Question

Use the Price-earnings Ratio and the DuPont Model to perform an equity analysis for The ABC firm for the years 2012 and 2013.

The following financial information is available for your use:
Revenue: $130,500,000 (2012); $202,560,000 (2013).
Net Income: $22,740,000 (2012); $44,563,000 (2013).
Assets: $210,000,000 (2012); $206,700,000 (2013).
Shareholders' Equity: $146,500.000 (2012); $148,824,000 (2013).
Market Value Per Stock Share: $23.15 (2012); $28.22 (2013).
Earnings Per Share: $2.87 (2012); $4.10 (2013).
Industry Average ROE: 22.5% (2012); 27.3% (2013).
Industry Average Price/Earnings Ratio: 7.7 (2012); 8.2 (2013).
Compute and analyze the following:
Compute the return on equity (DuPont Model) for 2012 and 2013 and show all intermediate calculations to arrive at the ROE figure.
Analyze the return on equity (DuPont Model) change from 2012 to 2013, comparing it with the industry average ROE given in the assignment. In two paragraphs or less, write up your analysis discussing the positive and negative aspects of the company's performance.
Compute the Price-earnings Ratio for 2012 and 2013 and show all your calculations.
Analyze the Price-earnings Ratio change from 2012 to 2013, comparing it with the industry average Price-earnings Ratio for each year. In two paragraphs or less, write up your analysis discussing the positive and negative aspects of the company's Price-earnings performance.
Combine your analyses of the ROE and Price-earnings Ratio into a single memo that will be sent to all senior management. In addition to your analysis of the changes from 2012 to 2013, outline your recommendations for the year 2014.

Answer 1

The ABC firm's Price-Earnings Ratio decreased from 8.07 in 2012 to 6.88 in 2013, while the Return on Equity increased from 15.5% in 2012 to 29.9% in 2013, surpassing industry averages. This indicates improved profitability but potentially lower market valuation, signaling a need to assess market perceptions.

Step-by-step explanation:

Equity Analysis Using the P/E Ratio and DuPont Model

To perform an equity analysis for The ABC firm, we first compute the Price-Earnings (P/E) Ratio and the Return on Equity (ROE) using the DuPont Model.

Price-Earnings Ratio

The P/E Ratio for 2012 is calculated by dividing the Market Value Per Stock Share by the Earnings Per Share (EPS), resulting in 23.15 / 2.87 = 8.07. For 2013, it is 28.22 / 4.10 = 6.88. This shows a decrease in the P/E Ratio, which means the market is paying less for each dollar of the company's earnings compared to the previous year.

Return on Equity (DuPont Model)

The DuPont Model decomposes ROE into three parts: Net Profit Margin, Asset Turnover, and Equity Multiplier. For 2012, we calculate Net Profit Margin (Net Income / Revenue) as 22,740,000 / 130,500,000 = 0.174 or 17.4%, Asset Turnover (Revenue / Assets) as 130,500,000 / 210,000,000 = 0.621, and Equity Multiplier (Assets / Equity) as 210,000,000 / 146,500,000 = 1.433. ROE for 2012 is their product: 0.174 * 0.621 * 1.433 = 0.155 or 15.5%. For 2013, Net Profit Margin is 44,563,000 / 202,560,000 = 0.220 or 22.0%, Asset Turnover is 202,560,000 / 206,700,000 = 0.980, and Equity Multiplier is 206,700,000 / 148,824,000 = 1.389. ROE for 2013 is 0.220 * 0.980 * 1.389 = 0.299 or 29.9%.

Overall, the company's ROE substantially improved and surpassed industry average ROE. The decrease in the P/E Ratio in the face of increasing profitability suggests the market may not fully value the firm's higher earnings. To inform senior management, we recommend focusing on the factors that may be causing a lower market valuation and strategies to bring P/E in line with enhanced profitability.