XACC 280 WK 7 - DQ 2 - 8051

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DQ 2

Given the data, would you have invested in Quality Department Store in 2006? Explain why or why not. Summarize your analysis of the financial data to support your reasoning. What recommendations would you make to improve the financial health of this company? Explain why.

Well, let me start by saying that I would not make an investment (presumably stock purchases) in Quality Department Store without looking at other types of data, most notably macroeconomic fundamentals that could lead to a decrease in consumer spending. Also, there could always be an alternative investment that I think could give me greater returns on my investment. With that said, the question asks if I would invest based solely on the data in the various ratios, so I will assume that there are no worries about any types of economic factors and there are no other worthy alternatives to invest in. In this case I would invest in this company for a number of reasons.

First, they have an above average and stable profit margin that has grown over the last two years. Most importantly, I think their return on assets ratio is quite impressive compared to the related companies; this shows me that the management has a knack for running the business efficiently with low operating costs. Moreover, the management is able to have a high return on assets in spite of the fact that they have low asset turnover ratios. To me, I see this is an area that could improve with a seemingly capable management and would help bring in more revenue. The return on shareholder's equity is also something that shows me this company may be a worthwhile investment. Lastly, the P/E ratio is rather low compared to other companies in that industry, leaving me with the impression that this company may be undervalued by investors.

 

Instructor response

Here is the ratio analysis of Quality Department Store:


Profit Margin – Consistent from 2004 to 2005 and above the industry average.

Asset Turnover – Consistent from 2004 to 2005 and below the industry average.

Return on Assets – Increased in 2005 compared to 2004.  Both years exceeded the industry average.

Return on Stockholders Equity - Consistent from 2004 to 2005 and above the industry average.

Earnings per Share – Increased $0.20 from 2004 to 2005.

Price Earnings – Increased in 2005 compared to 2004.  Both years below the industry average.

Payout Ratio – Decreased in 2005 compared to 2004.  Both years above industry the average.

Solvency Ratio - Decreased in 2005 compared to 2004.  Both years above the industry average.

Times Interest Earned - Increased in 2005 compared to 2004.  2005 exceeded the industry average.

 

Based upon the performance of Quality Department Store (QDS) for 2004 and 2005, I would consider is a good investment for the following reasons:

1.   Strong Profitability Ratios - QDS is not only profitable, but is considerably more profitable than its peers.

2.   Strong Return on Common Stockholders Equity - QDS has delivered value to its stockholders.

3.   P-E Ratio - QDS trades at 13 times its earnings.  The industry average is 26 times.

A few things which I would watch about QDS are:

1.   Debt Ratio - QDS' ratio is acceptable, but additional debt may not be in the stockholders best interests.

2.   Times Interest Earned - QDS is now well covered in 2005, but in 2004, it was not in as good of shape.

In my opinion one of the best things management could do to make the company a more attractive investment is to decrease the debt.  A lower debt load would provide for more free cash flow which could be used to pay more back to the shareholders.

 

Solution Description

DQ 2

Given the data, would you have invested in Quality Department Store in 2006? Explain why or why not. Summarize your analysis of the financial data to support your reasoning. What recommendations would you make to improve the financial health of this company? Explain why.

Well, let me start by saying that I would not make an investment (presumably stock purchases) in Quality Department Store without looking at other types of data, most notably macroeconomic fundamentals that could lead to a decrease in consumer spending. Also, there could always be an alternative investment that I think could give me greater returns on my investment. With that said, the question asks if I would invest based solely on the data in the various ratios, so I will assume that there are no worries about any types of economic factors and there are no other worthy alternatives to invest in. In this case I would invest in this company for a number of reasons.

First, they have an above average and stable profit margin that has grown over the last two years. Most importantly, I think their return on assets ratio is quite impressive compared to the related companies; this shows me that the management has a knack for running the business efficiently with low operating costs. Moreover, the management is able to have a high return on assets in spite of the fact that they have low asset turnover ratios. To me, I see this is an area that could improve with a seemingly capable management and would help bring in more revenue. The return on shareholder's equity is also something that shows me this company may be a worthwhile investment. Lastly, the P/E ratio is rather low compared to other companies in that industry, leaving me with the impression that this company may be undervalued by investors.

 

Ins