Investing in Life Insurance Companies - Research Paper Example

PART I – Your Pension This part of the report will analyze how much an individual can earn by investing in life insurance companies. Usually, life insurance companies use the concept of perpetuity, which means that as the amount has been deposited, the individual will get the return from that particular time till he is alive (Brealey, and Myers, 1997). Formula to calculate perpetuity is as follows: PV = A / i PV = Present Value of the Investment A = Amount of Periodic Payment i = Interest rate As it has been assumed that after retirement I would be able to accumulate EUR 500,000 then the return that I would earn annually with a normal interest rate of 4%, which is generally paid by different insurance companies, would be: 500,000 = A / 4% So, annual periodic payment would be: A = EUR 20,000 Now I believe that I would need more money than EUR 20,000 annually. There would be different factors that would reduce the value of EUR 20,000 at that time, e.g. inflation. Therefore, when I retire, EUR 30,000 should be a valuable amount that I would need every year to spend my life happily. So, in order to have this amount every year, the interest rate should be 6% as calculated using Goal Seek option in Microsoft Excel. I feel that EUR 28,000 would be a sufficient amount, and I would be able to manage it somehow; then, the interest rate to earn EUR 28,000 annually should be 5.6%. PART II - SHARE ANALYSIS This part of the report will analyze two companies from the investment analysis. Financial ratios have been used to analyze the performances of the company, and at the end the report recommends which company is better for investors to invest into. Two companies selected for this report are: Lockheed Martin Corporation and Altera Corporation. 1. Lockheed Martin Corporation Lockheed Martin is a global leader in providing aeronautics and defense security services. The company is the world’s largest federal agency’s contractor with unique product portfolio. Headquarter of the company is situated in Bethesda, Maryland, in Washington Metropolitan Area while the company is present in more than 75 countries. The company has partnership with more than 300 industry players all around the world. It employs around 120,000 people worldwide including 80,000 scientists, engineers and IT professionals. Lockheed has reported $46.5 billion revenue in 2011 through its portfolio which includes aeronautics, electronics system, IT and global services, and space system. Net Income of the company is $2.65 billion in 2011. Presently, its share price is $93. Financial Ratios of Lockheed Martin Earnings Per Share The Earnings per share indicates that how much a return a shareholder is earning for each share (Friedlob, & Plewa, 1996). The earnings per share of the Lockheed Martin is 7.81 in 2011. However the average 3 year EPS growth rate of the stock is 0. Price Earnings Ratio Price Earnings ratio is the calculated as the market price per share divided by annual earnings per share. The higher P/E of the stock shows that investors are paying more for earning every dollar (Gitman, 2003). Hence, the share is more expensive than the stock with lower P/E ratio. The P/E ratio of Lockheed martin is 10.9, and this figure shows that the investors have to pay $10.9 to earn every dollar. On the other hand, the industrial average P/E ratio is 13.2. Therefore, the Lockheed’s stock is paying more as compared to the industry. Price Per Book The ratio shows the price of the stock to its book value. The lower the P/B ratio, the better the value of the stock (Kaplan, and Atkinson, 1998). The P/B ratio of Lockheed martin is 13.7 as compared to its industry average, which is only 3.0. This ratio does not show positive indications for investors to invest in Lockheed Martin. Price Per Sales P/S ratio is the ratio of share price divided by the revenue per share. If the value of P/S ratio is less than 1, then usually it is considered favorable as investors are paying less for each unit of sales. The P/S ratio of Lockheed Martin is 0.6, as compared to the industry, which is 0.8. Hence the ratio makes the stock favorable for investors. Return on Equity The ROE is calculated as Net income divided by shareholder’s equity. ROE shows how much profit company generates using shareholder’s equity (Ross, Westerfield, and Jordan, 2009). Lockheed martins’ ROE is 103.1%, as compared to the industry, which is only 22.1%. The figure shows that the company is generating more income than the shareholder’s equity; hence, it is very much impressive for the investors. Payout Ratio Payout Ratio reflects the earnings that the company has distributed in the form of dividends to the shareholders (McLaney, 2009). The company’s payout ratio is 41.4% in 2011, which shows that company has paid approximately 41% of its net income to the shareholders in the form of dividends. Meanwhile, the average industry’s payout ratio is 43.9% Price Per Cash Flow Price per cash flow shows the relationship between the share price and the cash flow per share. The price to cash flow ratio of the company is 10.4 against the industry ratio of 9.8. The company has higher ratio than the industry; therefore the, ratio is not attractive for investors. Dividend Yield Dividend yield shows how much dividend the company pays to its investors relative to its share price. The higher the yield, the more likely investors will be attracted towards the company’s stock. The dividend yield of Lockheed Martin is 4.3% against its industry average, which is 2.4%. It shows that the company is paying more yield to its investors, as compared to its average industry. 2. Altera Corporation Altera Corporation was founded in 1983 with the purpose to provide software solutions to the world. Based on the market share, the company is the second largest designer of programmable devices. It has obtained the second position in PLDs market and is behind XLNX. The company designs chips which are used in the data processing, communication devices, and consumer, automobile and industrial markets. The company only designs and sells these chips and outsources its manufacturing to a third party. The company generated $2.064 billion revenue in 2011 while its net income was $771 million. Presently, the share price of the company is $32.5. Financial Ratios of Altera Corporations Earnings Per Share The Earning per share of the company’s stock was $2.35 per share in 2011. However the average 3 year EPS growth rate of the stock is 25.8 against the industry average of 27.7. Price Earnings Ratio The P/E ratio of the company is 17.3 against the industry average of 16.5. It means investors have to pay $17.3 for earning every dollar which is quiet high, as compared to the industry. Therefore, the ratio discourages investors to invest in the company’s stock. Price Per Book The P/B ratio of the company is 3.3, as compared to the industry average, which is 2.4.The ratio is higher than the industry hence not attracting the investors to invest in the company. Price Per Sales The P/S ratio of the company is 5.8 against its industry average of 2.2. Hence, the investors pay more for each unit of sales, as compared to the industry. Thus, the ratio is not favorable for the company. Return on Equity The ROE of the company is 20.2% while its industry average is 15.3%. The company is able to generate almost 20% return using its equity. Moreover, the company is utilizing its investor’s money better than the industry. Payout Ratio The payout ratio of the company is 11.9% in 2011 while the average company’s payout ratio is 17.9%. Price Per Cash Flow The Price per cash flow is 15.6 against the industry average of 9.2. The company has much higher ratio than the industry; therefore, the ratio is not attracting investors. Dividend Yield The dividend yield of the company is 1.1% against its industry average, which is 2.4%. It shows that the investors are getting less dividend yield in comparison to the average industry. Conclusion Based on the above figures, the investor should invest in Lockheed Martin’s stock because the company has strong ratios, as compared to its industry and the Altera Corporation. Except Price per book, all the above ratios of Lockheed Martin’s stock are favorable for the investors, and the company is performing better than the other firms in the industry. The earning per share, dividend yield and payout ratios are remarkable for the investors, and encourage investors to invest in the firm. Moreover, the company is one of the highest dividend yield providers in the industry. On the other hand, Altera Corporation’s financial ratio is not showing a healthy picture for the investors to invest in the company. Except ROE, all of its ratios are not attractive in comparison to its industry and therefore for investment purpose, Lockheed Martin would be a better option than Altera Corporation. References Brealey, R. and Myers, S. (1997). Principles of Corporate Finance. New York: McGraw-Hill Companies. McLaney, E. (2009). Business Finance: Theory and Practice. New Jersey, Pearson Education Ross, S., Westerfield, R., and Jordan, B. (2009). Fundamentals Of Corporate Finance Standard Edition. New York, McGraw-Hill. Kaplan, R., and Atkinson, A. (1998). Advanced Management Accounting. New Jersey: Prentice-Hall. Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing. Friedlob, G., & Plewa, J. (1996). Understanding balance sheets. New York: John Wiley & Sons. Read More