Case Situation:
I chose Hewlett Packard Company (HP) to invest in. Hewlett-Packard (HP), the world’s largest computer and electronics company, ranking 11th in the Fortune 500 list has a powerful team of 150,000 employees doing business in more then 170 countries in five continents that are under-developed or developing. The company’s offerings span Information Technology (IT) infrastructure, personal computing and access devices, global services, imagining and printing. Product and service categories include desktops and workstations, notebooks and tablet personal computers (PC), printing and multifunction, handheld devices, monitors and projectors, fax, copiers and scanners, digital photography, storage, servers, supplies and accessories, networking and software products.
I am going to make a financial ratio analysis and compare HP with top competitors in its industry to show that it’s a good decision for investment.
Liquidity Analysis:
The liquidity ratio measures the extent to which a corporation or other entity can quickly liquidate assets and cover short-term liabilities, and therefore is of interest to short-term creditors. Current ratio and quick ratio are used in this analysis. Current ratio is found by dividing the current assets (total dollar value of cash and marketable securities) by current liabilities. Quick ratio, which is also called as acid-test ratio is another measure of company’s liquidity. It equals quick assets divided by current liabilities. Quick assets are found by subtracting inventories from current assets.
Table 1: Current and quick ratios
|
Fiscal year end
|
10/31/2003
|
10/31/2004
|
10/31/2005
|
|
Currents Ratio
|
1.53
|
1.48
|
1.54
|
|
Quick Ratio
|
0.70
|
0.96
|
0.99
|
As shown in Table 1, HP’s current ratio has made a slight increase in the last three years but the quick ratio jumped from 0.70 to 0.99 levels which is a sign of improvement for the creditworthiness of the company.
As shown in the table below HP’s current and quick ratios are close to industry averages and higher than all other U.S companies. But in the global market Japanese Canon has significantly better liquidity ratios then all its competitors.
Table 2: Comparative Liquidity Ratios
|
|
HP
|
Canon
|
Dell
|
IBM
|
Industry
|
|
Current Ratio
|
1.52
|
2.38
|
1.03
|
1.21
|
1.35
|
|
Quick Ratio
|
1.0
|
1.5
|
0.8
|
1.0
|
1.0
|
Financial leverage ratios provide an indication of the long term solvency of the firm. Unlike liquidity ratios that are concerned with short-term assets and liabilities, financial leverage ratios measure the extent to which the firm is using long term debt.
Debt/equity ratio is a measure of company’s leverage, calculated by dividing long term debt by common shareholders’ equity, usually using the data from the previous fiscal year. Sometimes, long-term debt plus preferred shareholder's equity is divided by common shareholders' equity, since preferred stock can be viewed as a form of debt.
Interest coverage ratio is the calculation of a company's ability to meet its interest payments on outstanding debt. Interest coverage ratio is equal to earnings before interest and taxes for a time period, often one year, divided by interest expenses for the same time period. It is also called interest coverage.
Table 3: Comparative Leverage Ratios
|
|
HP
|
Canon
|
Dell
|
IBM
|
Industry
|
|
Debt/equity ratio
|
0.18
|
0.03
|
0.08
|
0.76
|
0.42
|
|
Interest coverage
|
41.10
|
140.30
|
290.30
|
88.60
|
42.80
|
Hewlett-Packard (as shown in Table 3) has a greater debt/equity ratio then Canon and Dell which means that the company can offer greater returns to shareholders but is also riskier. However the interest coverage ratio shows that the company has also larger debt burdens than its competitors which is an important weakness.
Activity Analysis
Activity ratios show how effectively a firm’s assets are being managed. Activity analysis, together with the leverage ratios are the key factors in determining profitability.
Asset turnover ratio is one of the measures of activity. It is also called as asset turnover. Another activity measure is the inventory turnover ratio. It is the ratio of annual sales to inventory; or equivalently, the fraction of a year that an average item remains in inventory.
Table 4: Comparative Activity Ratios
|
|
HP
|
Canon
|
Dell
|
IBM
|
Industry
|
|
Asset turnover ratio
|
1.1
|
1.1
|
2.5
|
0.9
|
1
|
|
Inventory turnover ratio
|
8.8
|
3.3
|
94.9
|
16.4
|
14.2
|
According to Table 4 Dell company has a bigger asset turnover which means that the company is using its assets more efficiently than other competitors in the industry. Company’s “no- inventory” policy has significant effects on its superiority. HP has the third highest inventory turnover ratio and far behind Dell and IBM which means that the company should find ways to reduce inventory.
Profitability Analysis:
Profitability ratios measure and explain the ability of the firm to generate income. Return on assets (ROA) is one of the profitability measures and equal to a fiscal year's earnings divided by its total assets, expressed as a percentage. Return on equity (ROE) shows how well a company used reinvested earnings to generate additional earnings. It is equal to fiscal year's after-tax income (after preferred stock dividends but before common stock dividends) divided by book value, expressed as a percentage. According to Table 5 HP has less ROE and ROA than their competitor, which means that the company is less profitable than its competitors for the investors which is a bad sign. However the company’s ROE has a growing trend in the last 5 years can make investors optimistic about their decisions.
Table 5: Comparative profitability ratios
|
|
HP
|
Canon
|
Dell
|
IBM
|
Industry
|
|
ROE
|
0.084
|
0.158
|
0.476
|
0.28
|
0.118
|
|
ROA
|
0.044
|
0.094
|
0.148
|
0.081
|
0.046
|
Growth Analysis:
According to HP 2005 Annual Report the company shipped more than 50 million printers, 30 million PCs and 2 million industry-standard servers. From a financial perspective, HP exited fiscal 2005 with one of the strongest balance sheets in the industry. Cash flow from operations was $8 billion. They have $13.9 billion in cash and cash equivalents. Excluding the debt associated with their leasing business, they have virtually no operational debt. The operating profit for the full year was $3.5 billion, as compared to $3.6 billion in fiscal 2004 and $3.7 billion in fiscal 2003. HP anticipates they will continue to have significant research and development expenditures in the future to provide a continuing flow of innovative, high-quality products and services to maintain and enhance their competitive position.
References:
Gallagher, T.J. & Andrew Jr., J.D. (3rd Ed.) (2003). Financial Management, Principles Practice. Prentice Hall, Upper Saddle River, NJ 2005 Annual Report HP.