Company Evaluation: Marshalls and Polypipe Group (Case Study Sample)

COMPANY EVALUATION: MARSHALLS AND POLYPIPE GROUP Student’s Name Course Professor’s Name University State Date Company Evaluation: Marshalls and Polypipe Group Introduction Company valuation refers to the process of measuring the economic value of a corporation. According to Anderson (2009), this formal assessment establishes the fair value of a firm for a number of reasons that are sale value, determination of partner possession, and divorce dealings. The report is divided into two sections whereby the first section deals entirely with accounting valuation of Marshalls and Polypipe Group while the second section uses a forecast dividend growth model to value Marshalls' stock. The model is analyzed further by outlining its benefits and limitations. Marshalls and Polypipe Group are the corporations in construction and materials industry whose shares fall under the FTSE 350 stocks on the London Stock Exchange (LSE). In the stock market, the shares trade under the symbol MSLH and PLP respectively. The case of Marshalls and Polypipe Group undertakes the two company’s valuation using financial ratio and forecast dividend growth model in order to recommend the best company for investment. Part A: Financial Ratio Analysis Report In this section, financial statements for the two companies were obtained for 2016 and 2015 from the companies' websites. After that, the financial ratios of profitability, financial position, performance from an equity shareholders perspective, and the overall performance and position of Marshalls and Polypipe Group were computed. A recommendation of the best corporation for investment was then provided based on the analysis results. Evaluation of Profitability Profitability of Marshalls and Polypipe Group for the financial years ending 31st December 2015 and 2016 were evaluated using operating margin and return capital employed. Table 1 below shows the profitability ratios for the two companies. Marshalls 2015 2016 Operating margin 9.81% 11.85% Return on Capital Employed 16.50% 20.44% Polypipe Group Operating margin 13.94% 14.12% Return on Capital Employed 11.82% 12.88% Table 1: Profitability Ratios Based on the table above, Marshalls is more profitable than Polypipe Group. It attained operating margin growth of 2.04% and return on capital employed growth of 3.94% between 2015 and 2016. On the other hand, Polypipe Group attained growths of 0.18% and 1.06% for operating margin and return on capital employed respectively. Evaluation of Financial Position A liquidity ratio is used to measure the short-term financial position while a gearing ratio measures a firm’s financial position over a long period. For simplicity, current ratio was used as the only measure of liquidity and was computed as follows: Current ratio = Current Assets/Current Liability Marshalls’ values were as follows for 2015 and 2016: Current ratio (2015) = 137.02/87.07 = 1.574 Current ratio (2016) = 139.68/87.07 = 1.604 The current ratios of Polypipe Group the years 2015 and 2016 were obtained as follows: Current ratio (2015) = 99.60 /87.20 = 1.142 Current ratio (2016) = 119.50/104.50 = 1.144 The results for the two years reveal that Marshalls was in a better position of repaying its current debts than Polypipe Group. On the other hand, the gearing ratio was quantified using debt-to-equity ratio (total liabilities/shareholders equity), equity ratio (shareholders equity/total assets), and debt ratio (total liabilities/total assets). For Marshalls, gearing ratios for 2015 and 2016 were obtained as follows: Debt-to-equity ratio (2015) = 138.25/192.72 = 0.7174 Debt-to-equity ratio (2016) = 117.42/217.12 = 0.5408 Equity ratio (2015) = 192.72/329.83 = 0.5843 Equity ratio (2016) = 217.12/333.08 = 0.6519 Debt ratio (2015) = 138.25/329.83 =0.4192 Debt ratio (2016) = 117.42/333.08 =0.3525 The gearing ratios for Polypipe Group for 2015 and 2016 were computed as follows: Debt-to-equity ratio (2015) = 315.10/261.00 = 1.2073 Debt-to-equity ratio (2016) = 304.70/287.40 = 1.0602 Equity ratio (2015) = 261.00/576.10 = 0.4530 Equity ratio (2016) = 287.40/592.10 = 0.4854 Debt ratio (2015) = 315.10/576.10 =0.5470 Debt ratio (2016) = 304.70/592.10 = 0.5146 Marshalls has low gearing ratios compared to Polypipe Group. As such, Polypipe Group has a high degree of leverage, which means it has a riskier financing structure than Marshalls. Equity Shareholders’ Perspective of Performance The performance of a firm from an equity shareholders perspective is best estimated by shareholders equity ratio. According to the calculations gearing ratio computations in the previous section, Marshalls attained a shareholder equity ratio of 0.6519 while Polypipe Group’s shareholder equity ratio was 0.4854. It is worth noting that equity ratio highlights two important concepts regarding solvency and sustainability of a business. First, it represents the proportion of ownership of the business belonging to investors. For instance, in the current case, 65.19% of Marshalls was owned by shareholders while in 48.54% of Polypipe Group’s ownership belonged to investors. Secondly, it indicates how leveraged the firm is in debt. In general, higher values of equity are preferred because it implies the company is being financed more with equity than debt. As a result, Marshalls is better than Polypipe Group from shareholder's point of view. Overall Performance and Position According to John, John and Lang (2010), return on equity is employed by most Wall Street analysts and investors as the best measure of a firm's overall performance and position. While there are other valuation methods like IRR, CFROI, and DCE, return on equity is still the most enduring measure. Return on equity is obtained by dividing net income by total shareholders' equity. For Marshalls, return on equity for 2015 and 2016 was obtained as follows: Return on equity (2015) = 28.47/192.72 = 14.77 % Return on equity (2016) = 37.51/217.12 = 17.28 % For Polypipe Group, return on equity for 2015 and 2016 was obtained as follows: Return on equity (2015) = 34.10 /261.00 = 13.07 % Return on equity (2016) = 44.20 / 287.40 = 15.38 % From the calculations above, Marshalls acquired higher returns on equity between 2015 and 2016 than Polypipe Group. Moreover, Marshalls' growth return on equity was higher than that of Polypipe Group. Increasing ROEs obtained by both companies between 2015 and 2016 indicated that the two corporations were increasing their ability to generate profit without requiring additional capital (Heerkins 2006). While both companies’ managements deployed their shareholders' capital well, Marshalls was better than Polypipe Group in doing so. Recommendation Based on all the above company evaluation techniques, Marshalls is a better investment than Polypipe Group. In terms of profitability, it attained higher operating margins for the years 2015 and 2016 than Polypipe Group. When analyzing financial position, Marshalls had low gearing ratio implying that the firm as a financing structure was less risky compared to that of Polypipe Group (Bodie, Alex & Alan 2004). The other method which preferred Marshalls’ stocks to Polypipe Group’s shares was Equity shareholders’ perspective of performance. To be more specific, Marshalls was largely owned by investors and financed more with equity than debt (Brown 2007). Marshalls’ management was better than Polypipe Group’s managers in deploying their shareholders' money. Return on equity of the two companies for years 2015 and 2016 also indicated that it was better to trade in MSLH stock than PLP. As such, if an investor wants to invest in a stock market dominated mainly by Marshalls’ and Polypipe Group’s shares, the investor should choose Marshalls over Polypipe Group shares. Part B: Company Evaluation Using Forecast Dividend Growth Model When computing the value of a share using the forecast dividend growth model, it is appropriate to assume a growth rate as well as a dividend payout rate. The growth rate can be estimated using three methods. First, a future growth rate can be assumed based on observed historical growth in dividends of the company. Second, the median industry dividend growth rate can be used as the dividend growth rate. Lastly, a suitable growth rate can be computed using return on equity (ROE) and an assumed dividend payout ratio. Since Marshalls is the recommended company for investment, this section endeavors to compute the dividends growth rate for Marshalls. Sustainable Growth Rate According to Brown (2007), suitable growth rate refers to the rate at which the firm can progressively grow without further borrowing or issuing new stocks. The formula for computing a suitable growth rate is: g = ROE * (1 – Dividend payout ratio) At this point, it is assumed that the dividend payout ratio is 0.42. From the early calculations, Marshalls Company's return on equity (ROE) was 15.38 % in 2016. These values are substituted in the formula to obtain sustainable growth rate (g). g = 0.1538 * (1 – 0.42) g = 0.1538 * 0.58 g = 0.0892 The implication here is that with a return on equity of 15.38 % and a dividend payout ratio of 0.42, Marshalls can sustain a growth of 8.92 %. The actual market values for dividend growth were 1.92% and 3.30% respectively for the years 2015 and 2016. The predicted value is high implying that Marshall’s stock has a potential to grow in the future. Once g is computed, the stock's price can be obtained using the formula: P = D / (k-g) where P is the share price, D is the dividend payout rate, k represents the required rate of return, and g is the suitable dividend growth rate. From the previous assumptions and computations, D = 0.42, k = 15.38 %, and g = 0.0892. These values are substituted in the equation as follows: P = 0.42/ (0.1538 �...