A Report on the Profitability of Stock Investment in Ted Baker PLC - Term Paper Example

 A Report on the Profitability of Stock Investment in Ted Baker PLC Relative to its Competitors Executive Summary The financial performance of a business entity is an essential factor in determining the profitability of a stock investment. This paper assesses the profitability of Ted Baker PLC’s stock by performing an in-depth financial analysis. Profitability, gearing, and liquidity are assessed. The key findings are as follows: 1. the company’s profitability have increased for the last two fiscal years 2. gearing ratio is relatively low implying stockholder’s exposure to gearing risk 3. the company has ample liquid asset to cover current liabilities 4. stock price is in an upward trend; and 5. dividends are increasing annually. The company is also benchmarked with its competitors utilizing the same ratios. In the end, Ted Baker PLC was found to be a less profitable investment compared to Marks and Spencer and NEXT PLC. Table of Contents Page I. Executive Summary 2 II. Introduction 4 III. Ted Baker PLC A. Historical Performance 5 B. Current Financial Situation 11 IV. Top Competitors A. Marks and Spencer 13 B. NEXT PLC 13 V. Competitor Benchmarking 14 VI. Conclusion and Recommendation 17 Reference 19 Appendix 20 I. Introduction Choosing stocks to invest in is a critical decision faced by a prospective investor. Peter Lynch, one of the most successful investors of our time left practical advices on how to choose stocks which will yield the higher return for prospective stockholders. In his article Strategies for Stock Selection, he put forward four factors to look at: markets; economic cycle; obvious risks; and company (How to Choose Stock 2006). Foremost in his recommendations is buying stocks that an investor is not only acquainted with but knowledgeable in. Peter Lynch advises that an investor should buy the stock of a company whose products are purchased by him and his social circle. He should asses if this product will continue to become popular in the future. He cautioned investors that if they can’t explain what a company is doing, they should not invest its stocks. In the process of knowing a company, it is imperative that an investor also looks at the current financial position of the company by looking at the different aspects of the business with the help of financial ratios. These ratios reflect not only reflect the financial situation of a business entity but also shows the company’s strengths and weaknesses in terms of numbers. Aside from gaining a deep insight on the company’s operation and current financial position, an investor should also look at the company’s historical performance in terms of financial ratios and stock prices. To maximize the investment profitability, return of a stock should be compared with other stocks in the same industry (How to Choose Stock 2006). This report is an analysis of the profitability of holding Ted Baker PLC’s stocks as an investment. The next section will briefly introduce the company. Financial analysis will be used to ascertain the current and historical performance of the company. Competitor analysis through a thorough quantitative data will also be employed. The paper will conclude with its findings and recommendations. An appendix containing the accounts used in the financial analysis will be presented. II. Company Profile Ted Baker PLC is primarily involved in the design, manufacture, wholesale and retail of menswear, womenwear, and childrenswear and related accessories which includes skinwear, fragrances, eyewear, and watches. The company was formed by Ted Baker and J. Peterman and is a leader in the apparel and textile industry in the United Kingdom. Ted Baker PLC has 100 retail distributors in the United Kingdom. Internationally, the company’s product line is sold in 600 other stores abroad (Ted Baker PLC 2006). A. Historical Performance Looking at the historical performance of the company is essential in determining trends in the profitability of the company. Historical performance will be assessed using the major accounts of Ted Baker PLC and the corresponding financial ratio analysis. Financial ratio analysis is a very essential tool in assessing the financial health of a business entity. Specifically, it enables a financial analyst to spot trends in a business and to compare it with the performance of similar business enterprises within the same industry. Financial ratios are grouped into three categories, each showing a different aspect of a company’s financial operations. These are profitability, financial leverage or gearing, and liquidity/solvency ratios. Profitability Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred. Ted Baker’s ability to efficiently manage its accounts and generate revenue and profit for the company can be assessed by looking at the trend in the turnover and profit. Profitability is not only denoted by the expansion in the numerical value of revenue and profit but by looking at the growth rate of these accounts. Figure 1 shows the growth rate of Ted Baker’s revenue and profit from the five-year period 2001-2002. It can be seen that the growth in profit follows the expansion of turnover. It is noticeable that in the past two years, the recorded profit of Ted Baker grows at a faster and more steady rate than revenue implying a more efficient cost management. Figure 1. Growth Rate of Turnover and Profit (2002-2005) Other profitability ratios are shown in Table 1 and the trends are shown in Figure 2. It can be seen that 2003 seemed to be a tough year for Ted Baker as all the ratios dipped from the 2002 level. However, the company is showing recovery as net profit percentage, return on capital employed, and asset turnover slowly increased for the past two years. Earning per share is on a decline due to the faster growth of the company’s common stocks relative to profit. Table 1. Profitability Ratios of Ted Baker PLC (2001-2005) Figure 3. Trends in Profitability (2001-2005) Gearing Financial leverage or gearing ratio provides an indication of the long-term solvency of the firm. They indicate the extent of non-owner claims on the firm’s profits as well as the firm’s operating capability to meet its obligation. The trend in Ted Baker’s gearing show is shown in the Figure 4. It can be seen that the company’s gearing has significantly declined from the 2001 level. During 2001, the company’s creditors financed 20% of the company’s resources. This ownership was reduced to 2% during 2005 which indicates the company’s preference in acquiring more financing from its shareholders. The lower gearing ratio indicates lower gearing risk. Figure 4. Trends in Gearing (2001-2005) Liquidity Liquidity or solvency ratios are used as measures of the company’s ability to finance its short-term obligations by its cash and near cash items. Included in these ratios are current and quick ratios. Since the company’s historical annual report does not report the total stocks for the fiscal year, this paper can only depend on the 2005’s current ratio of Ted Baker to asses its liquidity. According to Table 2, the current ratio is 1.63 indicating that the current assets of the company are more than enough to pay off all its current liabilities. However, the quick ratio is .73 which implies the huge amount of stocks tied in Ted Baker’s inventory. Stock Profitability Stockholders gain from their investment in shares through dividends and capital gains. Dividends are declared by the discretion of the company. Declaration of dividends is often dependent of the amount of profit the business gains from the fiscal year and the size of the company’s cash account. Market forces determine the capital gains to be gained from a stock investment. A lot of factors can affect the price of stock such as interest rates, dividends, and even qualitative information. Figure 5 shows the Ted Baker’s stock price for the five-year period. From 2001, we can see that there had been periods of ups and downs in prices indicative of the unpredictable behavior of prices. However, there is a generally upward trend in stock prices commencing in the mid-2003 to 2006. This shows that Ted Baker PLC’s stock is increasingly valued by investors through time. Figure 5. Trends in Stock Prices (2001-2005) The value of dividends declared by the company can be seen to be increasing since 2001. Figure 6 shows a stable upward trend in dividends starting from 7p in 2001 to 10.8 p in 2005. Figure 6. Trends in Dividends (2001-2005) B. Current Financial Situation During the fiscal year 2005, Ted Baker PLC was able to generate £105. 753 million total turnover utilizing its £58.942 million total assets. The company’s pool of resources is comprised mainly of current assets which is valued at £41.090 million (69%). Meanwhile, the company’s operation is financed mainly of less risky stocks and long-term debt. Figure 1 shows the financial ratios Ted Baker PLC during the fiscal year 2005. In terms of leverage or gearing, it can be seen that Ted Baker PLC that bulk of the resources of the company is financed by less risky equity. Debt to equity ratio is extremely low at 0.04 while assets to equity ratio is 1.82. The firm’s capital structure is beneficial to the firm and its stockholders. For one, the company’s allocation for interest payment is low because of the low level of debts. Due to this low interest obligation, the company can channel its fund to finance more profitable ventures. For stockholders, low gearing risk implies that investors have more power than creditors in the company’s resources. It should be noted that interest obligations are paid and only the residual income can be attributed to stockholders. As the company only pays an insignificant amount of interest, it can readily declare dividend payment to stockholders maximizing the value of their stock investments. The company is fairly stable in terms of liquidity. During 2005, its current ratio of 1.63 can more than cover all its current obligations. However, we can see that a lot of its current assets is tied up into less liquid stocks as its quick ratio is only 1.63. Cash comprises almost one fourth (23%) of the company’s current assets. Table 2. Financial Ratios of Ted Baker PLC (2005) The year 2005 has been profitable for Ted Baker PLC. Net profit is 11.06% of the total turnover while ROCE is 34.62%. There is also a high return on assets at 21.75%. Utilization of asset is fairly efficient as the company reported 1.97 asset turnover. III. Top Competitors A. Marks and Spencer Group PLC Marks and Spencer is the major competitor of Ted Baker PLC. The company is a manufacturer and distributor of mid-priced clothing, food and household items. Regarded as UK's top seller of clothing, it has sold off most overseas operations in order to salvage its 400 M&S stores in the UK. M&S owns stores in Ireand and Hong Kong, operates franchises in 30 countries, as well as the 25-store Kings Super Markets chain in the US (Marks and Spencer 2006). B. NEXT PLC NEXT PLC distributes moderately priced clothing for men, women, and children; housewares; and furniture through more than 350 stores primarily in the UK and Ireland. Aside from these operations, NEXT PLC also franchises about 70 stores elsewhere in Europe, Asia, and the Middle East. NEXT targets customers in their 20s and 30s who are looking for stylish but affordable clothes to take them through the next fashion trend. Revenue comes from its retail stores, its NEXT Directory catalog, a Web site, and Ventura, a division which provides call center and customer support services for other firms (NEXT PLC 2006). V. Competitor Benchmarking In order to compare the companies, this paper will analyze the different financial ratios of Ted Baker PLC, Marks and Spencer and NEXT PLC. Thus, the paper will compare each company in terms of profitability, gearing, liquidity and investors’ ratios. Profitability NEXT PLC corners the largest market share as the company recorded the largest turnover at £2,858.50 million followed by Marks and Spencer with £7,942.30 million. On the other hand, Ted Baker records the lowest turnover (£105.75 million) for the fiscal year. Though NEXT generated the highest turnover, Marks and Spencer gained the largest pre-tax profit at £745.30 million. NEXT PLC and Ted Baker tagged behind with £422.90 million and £16.76, respectively. Figure 7. Profitability Ratios of Players (2005) Figure 7 compares the profitability ratios of the competitors. It can be seen that NEXT PLC shows superlative profitability as it generated the highest ratios except return on equity. Ted Baker is second best with ratios relatively higher than Marks and Spencer. It should be noted that though Marks and Spencer reported lowest profitability ratios, it is exceptional in terms of return on equity. Marks and Spencer’s ROI reached 128.81 compared to the 110.38 recorded by NEXT PLC and the relatively low 36.05 posted by Ted Baker. Gearing Figure 8. Leverage Ratios of Players (2005) Ted Baker exhibits the least gearing risk among the three companies. The highest risk is shouldered by Marks and Spencer as its creditors finance more than 87% of its resources while shareholders’ ownership is only 12.67%. NEXT PLC is also highly leveraged with 78-22 creditor-stakeholder balance (Figure 8). Liquidity NEXT PLC appears to have the highest liquidity among the three companies in consideration. Though NEXT posted lower current ratio than Ted Baker, its composition of current assets is more stable than the latter. Only a small percentage of its current assets is tied up in inventory while the cash account is minimized. Marks and Spencer is lowest in terms of liquidity (Figure 9). Figure 9. Liquidity Ratios of Players (2005) Investor Ratios In terms of investor ratio, NEXT PLC posted superlative ratios. The company has exceptionally high earnings per share in 2005 totaling to 118.10. This high EPS can be attributed to the relatively high level of earnings distributed to fewer numbers of shares. The company also leads in terms of dividend yield though it should be noted that the three players under consideration has almost the same yield (2%+). However, Marks and Spencer should also be considered as it has an extremely high return on equity which has a very important bearing for investors. When a company liquidates, the company’s ROE will determine the gains that an investor will acquire. Figure 10. Investor Ratios of Players (2005) VI. Conclusion and Recommendation This report tackled the financial performance of Ted Baker PLC and its main competitors, Marks and Spencer and NEXT PLC. It was shown that the company’s profit has been growing in the past two years and that its expansion surpasses the growth in total income. Profitability is evidenced by the upward trend in ROCE, asset turnover, net profit percentage, and earnings per share. Compared to Marks and Spencer and NEXT PLC, Ted Baker has lower investor ratios and profitability yet surpassed the two players in terms of gearing. As the company’s resources are strongly financed by stockholders, the company has lower interest obligations and exposed to less gearing risks. This paper does not recommend Ted Baker PLC to a prospective stockholder who wants to maximize their earnings. Though the company’s share price is in an upward trend and the firm annually declares dividend, investors will profit more in investing in the stocks of its competitors like Marks and Spencer and NEXT PLC. In terms of profitability, leverage, and liquidity, NEXT PLC is the better choice. However, the high ROE ratio of Marks and Spencer is very attractive to competitors. As the claim of investors in a company comes last, ROE is a very viable indicator of the profitability of investment in its stocks. Having an ROE of 128.81, Marks and Spencer emerged with the highest gain for investors. References Marks and SP Company Financial Information. (2006). Retrieved 10 March 2006, from Advance Financial Website: http://www.advfn.com/p.php?pid=ukfinancials& symbol=L^MKS NEXT PLC Company Profile. (2006). Retrieved 10 March 2006, from Yahoo Finance Web Site: http://biz.yahoo.com/ic/55/55963.html Next PLC Company Financial Information. (2006). Retrieved 10 March 2006, from Advance Financial Website: http://www.advfn.com/p.php?pid=ukfinancials&symbol= LSE%3ANXT How to Choose Stocks. (2006). Retrieved 10 March 2006, from Econnections Web Site: http://www.e-connections.org/lesson3/l14.pdf Ted Baker PLC Company Profile. (2006). Retrieved 10 March 2006, from Yahoo Finance Web Site: http://biz.yahoo.com/ic/102/102917.html Ted Baker Company Financial Information. (2006). Retrieved 10 March 2006, from Advance Financial Website: http://www.advfn.com/p.php?pid=ukfinancials&symbol=L^TBK Ted Baker’s Annual Report. (2005) Appendix 1. Ted Baker PLC: Five-Year Summary of Performance Appendix 2. Marks and Spencer Financial Ratios Appendix 3. Financial Ratios of NEXT PLC Read More