Ratio Analysis of Commonwealth Bank - Case Study Example

Topic: Ratio Analysis Name: Lecture: Course Code: Course Name: Date STOCK RESEARCH OF COMMONWEALTH BANK Executive summary The stock research of Commonwealth bank stock was done basing on the analysis of the industry, economic analysis and the fundamental analysis. Fundamental analysis ratios categorized under profitability ratios, financial stability and valuation was mostly applied in the research. The ratios analyzed include return on equity, return on assets, interest coverage ratio, earnings per share, dividends per share, net interest margin, operating expenses to total operating income, profit after tax growth, return on capital employed, net margin, operating margin among other analysis. The industry and economic analysis was captured in the financial reports of the bank. Introduction Commonwealth Bank of Australia is one of the multinational banks of Australia having branches in New Zealand, Asia, Fiji, United Kingdom and United States of America. Commonwealth bank offers a range of financial services retail, institutional and business banking, management of funds, superannuation, and provision of insurance services, brooking services and investment. It is the second biggest Australian listed company as of January 2008 on the Australian securities exchange. Commonwealth bank has brands such as Colonial Fist State Investments Limited, Bankwest, ASB bank, Commonwealth Insurance limited and Commonwealth Securities limited. The government of Australia found Commonwealth bank in the year 1911, and it was listed in the Australian stock exchange in 1991. The bank was later privatized fully in the year 1996. The main goal of the bank is to gain total shareholder return within the shortest time to rival other listed banks in Australian stock exchange. The bank has three major strategic strengths which include the brand, scale of operation and diversity in business mix. The bank serves their customers through five business divisions which strategically bring into line development in product and delivery of service. These business divisions include retail bank services, private and business banking, institutional banking and markets, management of wealth and international financial services. The bank also has five support divisions which include financial services, enterprise services, risk management, group cooperate affairs and human resources. Top down approach Top down approach is followed in the analysis of commonwealth bank, and it includes the analysis of the industry, economy and fundamental analysis. Economic analysis reveals the conditions in relation to share valuation. It is concerned with the general state of the economy and its impact on the shares of a company. Some of the economic factors include interest rates, taxes, inflation, factors affecting foreign trade among others. Industry analysis is carried out in order to reveal the competitive advantage of firms operating in the same industry. It determines how companies operate in relation to one another in an industry. The main objective of carrying out fundamental analysis is to evaluate the intrinsic value of the bank's shares. It establishes if the true value of shares in relation to the stock market's value. Fundamental analysis focuses on various factors such as growth, the actual business of the bank, the bank’s financial strength and the prospects of the future. Fundamental analysis is broken into financial stability ratios, performance indicators and valuation parameters. Contained in this article are different parameters connected to fundamental analysis, economic analysis and industry analysis which are very vital in enabling stock research of Commonwealth Bank (International, 2007). The information for analysis were extracted from the balance sheet and profit/loss statements and other relevant notes found in the financial reports because the targeted uses of this analysis are potential investors. Reasons for carrying out analysis before investing 1. To provide informed decisions for potential investors who want to invest. 2. If the bank fails, investors will be aware of the cause of the problem and learn from that. Financial stability ratios These financial ratios are useful to check the inherent financial potency of the company and its cash flow patterns. From the bank’s media release report, Commonwealth bank’s statutory net profit after tax for the half year period that ended on 31/12/2012 was 3661 million dollars. This represented a 1% increase on the last comparative period. On the other hand, cash net profit after tax for the half was 3780 million dollars which represents a 6% increase. ROE Owners of the business are interested in the profits made for them by the business. ROE is used to determine the performance of the business in relation to shareholders equity. ROE is calculated by dividing shareholders equity by net income and it is expressed as a percentage. Cash return on ROE of the bank decreased in 2012 to 18.1 down from 19.2 in 2011. This shows that out of the one dollar of the shareholders equity in 2011 gave 19.2 cents and in 2012 it gave 18.1 cents of earnings available to be distributed to shareholders. Dividend ratios From the information released to the media, the management of Commonwealth bank declared an interim dividend of 1.64 dollars per share (Earl K. Stice, 2009). This represented an increase of 20% as compared to interim dividends of 2011. The cash basis dividend ratio of the bank increased in 2012 to 70% up from 61% in 2011. The management commented that the increase was in line with the new dividend policy which made an increase in the dividend payout ratio. Dividend per share ratio increased in 2012 to 164 up from 137 in 2011. Funding analysis of the bank Debt to equity ratio is used to determine the leverage situation of a company. It compares the total liabilities to the total shareholders’ equity. Debt to equity ratio is calculated by dividing total share capital to total liabilities. From the information in the financial report, it shows that the bank’s growth in lending is funded significantly by customer deposits which are standing at 63% of the total funding base. Net interest margin Interest coverage ratio is used to determine how a company can easily pay its outstanding debts. It is computed by dividing interest by earnings before interest and tax (EBIT). The net interest margin of as per the financial report of Commonwealth bank revealed a decrease. The bank’s net interest margin decreased in 2012 to 2.1% down from 2.12% in 2011. This was due to increase in asset prizing and mix, decrease in funding cost and an increase in replicating portfolio. This trend shows that the bank improved on payment of its outstanding debts in 2012 but the ratio is still lower than the recommended ratio of not less than two. Analysis of Performance indicators These ratios are used to analyze the performance of the company. Operating expenses to total operating income According to financial report of Commonwealth bank, operating expenses to total operating income had a downward trend in 2012 of 45.1 down from 45.8 in 2011 (Earl K. Stice, 2009). Operating expenses increased by 3% (cash basis) and this was the result of the downward trend even though the income increased but the increase in income could not match the decrease in expenses. Operating expenses to banking income From the financial report of commonwealth bank, operating expenses increased in 2012 to 36.1 up from 35.7 in 2011. This was because of a considerable increase in operating expenses in relation to the banking income. Operating Margin Ratio Operating margin is calculated by dividing net sales by earnings before depreciation, interest and taxes and it is expressed as a percentage. This ratio is used to determine the profitability of company operations. The table below shows the operating margin of Commonwealth bank for 2011 and 2012. 2011 2012 EBDIT 10,288 10,639 Net sales 8,709 8,972 Operating margin 118.13% 118.58% 2011: operating margin ratio = 10288 / 8709 x 100 = 118.13% 2012: operating margin ratio = 10639 / 8972 x 100 = 118.58% From the above figures, Commonwealth bank's profitability of operations increased in 2012 to 118.58% up from 118.13% in 2011. Net Margin Net margin is premeditated by dividing net profit by net sales, and it is represented as a percentage. The table below shows the comparison of net margin of Commonwealth bank for 2011 and 2012 2011 2012 Net profit 3,624 3,661 Net sales 8,709 8,972 Net margin 41.61% 40.80% 2011: Net margin = 3624 / 8709 x 100 = 41.61% 2012: Net margin = 3661 / 8972 x 100 = 40.80% From the figures above, net margin of Commonwealth bank decreased in 2012 to 40.80% from 41.61% in 2011. This shows that the profitability of the bank dropped in 2012. Return on Assets (ROA) Return on assets is used to determine business's profits to available assets used to make profits. ROA is calculated by dividing total assets by net profit. According to financial report of Commonwealth bank, it revealed that the bank’s ROA remained constant at 1.0 in both 2011 and 2012. A constant ROA is an indication that there is no change in dollar of earnings they make from each dollar of assets they control (Daryl Fleay, 2011). Return on Capital Employed (ROCE) ROCE is used to determine the company's profitability relative to the total capital employed. It also measures the ability of the management in utilizing capital to generate profits. ROCE is calculated by dividing net profit by (total debt + total share capital). ROCE is represented as a percentage. The table below compares the ROCE of Commonwealth bank for 2011 and 2012. 2011 2012 Net profit 3,624 3,661 Total debt + total share capital 38,875 43,299 ROCE 9.32% 8.46% 2011: ROCE = 3624 / 38875 x 100 = 9.32% 2012: ROCE = 3661 / 43299 x 100 = 8.46% The figures above reveals that the company's profitability in relation to total capital employed decreased in 2012 to 8.46% down from 9.32% in 2011. Operating cash flow per share (OCFPS) Operating cash flow per share = (net cash flow from operating activities – preference dividend) / weighted number of ordinary shares on issue. It is used to determine the net cash flow from operating activities available to finance future investments and to pay shareholders. 2011 2012 Net cash flow from operating activities – preferred dividend 5210 613 Weighted average number of shares on issue 1561 1593 Operating cash flow per share 3.34 0.38 From the calculations above, OCFPS of Commonwealth bank has a decreasing trend in 2011 which was 3.34 to 0.38 in 2012. Earnings per share EPS = net profit available to ordinary share holders/weighted number of ordinary shares on issue 2011 2012 Net profit available to share holders 3,519 3,958 Weighted number of ordinary shares on issue 1561 1593 EPS 2.25 2.48 EPS is has a positive trend. It rose in 2012 to 2.48 down from 2.25 in 2011. EBIT Growth This ratio is used to determine the percentage growth of company's earnings before interest and capital. EBIT growth is calculated by (this year's EBIT / last year's BBIT – 1) * 100 The table below shows the comparison of EBIT of Commonwealth bank in 2011 and 2012. 2011 2012 EBIT 17903 16095 EBIT growth = (16095/17903 – 1) * 100 = (10.10) EBIT growth of Commonwealth bank is negative. This means that the EBIT is decreasing. h) PAT Growth This reveals the growth of profits after tax. It is calculated by (this year's PAT / last year's PAT – 1) * 100. The table below compares PAT of commonwealth in 2011 and 2012. 2011 2012 PAT 3,624 3,661 PAT growth = (3661/3624 – 1) * 100 = 1.02% PAT growth for Commonwealth bank is positive. EPS Growth EPS shows the portion of profits from the company is allocated to each outstanding common stock share. It indicates the profitability of the company (Clarke, 2012). EPS is calculated by dividing average outstanding shares by the net income. It is revealed in the financial report that the EPS for 2012 rose as compared to 2011. EPS for 2011 was 227.2 which rose to 235.5 in 2012. EPS grew from 2011 to 2012 by 4%. Credit quality According to the financial report of Commonwealth bank, collective provision ratio increased to 1.11% in 2012. This was due to the reduction in credit risk assets. These assets had provision coverage of 42.78%. Market risk The bank uses value at risk (VaR) in analyzing the market risk in traded and none traded. VaR measures potential risk in the market basing on historical and making comparisons of different markets. According to the financial report of the bank, the total traded market risk reduced in 2012 to 8.5 down from 12.2 in 2011. Non-traded equity risk VaR (20 day 97.5 confidence) of Commonwealth bank as shown in the financial report reduced in 2012 to 94% down from 99% in 2011. Intangible assets The total intangible assets of Commonwealth bank according to the financial report revealed an increase in 2012 of 10,366 up from 10,026 in2011. The increase was due to the increase in goodwill, increase in computer software cost, a decrease in core deposits among others. Taxes There were changes in effective tax rates in 2012 as compared to 2011. For instance total corporate tax rate increased in 2012 to 27.8% up from 27.6% in 2012,corporate retail banking services increased from 29.3% in 2011 to 29.9% in 2012, corporate business and private banking increased from 30.0% in 2011 to 30.1% in 2012. This reveals an upward trend in taxation rates in 2012 as compared to 2011. Dividend valuation Investors invest so as to gain returns from the investments. The level of returns that the investor is expecting from the stock depends on the amount he invested (Australia), 2012). The investor expects returns in form of dividends and the value of the stock when he will sell. The value of the stock should equal the present value of the expected cash flows from the share. Applying the dividend valuation method, the banks value of the stock is as follows. = 1.64(1 + 0.09) / (0.091 - 0.09) = 1.7876 / 0.001 = $1,787.6 Conclusion According to the analysis of the Commonwealth bank, findings basing on economic analysis, industry analysis and fundamental analysis were as follows; The bank’s ROE decreased by a small margin of 1.1 in 2012. ROE in 2011 was 19.2 which decreased to 18.1 in 2012. On the other hand return on assets remained constant in 2011 and 2012. The bank declared interim dividends of $1.64 which represents 20% increase from the previous period. Cash dividend ratio also rose 9% in 2012 to 70% up from 61% in 2011 and also the statutory dividend ratio rose. This upward trend triggered an increase in dividend per share which rose up from 137 in 2011 to 164 in 2012 (Albrecht, 2010). Earnings per share also rose from 227.2 in 2011 to 235.5 in 2012. Growth in customer deposits led to growth in lending because customer deposits were used to fund lending. Customer deposits represented 64% of the total lending. Net interest margin decreased in 2012 to 2.1 down from 2.12. Operating expenses to total operating income decreased from 45.8 in 2011 to 45.1 in 2012. The bank’s operating margin increased in 2012 to 118.58 from 118.13 in 2011. The bank’s profit after tax growth improved in 2012 by 1.02%. Collective provision ratio also increased to 1.11% in 2012. There was a decreasing trend in both traded and non traded market risk. Traded market risk reduced to 8.5 in 2012 down from 12.2 in 2011, while on the other hand non-traded market risk reduced from 99% in 2011 to 64% in 2012. Recommendation I recommend the potential investor to invest in Commonwealth bank shares. This is because basing on the fundamental analysis; the bank is financially stable, and it is also profitable. From the information on the financial report, it shows that the bank is among the best Banks in Australia meaning that it controls a wider market and it has market acceptability. The bank has been rated to be stable by Fitch Ratings, Moody's Investor Services. Reference List Albrecht, W.S., 2010. Financial Accounting. Cengage Learning. p.417. Australia), I., 2012. Chartered Accountants Financial Reporting Handbook 2012, Google eBook. John Wiley & Sons. Clarke, E., 2012. Accounting: An Introduction to Principles and Practice. Cengage Learning. p.12. Daryl M., 2011. TAFE Accounting: Financial Accounting Applications. Cengage Learning. Earl K., 2009. Accounting: Concepts & Application. Cengage Learning. p.402. International, N., 2007. The international handbook of financial reporting. Cengage Learning EMEA. p.32. Paul D. Kimmel, J.J.W.D.E.K., 2008. Accounting: tools for business decision making. John Wiley & Sons. p.452. Sllsn, C., 2010. Code of Ethics for Professional Accountants Supersedes Code of Ethics for Professional Accountants. Cengage Learning. Walton, P.J., 2006. Global Financial Accounting And Reporting: Principles And Analysis. Cengage Learning EMEA. p.146. Read More