Question

From the Annual Report of Robert Half. Please help me with these questions?

1. Are you optimistic or pessimistic regarding the future of your chosen corporation? Explain.

2. Would you invest in the stock of the company? Explain.

3. Would you invest in the bonds of the company? Explain.

Answer 1

Stock investing requires careful analysis of financial data to find out the company's true worth. This is generally done by examining the company's Annual report which includes profit and loss account, balance sheet and cash flow statement. An easier way to find out about a company's performance is by analysing its financial ratios. There are various types of ratios on the basis of which situations given in the question can be explained.

1. P/E RATIO
   The price-to-earnings, or P/E, ratio shows how much stock investors are paying for each rupee of earnings. It shows if the market is overvaluing or undervaluing the company. A high P/E ratio may indicate that the stock is overpriced. In this case, the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.

A stock with a low P/E may have optimism and will not attract investors              in investing in stocks and bonds.

2. PRICE-TO-BOOK VALUE

The price-to-book value (P/BV) ratio is used to compare a company's market price to its book value. Book value, in simple terms, is the amount that will remain if the company liquidates its assets and repays all its liabilities. P/BV ratio values shares of companies with large tangible assets on their balance sheets. A P/BV ratio of less than one shows the stock is undervalued (value of assets on the company's books is more than the value the market is assigning to the company). In this case, the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.

3. DEBT-TO-EQUITY RATIO

It shows how much a company is leveraged, that is, how much debt is involved in the business vis-a-vis promoters' capital (equity). A low figure is usually considered better. But it must not be seen in isolation. In this case, the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.

If the company's returns are higher than its interest cost, the debt will enhance value. However, if it is not, shareholders will lose.

Also, a company with low debt-to-equity ratio can be assumed to have a lot of scope for expansion due to more fund-raising options.

4. OPERATING PROFIT MARGIN (OPM)
   The OPM shows operational efficiency and pricing power. It is calculated by dividing operating profit by net sales. While analysing a company, one must see whether its OPM has been rising over a period. Investors should also compare OPMs of other companies in the same industry. In case of higher OPM, the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.
5. RETURN ON EQUITY

The ultimate aim of any investment is returns. Return on equity, or ROE, measures the return that shareholders get from the business and overall earnings. It helps investors compare profitability of companies in the same industry. A figure is always better. The ratio highlights the capability of the management. In this case, the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.

ROE is net income divided by shareholder equity.

6. INTEREST COVERAGE RATIO

It is earnings before interest and tax, or EBIT, divided by interest expense. It indicates how solvent a business is and gives an idea about the number of interest payments the business can service solely from operations. Higher Interest coverage ratio indicates that the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.

7.CURRENT RATIO

This shows the liquidity position, that is, how equipped is the company in meeting its short-term obligations with short-term assets. A higher figure signals that the company's day-to-day operations will not get affected by working capital issues. A current ratio of less than one is a matter of concern.

8.ASSET TURNOVER RATIO

It shows how efficiently the management is using assets to generate revenue. The higher the ratio, the better it is, as it indicates that the company is generating more revenue per rupee spent on the asset. In this case, the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.

Experts say the comparison should be made between companies in the same industry.

9.DIVIDEND YIELD

It is dividend per share divided by the share price. A higher figure signals that the company is doing well. But one must be wary of penny stocks (that lack quality but have high dividend yields) and companies benefiting from one-time gains or excess unused cash which they may use to declare special dividends. In this case, the investor will be pessimistic and will be interested in investing the stocks and bonds of the company.

Similarly, a low dividend yield may not always imply a bad investment as companies (particularly at nascent or growth stages) may choose to reinvest all their earnings so that shareholders earn good returns in the long term.