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The analysis in the readings below represents a genuine opinion of an equity analyst hired by a mutual fund that is in search of an ideal company to invest. To be more precise, the equity analyst was assigned with the task of analyzing the quarterly financial statements of Linamar Corporation (LNR – TSX) to establish its operations and provide recommendations to the mutual fund on whether to continue with the investment or not. With that said, below is given an analysis of Linamars ratios, the price forecast of Linamar corporations, the Net Present Value (NPV) added with the payback period and finally a brief recommendation provided by the analyst to the mutual fund on whether the knowledge obtained from the financial statements analysis is worth the mutual funds investment.
An industry analysis is a market assessment tool designed in a way to serve the purpose of providing business owners or potential investors with an idea of how complex a specific industry is. To be more precise, analyzing an industry involves reviewing of all the factors that influence the industry development. These are the economic, market and political factors. Also, significant factors affecting the operation of an industry include the likelihood of new market entrances, competitors condition and lastly the power exercised by the buyers and suppliers.
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An industry analysis of the sector that Linamar Corporation operates in will be conducted using Porters five forces model of industry analysis. In this model created and analyzed by Porter, a framework showing how the five forces influence every industry in one way or another is provided. As a result, the model below gives a clear understanding of how the five forces operate.
The Five Forces of Porter
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SUPPLIER POWER The concentration of suppliers how volume is of importance to suppliers effects of differences in inputs |
||
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THREAT OF NEW ENTRANTS Barriers to Entry Absolute significances of cost inputs |
|
THREAT OF SUBSTITUTES -Substituting costs -Changes of customer tastes -Substitutes price performance concerning buyer |
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BUYER POWER Buyers bargaining power information obtained by the buyer concerning the product |
DEGREE OF RIVALRY -Barriers to exit an industry -the concentration available in an industry |
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Rivalry
Business enterprises and firms operating in the same industry strive to obtain or capture the better if not the entire share of the customer base. Similarly, the competition is also meant to achieve a competitive advantage over their rivals to throw them out of the business by providing the best quality services to the customers. However, harsh competition is not present in all industries. To be more precise, there are some industries where competition is very intense and industries where competition is feeble. With that said, the major role of strategic analysts in a company like Linamar Corporation is to determine the causes of these variations because these causes would show how concentrated an industry is, and therefore, reveal the level of rivalry among companies in the given sector. To be more precise, an industry that yields a very high concentration ratio indicates that the given company owns most part of the market share in that industry. On the other hand, a low concentration ratio is an indication that several rivals who own a significant proportion of the market characterize the industry.
Threat of Substitutes
Substitute products are the products of other sectors. Therefore, this kind of threat arises when the change in the price of the substitute affects the demand for a product. To be more precise, increased availability of substitute products leads to an increase in the elasticity because customers now have more alternatives to choose from. As a result, continuous increase in the companys competitive environment due to the existence of many substitutes lowers the profit potential.
Buyer Power
The Buyer Power can be referred to as the impact that the customers have on the producing company. To be more precise, in the event of a high buyer power, the relationship that exists in such case is called a Monopsony. It is a market characterized by many suppliers and only one customer and it is in such conditions that the buyer sets the prices. It is therefore undoubted that such a case lowers the profit potential of the company.
Supplier Power
Every industry engaged in production requires raw materials including labor and other components of production. As a result, this creates a buyer supplier relationship. Therefore, if the suppliers are powerful enough, they have a greater chance of selling their raw materials to the production company at a high price hence capturing some of the industrys profits. Equally, highly dominant suppliers have the potential to increase costs in the producing industry without affecting their sales volumes.
Threat of New Entrants
Incumbent firms in an industry pose significant threats to the new companies willing to join the sector. However, this is not always the case, because in some instances, the new businesses tend to pose a threat to the incumbent firms because they enter the market with new ways of handling issues. If an industry is profitable or has the potential to become profitable, it will attract new investors. Therefore, new companies joining the industry unless there exist barriers to entry can quickly change the dynamics of any industry. As a result, in the case of many new entrants into an industry, the profitability of the industry will substantially decline.
The Dividend Discount Model is a procedure commonly used in the valuation of the prices of stocks by using predicted dividends and discounting them back to their present value.
Since the dividends have been following a constant growth rate quarterly by 0.1 adding up to 0.5 in the last dividend payout, it is assumed that this will also happen in the next period. To be more precise, the dividend will follow the similar pattern and therefore, dividend payable for the next period will be 0.6
With that said, the price forecast can be calculated as follows;
Dividend payable for next period= dividend payable in previous period X dividend growth rate
100
0.6= 0.5 X g
100
Where g is the dividend growth rate
Therefore, growth rate (g) = 0.6
50
=0.012 or 1.2%
With this done, the price forecast is calculated from the formula
Value of stock = Dividend per share
Discount rate Dividend growth rate
The variables in this model are P representing the current stock price, g representing constant growth rate, r representing the constant cost of equity capital and D1 representing the value of dividends in the next year.
Value of stock = 0.6
0.08 0.012
= 8.82
Value of stock = 8.82
From the above calculations, it is evident that the dividend-price in the next period will have increased by 1.21 from 7.5 to 8.82. It is a clear indication that Linamar Corporation is a promising business and any potential investors should invest in it since with such a growth rate in the dividends payable per share their returns will be met quickly.
The Constant Growth Dividend Discount Model is the most suitable model to be used in this case in the computation of share price. The reason is that this model does not rely on the market conditions while computing company stocks, therefore, making it very easy for potential investors to compare the stocks of different companies operating in different industries. However, Constant Growth Dividend Model is characterized by several shortcomings, primarily, it heavily operates on the assumption that the growth rate of dividends in a company is always known and stable which is not the case in real-life situations. Secondly, this model does not rely on non-dividend factors such as retaining customers, the loyalty of brands in the company and the effect or impact that intangible assets owned by the corporation in question has on share price.
The price forecast of 8.82 is relatively higher than the current share price of 7.5. The reasons behind these differences are as follows. The first one is the increase in the overall net profits of the Linamar Corporation. It is from these net profits that dividends are paid. The second and rarer one is a companys decision whereby the board of directors through the advice of financial engineers decide to channel less of its earnings to the growth and expansion of the company hence leaving a large share of its net profits to be issued out to investors as dividends.
Market Value per Share
According to Guerard (2010), market Value per Share is the ratio used in the valuation of companies that measures their current stock prices about their per-share earnings. To be more precise, the Market Value per Share is very different with the current price that a stock is trading. The reason is that the current trading price is highly based on the investor buying and selling behavior while Market Value per Share is not. Therefore, If the investors intend to pay more than the Market Value per Share, this leads to an assumption that the stock is overvalued, and if the investors tend to pay less than the intrinsic value which is the Market Value per Share, then the stock is definitely undervalued.
Kd=
Where; Kd=Cost of capital
Po=Market value per share
D=Grown dividend
0.08=0.6/Po
Po=7.5
Market value per share=7.5
Book Value per Share
According to Stowe (2007), Book Value per Share compares the total shares that investors own in a firm to the number of shares that are yet to be issued out to the public or that the company chooses to hold for itself. Therefore, if the Market Value per Share is lower than the Book Value per Share, then it is correct to deduce that the price of shares is undermined. The Book Value per Share of Linamar Corporation is calculated as shown below
Book value/share = Shareholders Total Equity-Preferred Equity
Total Shares Outstanding
Diluted Average EPS= (1.44+1.64+1.83+1.73+1.10)/5
= 1.55
Total income= 95.27+107.61+120.11+113.68+71.78=508.45
1.55=508.45/Shares
Total shares=508.45/1.55
=328
Shareholders Total Equity=328?7.5=2460
Book value/share=2460/328
=7.5
Book Value/ Share= 7.5
Ratio of Price to Book
According to Damodaran (2012), the price to book ratio is used to give a clear and full comparison on how shares are currently valued in the market against the values obtained or evident in the books of accounts. To be more precise, it is only calculated by dividing the prevailing closing price of the securities by the latest figure of the shares in the books. With that said, the price to book ratio of Linamar Corporation is:
Ratio of price to book= Current closing price of the stock
Latest Quarter book value per share
=1.10/7.5
=0.145
Price to book ratio=0.145
P/E Ratio
According to Anderson (2012), the Price Earnings ratio (P/E Ratio) is the ratio commonly used in the valuation of a companys current share price against its current per-share earnings. Similarly, the Price Earnings Ratio is also employed to determine whether a companys stock is undervalued or overvalued. As a result, after computation, companies with a high P/E Ratio represent growth stocks. However, P/E ratio gives a vague picture of the growth potential of a company. The reason is that the P/E Ratio often uses past earnings trailing all the way back to twelve months.
P/E Ratio=MPS/EPS
=7.5/1.55
=4.84
P/E Ratio is 4.84
ROE (Return on Equity Ratio)
Return on Equity is the amount of the entire income earned (Net Income) and returned as a percentage of the equity of the shareholders. For this ratio to measure a corporations profitability, it has to reveal the amount of profit that is generated by a company using the financial resources invested by the shareholders. Therefore, it is to be stated categorically that the top most function of ROE is to measure how efficiently and fast a company can use the money from shareholders who have invested and trusted in the firm’s operations to generate more profits. ROE is always expressed as a percentage.
ROE=Net income?
Shareholder Equity
=508.45/2460
=0.21
Return on Equity Ratio= 0.21
Dupont Ratio
The Dupont Ratio is based on the ROE ratio used for the computation of a companys ability to increase its returns from the funds invested by the shareholders.
Dupont Ratio=Profit/Sales
Total sales=1242.98+1273.88+1368.12+1277.46+1003=6165.44
=508.45/6165.44
=0.082
Dupont Ratio is 0.082
Industry Analysis
Linamar Corporation is a company majoring in the manufacture of engineering products powered vehicles in Guelph, Ontario. It is ranked as the top most Canadian supplier in the industry of metal parts for mobile industry, energy and automotive markets. However, the company is not alone in the industry. To be more precise, its great competitors are Dana Holding Corporations, Magna International Inc. and Meritor Inc.
In conclusion, the advice to the public firm is to invest in Linamar corporations. The reason is that compared to its competitors, it is fairly better just as its financial statement indicates and it still has a great potential to do even better in the future. To be more precise, Linamar corporations has registered a positive trend in the rates of dividends, therefore, giving investors a degree of assurance that their money will be put to good use and that with the continued increase in dividend payout, investments will not be a wrong idea. The steady growth in the profits confirms the assertion that Linamar Corporation has a promising future that investors should gamble. Therefore, I advise the mutual fund to invest its money in Linamar Corporation, and they will not regret this choice.
PART B
Net Present Value
|
Investment |
Year |
Cash flow (million) |
Discounting Factor at 8% |
Discounted cash flows |
Totals |
|
1 billion |
0 |
0 |
0.9259 |
0 |
0 |
|
1 |
0 |
0.8573 |
0 |
0 |
|
|
2 |
0 |
0.7938 |
0 |
0 |
|
|
3 |
150 |
0.7350 |
110.25 |
110.25 |
|
|
4 |
172.5 |
0.6806 |
126.79 |
237.04 |
|
|
5 |
198.38 |
0.6302 |
135.02 |
372.06 |
|
|
6 |
228.13 |
0.5835 |
143.77 |
515.83 |
|
|
7 |
262.35 |
0.5435 |
153.08 |
815.81 |
|
|
8 |
257.10 |
0.5403 |
138.08 |
668.91 |
|
|
9 |
251.96 |
0.5002 |
126.03 |
794.94 |
Cash flows beyond nine years
=251.96/0.08
=3149.5
Payback Period
Payback period is the amount of time required for any investor to recover the initial sum of money that had been invested in terms of profits or savings (Kinney & Raiborn, 2009).With that said, the computation of the payback period of Linamar Corporation is as follows.
Payback Period=9+ (7943149.5)
=9.25
Advantages of Payback Period
Among the many benefits of embracing the estimate of payback time is that this method is simple to compute and it is very easy to follow and understand every detail without the help of any analyst because the formulae are straightforward. Secondly, it is not only regulated by a specific industry but is used by all manufacturers all over the world. Thirdly, the liquidity for making decisions about the laid down possible investments proposals are given the first chance and much concentration is channeled to them. Lastly, the expenditure of capital circulation requires a relatively short period for it to be realized. Therefore, payback computation strategies are most suitable in this situation because they are realized using a very short-term approach.
Disadvantages of Payback Period
The first disadvantage is that in its computation, payback fails to recognize the time value for money. Secondly, payback highly ignores the aspects of profitability and lays a high emphasis only on liquidity. Lastly, payback fails to consider the cash that was incurred the period after payback. To be more accurate, it only channels its concentration on the cash flow that a company incurs before breaking even.
In conclusion, a company registering a positive growth in the dividend payout indicates that the firm is doing well in the market, and in the case of Linamar Corporation; it indicates an expected growth rate of 1.21. To be more accurate, this is the difference between the expected/ forecasted share price in the next dividend payout period and the current share price used to compute bonus during the latest dividend payout period. Also, the change in the share price is an indication that the net profits of Linamar Corporation are increasing. The increase in net profits is a sign that the company is successfully expanding its customer base in the market. Therefore, this shows that if all other factors are not expressed in public by the management of Linamar and remains constant, the company will continue making more profit hence paying more dividends. However, if the companys additional net profits are derived from reducing the share of net profit that is used for the growth and expansion of the company, the decision of investing in the company would change. Assuming that this is not the case because there is no information stating so, the decision to invest in Linamar Corporation would be still relevant.
