¶ Funds (ROSF) a. Return on Capital Employed (ROCE) a. Return is the net profit for the period b. The general formula is the following:   Return = X 100 i. we also use the ³average of two consecutive years¶ total stockholder equity. and retained earnings´ to calculate the return on shareholders¶ funds. Return means net profit for the period + any preference share dividends + loan notes and long-term loan interest b.3 II. and other long-term liabilities´ to calculate the return on capital employed. It should be noted that we use the ³average of two consecutive years¶ common stock.

96% 7.03% 54.03% 23. ROSF once peaked at 21. However.64% 2009 18. In contrast to ROSF.64% in 2008. Such returns suggest that the company could effectively utilize its equity and obtain the possible maximum return on it.90% in 2010. the return on capital employed (ROCE) has progressively grown since 2007. and the other two cases are analyzed from 2008 to 2010. Category/Year Return on shareholders¶ funds Return on capital employed Gross profit* as percentage of sales Net profit as percentage of sales 2007 19.14% 24.09% 2008 21. In the time period from 2007 to 2010. then fell to 18. In 2007.59% 23.22% 58. HP reached a peak of 24.95% * Gross profit = Total net revenue ± Cost of Sales Cost of Sales = Cost of products + Cost of services + Financing interest HP seems to have a rather random return on shareholders¶ funds (ROSF). This is true in HP¶s case.68% 6.35% yet its gross profit margin came slightly down. it is important to look at the company¶s gross profit margin.91% 64. The reason is that the fluctuation in certain ratios could be better seen if the 2007 analysis is included. it maintained a relatively stable gross .4 ROCE =           X 100 It must be mentioned that the ratio analysis of 2007 is also included in order to show a rather big picture of HP¶s performance.90% 38. In order to see how HP manages its cost of goods sold (or cost of sales) over four years.50% in 2009.50% 2010 19.75% 6.35% 24. and went up to 19.03% 6.

08 9536 2010 1.01 -1211 2009 1. that is.22 1. Particularly. HP could manage to maintain notable increases in the figures of net profit margin.07 0. .5 profit thereafter. Here. we also have to look at the figures of net profit margin.97 0. Though the company¶s net profit margin came back to 6.02 0.20 1.97 in 2008 and 1.09 in 2010 yet could be able to bid up the ratio to its normal level in 2009 and 2010. HP experienced drops of 0. This might also be due to that year¶s financial crisis. net working capital also fell to a negative amount.96% (2007¶s net profit margin) to 7. Regarding its current ratio.. i. to see how easy it was for HP to pay its interest and taxes. we notice a big jump from 6.e.68% in 2009. A higher current ratio makes the company capable of paying its short-term debt as they come due.09 0. Liquidity Ratios Category/Year Current ratio Acid-test ratio Net working capital to total asset ratio Working capital 2007 1.09 8142 2008 0.82 -0. which is a sign of increasing profitability.03 4781 Liquidity ratios suggest how efficiently a company functions in short-term. in line with a notable drop of current ratio and acid-test ratio in 2008. In regard with the acid-test ratio. which might be an indication that the company¶s strategy to keep the cost low works well.96 0. To highlight the overall performance of HP.03% (2008¶s net profit margin). it still increased to 6. HP seemed to have problem paying its short-term obligations in 2008 and 2010 due to the raise in current liabilities and fall in current assets.95% in 2010. Considering the context in which the company performed. the 2008 financial crisis.

The accounts payable-to-purchase ratio measures how much time it takes HP to pay its creditors. it delayed the payment of its payables. As HP moved from 2007 towards 2010. as a result of HP¶s attempts to keep inventory as low as practical and enhance sales.6 Efficiency Ratios Category/Year Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase* ratio 2007 9. It is suggestive of how successful the company¶s executive management is implementing its sales or inventory strategies. In 2010.5 days) 0. which is a drastic drop compared with the 62 days in 2009.1 days) 2008 11.144 (52.143 (52.30 times 0. however. we notice that inventory turnover obtains a faster pace year by year. .75 days) 2009 12.14 (51.02 days) * Purchase = (Cost of sales + Closing inventory) ± Beginning inventory Perhaps. in 2008. On the other hand. In 2007. the time span increased to about 52 days.148 (54. the more time it takes HP to collect its debt.146 (53.05 days) 2010 15. The greater this ratio becomes.29 days) 0. which might have contributed to the dramatic drop in the current ratio and the negative amount of net working capital of 2008.17 (62.49 times 0.15 (54.12 (43.25 times 0.99 times 0. the time that it took HP to pay off its creditors dropped to 54 days. the analysis shows that the accounts receivable-to-sales ratio has taken an increasing pace from 2007 to 2010.8 days) 0. it took HP about 43 days to collect debts.1 days) 0.

78 10.21 15.32 0.37 $0. however. In 2007. Gearing Ratio Category/Year Gearing* *     2007 28. Once again.64% 8. By looking at the low level of HP¶s dividend yield. EPS is an important determinant of the ordinary shares¶ market price and P/E ratio.26 $34. it becomes clear that one should purchase HP¶s common stock only if her investment objective is capital gain.32 0.31 in 2010.net/NYSE/Company/Hewlett-Packard-Co/Valuation/Ratios#PE From 2007 to 2010. it dropped to 10. not receiving a constant income.08 $49.63% 10 2010 $3.stock-analysis-on.82% 11.60 in the next year. HP had the P/E ratio of 18. it fell to 10.76 18.58 2008 $3.07 $0.60 $50. with the exception of 2009.32 0.35 10.46% X 100 2008 35. The dividend yield is defined as ³part of the total return that an investor receives along with capital gains and losses´ (Dodge).32 0.97 $0.31 $38.68% 2010 43.26 in 2008 but became 15.90 $0.08. This abnormal instability of the price-earnings ratio might be due to the tremulous era following the 2008 financial crisis.79 * http://www.47% 2009 41.93% 10.46 2009 $3.66% .7 Shareholder Ratios Category/Year Earnings per share Price to earnings (P/E) ratio* Market price Dividends per share Dividends yield Dividends cover 2007 $2. HP¶s earnings per share (EPS) have increased with slight proportions.

Ratio Analysis Profitability Ratios: As is mentioned in the introduction.wss. Later on. HP was considered to be a relatively low-geared company. however. It signals that HP has been willing to accept a higher rate of debt. We calculate ROSF based on the following formula: . Computing Scale Corporation. IBM played an important role in introducing new hardware systems and thus attracted the attention of potential investors. is the profitability ratios. and capital structure ratios. please visit http://www. there are five main categories of ratios with which one analyzes how healthy a company is: profitability ratios. They changed their name to IBM after deciding to enter the Canadian market in 1914. The History of the Company Hermand Hollerith founded Tabulating Machine Company in 1896. efficiency ratios. liquidity ratios..com/investor/financials/financial-reporting. Case Study 2: International Business Machines (IBM) I. HP¶s gearing ratio has steadily increased. the most important one. Time Recording Company.ibm. which could mean a higher rate of risk for potential investors. It must be noted that all financial data used in our calculations are taken from the annual reports available in IBM¶s website. II. The world witnessed the first IBM PC in 1981. From 2007 onwards. and Tabulating Machine Company were merged together to form CTR. from the standpoint of potential investors. Since then. Developing computer machines for the United State Air Force. It could be divided into two parts: return on shareholders¶ funds (ROSF) and return on capital employed (ROCE). For further information.8 In 2007. shareholder ratios. Of the above-mentioned ratio categories. IBM became the chief contractor of the defense industry.

and 2010 was 44. IBM had the highest percentage of return on capital employed in 2009.15 1.06%. It is clear that IBM had the highest gross profit as the percentage of sales in 2009.29%. and 45.09 2009 1. As the table shows.29 2010 1.72%.38% 84.02% 2010 11. 45. 90.12 .18 1.9 ROSF =        X 100 To arrive at ROCE.35 1. we use the following formula:           ROCE = X 100 It should also be noted that in the denominator of both formulas.06% 11.90% 2009 11. we use the average capital of two consecutive years.85% The percentage of return on shareholders¶ funds (ROSF) decreased from 2008 to 2010. 2009.07% respectively.02% 83. IBM had a progressing net profit margin from 2008 onwards.29% 45. Liquidity Ratios Category/Year Current Ratio Acid Test Ratio 2008 1.72% 14.13% 45. Category/Year Return on shareholders¶ funds Return on capital employed Gross profit as percentage of sales Net profit as percentage of sales 2008 12. The performance of the return on capital employed is rather random.07% 14. The gross profit margin for 2008.38% 44.56% 90.

1198 (43.30) 0. The account receivable period means how many days it takes IBM to collect its receivables. We need to compare the liquidity ratios with those of the industry in order to realize whether they are high or low.33 0.12 12.727) 0.69% 2010 $11.1209 (44. IBM had a higher ratio of current ratio and acid test ratio in 2009. the account payable period indicates that how many days it will take the company to pay its payable accounts. It is not so useful to compare the liquidity ratio of one company over different years.79 times 0.77% 2009 $10.89) We calculate efficiency ratios in order to realize whether the collection and payment of debts are efficiently managed. we calculate current ratio and acid test ratio. IBM operated unsatisfactory in 2009 in terms of inventory turnover and accounts receivable to sales ratio.1241 (45.1449 (52.0164 4.69 12.93 0.61 times 0.01 times 0.67% .0170 4.10 Liquidity ratios indicate that whether the company has the capability to meet its current obligations. Shareholder Ratios: Category/Year Earnings Per Share Price/ Earnings Ratios Dividend Yield Dividend Cover 2008 $9.41 days) 2010 21.02 9.55 0. Efficiency Ratios: Category/Year Inventory Turnover Account Receivable/Sales Account Payable/ Purchase 2008 21.1436 (52. Under liquidity ratios.0226 4. The inventory period means how many days it takes IBM to sell its inventory. In the span of time under our consideration.13 days) 2009 20.1165 (42.52) 0.

84% . in 2009. the greater the dividend yield. IBM had a progressing earning per share in the three consecutive years of 2008.69. As the table shows.38% 2010 39. Gearing: Category/Year Gearing 2008 44. The P/E ratio measures the value that investors are assuming for every dollar of current earning.2% 2009 42. The dividend yield measures the exact rate of return to shareholders based on their investment. and 2010. which implies that the company had 4.69 more times available capital to pay its dividend obligations. Therefore. Dividend cover signals the available amount to pay shareholders declared dividends. the more demand will be for its common stock. the dividend cover is 4. the more attractive the company will be for the potential investors. 2009. Thus.11 Based on the table. the higher IBM¶s P/E ratio is.

microsoft. Microsoft lunched its Initial Public Offering (IPO) in 1986 with the opening stock price of USD 21. History of the Company Microsoft is a multinational corporation headquartered in Washington.45 %29.02 %80. We compare the profitability ratios of Microsoft Corporation over three consecutive years.80 %60.95 Profitability ratios provide the analyst with the net results of financing policies and decisions.93 %79. monitors the performance of executive management. USA.41 %28. Ratio Analysis Profitability Ratios: Category/Year Return on shareholders¶ funds Return on capital employed Gross profit* as percentage of sales Net profit as percentage of sales 2008 %29.aspx. Microsoft started offering dividends in 2003.12 %55.26 %80.12 Case Study 3: Microsoft Corporation I.26 2010 %30. II. Microsoft¶s management attempts to enhance profitability as much as practical to encourage further investment. we can notice that it fell dramatically in 2009 perhaps due to the fact that operating expenses went up. It must be noted that all financial data used in our calculations are taken from the annual reports available in Microsoft¶s website. made up of mostly outsiders.17 %23. By looking at Microsoft¶s net profit margin.com/investor/AnnualReports/default. please visit http://www.16 %58.65 2009 %24. . While a high return on sales is good. For further information. The board of directors.

Acid-test ratio is the most used liquidity ratio. it may get a high return on each sale but not make many sales.82 1.44 1.75 times 0. which is calculated by deducting inventories from current assets and then dividing the remainder by current liabilities.77 times 0.06676 (24.5 days) Accounts receivable to sales ratio is also called ³average collection period´.2082 (76 days) 0. Inventories are typically the least liquid asset of the company. it might delay the payment of debts. In the case of Microsoft. Efficiency Ratios: Category/Year Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase* ratio 2008 11.7 days) 2010 16. the current ratio will fall. and this is a negative sign. Acid-test ratio measures a firm¶s ability to pay off short-term obligations without relying on the immediate sales of inventories. If a firm sets a very high price on its products. If current liabilities are rising faster than current assets.3 days) 2009 16.12 2. The current ratio of Microsoft Corporation has been increasing year by year. This ratio represents the average length of time that the firm must wait after making a sale to receive cash.13 everything else equal. we should also be concerned with turnover.1915 (70 days) 0.2249 (82 days) 0.79 2010 2. . It means that the company is able to pay its short-term debts with enough ease. Liquidity Ratios: Category/Year Current ratio Acid-test ratio 2008 1. this ratio increases in a decreasing rate.06441 (23.05688 (20.10 If a company is faced with financial difficulties.95 times 0.41 2009 1.

it takes less time (70 days) for Microsoft Corporation in 2009 to collect accounts receivable from debtors.57 $26. it took Microsoft 82 days to receive from debtors. if it is lower.18 0. Apparently. In this report. In 2008. In order for us to understand the standard amount of dividend yield.32% 2009 $1. it suggests that the company is regarded as being somewhat riskier. Dividend yield ratio shows how much the investor will be paid per dollar of reported profit.90 16. This ratio is higher for firms with strong growth prospects and relatively little risk.14 As the above table indicates.63 13.93 $32. When comparing this ratio with that of the industry.367096 4. two numbers for earnings per share are disclosed: basic and diluted EPS. These numbers differ with respect to the definition of available net income and the number of shares outstanding.12% In the financial statements of Microsoft Corporation.30 $21.52 2. we consider the basic earnings per share.13 12. this company does not hold a constant growth rate of EPS.194102 4.397971 3.68 0. on the other hand.15% 2010 $2. Shareholder Ratios: Category/Year Earnings per share Price to earnings (P/E) ratio* Market price Dividends per share Dividends yield (%) Dividends cover 2008 $1. and it varies in different years. it should be compared . P/E ratio shows how much the investor is willing to pay per dollar of reported profits.052 0.44 1.79 0.

90 2008 % 12.95 54.64 2009 % 18.02 IBM 2009 % 11.530733 X 100 2009 15.50 2010 % 19.38 2008 % 28.56 2010 % 11.89 45.26 2010 % 29.02 30.03 58.03 7.8 29. This ratio is also higher for firms with strong growth prospects and relatively little risk.45 80.68 44.07 14.75 6.06 11.90 33.59 6.33158 2010 17. Microsoft could obtain the highest return on .15 with other companies in the industry.95 36.85 60.16 30.26 55.91 23.14 23.74713 The Industry Analysis: A Comparative Study Profitability Ratios: a) Companies Category/Company Years Return on shareholders¶ funds Return on capital employed Gross profit as percentage of sales Net profit as percentage of sales HP 2008 % 21.41 80. Microsoft could manage to have a considerable increase in the rate of return on shareholders¶ funds. Similarly.02 In regard to the return on shareholders¶ fund (ROSF).65 Microsoft 2009 % 23.72 14. While HP and Microsoft experienced a slight decline in ROSF over the span of three years.1 24.60 45. Gearing Ratio Category/Year Gearing* *     2008 9.17 79.68 64.93 58. it is evident that Microsoft raced ahead of HP and IBM from 2008 to 2010.22 24.

77 49.18 1.82 2009 1.95 10.22 1.44 27. the net profit margin of Microsoft is greater than that of IBM HP whose net profit margin is surprisingly low.96 2008 1.12 2.09 IBM 2009 1. In 2009.77 50.35 1.23 26.4 2010 % 20. Microsoft could also be in a superior position regarding the gross profit margin.6 8.08 The industry norm is calculated by the sum of companies¶ profitability ratios divided over the number of companies.81 2009 % 17. all three companies experienced a drop in ROSF and ROCE.97 0. yet it is by far above that of IBM and HP. Over the three years.07 2010 1.44 1.41 51.16 26.41 2009 1.16 9.82 1. The lowest gross profit margin belong to HP.10 . Liquidity Ratios: a) Companies Category/Company Years Current Ratio Acid Test Ratio HP 2008 0.15 1. b) Industry Norms Years Return on shareholders¶ funds Return on capital employed Gross profit as percentage of sales Net profit as percentage of sales 2008 % 20.16 capital employed (ROCE).29 2010 1.79 2010 2. the lowest return belonged to IBM.12 Microsoft 2008 1. Reflecting a similar pattern.09 0. The company that has one or more ratios below the industry norm indicates the existence of a problem in its operation that must be identified and cured. Microsoft¶s gross profit margin fell in 2010.

143 2009 12.25 0.3 0. On the other hand.61 0.77 0. . Microsoft¶s ability to pay off its short-term debts has increased.20 0. Although being capable of paying its obligations. b) Industry Norms Years Current Ratio Acid Test Ratio 2008 1.01 0.11 IBM 2009 20. Microsoft and HP moved shoulder to shoulder with each other in this regard.38 2010 1.17 0. HP seems to push back the payment to its creditors as much as practical. implying that Microsoft does not delay its creditor¶s payments.45 1. The immediate liquidity of the firm as measured by acid-test ratio has gone up in proportionate with the current ratio.22 Microsoft 2009 16.14 0.146 2008 21. Microsoft¶s accounts payable to purchase ratio is low relative to that of HP and IBM.17 Moving from 2008 to 2010.12 0.46 1.79 0. relative to IBM and Microsoft.15 0.05 0.14 0.19 1.10 2009 1. IBM could also collect its debts much sooner than HP and Microsoft. Having a lower accounts receivable to sales ratio.75 0.19 2010 16.95 0.11 2008 11.49 0.39 Efficiency Ratios: a) Companies Category/Company Years Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase ratio HP 2008 11.06 0.06 IBM maintained a high level of inventory turnover. HP has the weakest position regarding.14 0.12 2010 21.144 2010 15.

156 0.55 1.67 0.15 0.71 32.68 26.26 34.77 0.15 0.18 21. Microsoft¶s P/E ratio stood above the industry¶s average in that year. In 2008.63 13.07 0.15 1.0226 4.12 2010 17.12 12.93 138.77 10. Regarding the dividend policy.13 12.79 9. the average P/E ratio was 12.13 It is evident that investors value each dollar of IBM¶s earnings much higher than the earnings of HP and Microsoft.48 0.35 10.93 0.78 10. .37 0.79 1.19 4.69 12.18.38 3.58 146.3 2.32 0.11 2009 16.31 38.052 0.42 2.46 3.02 9.69 11.0164 4.18 b) Industry Norms Years Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase ratio Shareholder Ratios: a) Companies Category/Company Years Earnings per share ($) Price to earnings (P/E) ratio* Market price ($) Dividends per share Dividends yield Dividends cover HP 2008 2009 2010 2008 IBM 2009 2010 2008 Microsoft 2009 2010 2008 14.21 15.94 1.32 0. HP¶s P/E ratio exceeded the industry P/E ratio in 2009.44 1.0063 10 3.90 16.6 50. In 2009.16 0.0093 10.33 0. Microsoft is also the most attractive option for potential investors.017 4.33 84.97 0.32 0.119 3. but IBM¶s EPS continued to grow.0082 11.93 0.9 0. HP¶s and Microsoft¶s EPS slightly dropped.19 0.37 4.85 2.

19 b) Industry Norms Years Earnings per share Price to earnings (P/E) ratio Market price ($) Dividends per share Dividends yield Dividends cover 2008 3.23 0. Though its gearing ratio increased. In other words.61 11.81 70.8 5.18 50.2 0.97 0.92 13. yet its gearing ratio decreased as it moved towards 2010.52 2009 3. Microsoft kept its financial leverage low compare to HP and IBM. as it moved towards 2010.68 2010 43.75 IBM is a highly geared company in the beginning of 2008.66 2008 44. b) Industry Norms Years Gearing (%) 2008 3.95 2010 4.89 0. HP experienced an inverse course of action.44 2009 5.38 2010 39.86 Gearing: a) Companies Category/Company Years Gearing (%) HP 2008 35.07 6.47 2009 41.71 0.64 12.47 6.20 IBM 2009 42.33 2010 17.84 2008 9.2 .39 2010 6. its gearing ratio increased.53 Microsoft 2009 15.82 0.94 70.

20 Work Cited: I. 18 May 2011." Scribd. 14 Apr. and Joe Barnes. Hewlett-Packard. Chad. 2008. Web. <http://www. .scribd. "Hewlett-Packard. Dodge.com/doc/54882240/HP-Paper>.

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