Analysis of Porter's Bulge Hypothesis - Research Paper Example

ANALYSIS OF PORTER”S BULGE HYPOTHESIS Name: Class Name: Instructor’s name: Institution’s name: City: Date: Introduction Background of the study Alternative Investment Market (AIM) is situated in the UK and it is a branch in the London Stock Exchange market. It specializes in enabling the smaller companies in the region to easily float their shares in a system which is highly regulated unlike in the case of the major market. AIM was founded in the year 1995 and since then it has managed to raise approximately 24 billion dollars from at least 2200 listed companies. Flexibility in the sector is provided to the companies ensuring that minimal or no capitalization regulations are requirements are required and as such no limit to the number of shares to be issued by the companies. In the last decade, many companies transferred their operations from the Main Market and concentrated it on the AIM. This was facilitated by the Market having a preferential tax advantages to its investors and also providing less burden on issues of regulation. According to the data provided in 2005, two of the companies moved away from the Main Market in an attempt to join AIM, while 40 companies joined AIM from the Main Market. Currently, AIM has been involved in the international exchange due to the minimal regulatory burden that is imposed by the international markets. This is duly in accordance to Sarbanes-Oxley Act despite that less than 25% of the listed companies in AIM qualify to be listed in the overall U.S. Stock exchange market. In the year 2005, the foreign companies admitted to AIM were approximately 270. The FTSE Group has designed indices which are used in the measurement of the AIM performance. These include: FTSE AIM All-Share Index, FTSE AIM 100 Index, and FTSE AIM UK 50 Index. In the analysis the focus will be focused on the 12 listed companies in AIM which are; Eaga, Real Good food, GTL Res, Wynnstay, Accsys, Eleco, TEG group, Hydro International, Geg, Helius energy, Ceres power holdings and the Clipper wind Power. The financial statements will be analyzed in order to determine whether they comply with Porters bulge hypothesis on the effect of the growth of a company to its overall sales turnover or the reported profits for the companies. Literature Review The success of the company is measured by the effectiveness to maximize its profit outlay and the achievement of the strategic goals within the shortest period possible. For this success to be attained in the current economy; the company or organization should well acquaint itself with the current trend in the market. This incorporates the information in regard to the agency relationship existing within the organization; potential customers and clients. A business entity should be knowledgeable on the changes imminent in the market’s opportunities and needs, how it can identify the potential customers and means of reaching them, its products’ quality, its advertising and marketing strategy, its productivity, and the management skills available in the organization (Cunill, 2006). These factors will show the organization’s position in the economy and its overall competitive nature. Accordingly, the organization should be able to deliver the required services and also products at the recommended capacity. The capacity to be delivered by the organization constitutes a vital component in the determination of the company’s growth. For instance the capacity delivered will entirely depend on the technical knowledge, technological advancement in the organization, staff’s skills and knowhow, range of products demanded in the market by the customers among others. Generally, the growth of the organization has been embedded to the product delivery optimization by the various scholars. According to Michael (2009), the organization should be regarded as a whole in order to culminate effective growth and the overall success. Growth is articulated to the organization’s entirety; its structures, procedures, policies, how the authority is implemented, systems, activities, decision making process, integration, coordination, and of vital, communication. These factors should be embedded on in order to culminate overall organization’s growth. They are the organization’s building blocks. The human resource in the company is also vital in ensuring that the business entity grows within the shortest period of its operations. These individuals are the ones who make the organization; its ability, energy, attitude and skills. The individuals in the organization are considered the imperative driving factors in the realization of the company’s success. In essence where the maximum opportunities are provided for the growth of the employees, then there is existence of maximum growth in the business operations. Employees should therefore work in groups in order to share the available knowledge. This business plan is a direct success in the organizations’ operations. The finances that the company or any organization has and needs to acquire define the organizations’ ability to monitor, manage and how it can utilize the capital resources in order to achieve the required growth. In most cases, it incorporates quality of the accounting system, efficiency of the budget management systems and the capital resources available (Clauss, 2009). Finance is vital in credit management, inventory regulation and purchasing in any business entity. In case where finances are not put into proper use, the organization will experience funding problems therefore lack the required technology and systems which would have otherwise aid in the growth of the entity. The business theory stipulates that for the company to realize full success it must articulate to the five factors that decides the organization’s success. As such it points out that the success of the business entity entirely depends on these factors which include: human resource (individuals working in the organization), the products and services available, the market, finances and the organization itself. In the case of human resource, the company should ensure that only qualified and competent personnel in the relevant field are selected to perform the company’s operations. The products and services provided should be of high quality and delivered to the customers where need be. In addition, the products should be segmented to meet the requirements of the customers. The market changes should be accessed. In the contemporary economy, the market is characterized by volatility and small changes in the information available to the public may cost the company its resources. It therefore implies that the company should be consistent in scanning the market and the environment therein. Finally, the organization as a whole should be able to perform its core functions effectively. For instance, it should plan, co-ordinate, organize, staffing, leading and controlling. Research methodology According to Porter’s bulge hypothesis, companies which are in the growing stage experience a decreasing or relatively flat revenue outlay and profits reported in their financial statements. He argues that when a company starts its operations most of the finances are directed to factors that will stabilize their overall business in the competitive economy. Most of the growing companies direct their resources to the advertisement and marketing of the product in order to ensure that the public are aware of the entity’s existence. This considered true by the proponents of this hypothesis and claims that no single business can start its operations and yield maximum sales and profits. Expansion is deemed to drain the company’s resources and in the long run the sales will increase as major infrastructure and development strategies would have been maximized. Practically, the Porter’s hypothesis may not hold, as the company will not survive or will be liquidated where it experiences negative profits and the overall sales are minimal. As such, where there is decreasing profits, investors will not be willing to invest in the company therefore lacking the vital capital needs for expansion and growth purpose. The listed companies in AIM (Alternative Investment Market) financial statements for the year 2009 are analyzed in order to device whether the hypothesis put forward by Porter holds. The financial analysis for the companies will enable us to figure out whether there has been decreasing sales and profits for these quoted companies which are considered ‘a growing companies’ by the scholars. The ranking of companies in regard to the output will be; Ranking Listed company in AIM Output 1 Eaga 5203.713 2 Real good food 2307.977 3 GTL Res 2058.33 4 Wynnstay 1351.54 5 Accsys 940.9467 6 Eleco 724.13 7 TEG group 334.3133 8 Hydro International 319.5533 9 Geg 154.3 10 Helius energy 132.6467 11 Ceres power holdings -218.86 12 Clipper Wind Power -2883.75 In order to determine the size index of the companies, calculation of the Gross capital employed (Fixed assets + current assets) will be of importance; Company ROCE Capital employed= PBT/ROCE Gross capital employed= Capital employed – current liabilities Eaga 0.292628 128928 127241 Real Good food 0.020838 78031 59658 GTL Res -0.35913 35709 32167 Wynnstay 0.129596 39492 35943 Accsys 0.019726 85775 85775 Eleco -0.35913 3982 3617 TEG group 0.008524 18184 17856 Hydro International 0.175864 10383 6436 Geg 0.120327 5510 5510 Helius Energy -0.1318 30152 30076 Ceres power holdings -0.38905 21393 21393 Clipper wind power 0.716532 -208768 196192 The table below analyses the size of the companies in regard to the size indexes for the company: Company Sales * 1% PBT * 10% (Fixed assets + Current Assets) * 5% Size index Eaga 7389.04 3772.8 6362.05 5841.297 Real Good food 2156.13 162.6 2982.9 1767.21 GTL Res 1016.09 -1282.4 1630.85 454.847 Wynnstay 2149.52 511.8 1797.15 1486.157 Accsys 289.74 169.2 4288.75 1582.563 Eleco 705.55 -143 180.85 247.8 TEG group 153.94 15.5 892.8 354.08 Hydro International 273.26 182.6 321.8 259.22 Geg 182.9 66.3 275.5 174.9 Helius Energy 5.54 -397.4 1503.8 370.647 Ceres power holdings 9.52 -832.3 1069.65 82.29 Clipper wind power 4603.99 -14958.9 9809.6 -181.77 Therefore, the listed companies ranking will be; Rank Company Size index 1 Eaga 5841.297 2 Real Good food 1767.21 3 Accsys 1582.563 4 Wynnstay 1486.157 5 GTL Res 454.847 6 Helius Energy 370.647 7 TEG group 354.08 8 Hydro International 259.22 9 Eleco 247.8 10 Geg 174.9 11 Ceres power holdings 82.29 12 Clipper wind power -181.77 The listed companies are ranked according to the size index prevailing in the organization. This is analyzed in order to determine the growth for different listed companies and to know the extent of market share prevailing in the economy. For instance in the table above, Eaga Ltd was reported to have the highest size index, therefore, attaining a large market share than other listed companies. Accordingly, the size index for the various listed companies was calculated basing on the formula; Size index = (sales*1% + profit before tax*10% + (Fixed + Current Asset) * 5%) / 3 For example taking the case of Helius Energy Company, the size index for the company will be calculated as follows; Size index = (sales*1% + profit before tax*10% + (Fixed + Current Asset) * 5%) / 3 = {40244.01 * 1% - 1545 * 10% + (1349 + 1651) * 5%} / 3 = {402.4401 – 154.5 + 150} / 3 = 132.6467 Financial analysis In analyzing the financial statements for the AIM listed companies, the major focus will be on the calculation of the gearing ratio, interest cover, EPS and the share price for the companies in AIM. Interest coverage ratio The gearing ratio to be undertaken in this case is the interest coverage ratio where it is given by: Interest cover = PBIT / Interest Listed company in AIM Interest cover Eaga 0.01631 Real good food 5.24021 GTL Res -2.65014 Wynnstay 5.62310 Accsys 0.78952 Eleco -1.20458 TEG group 0.23598 Hydro International 0.78954 Geg 0.125789 Helius energy -1.3254 Ceres power holdings -7.23145 Clipper Wind Power -15.3456 The interest coverage ratios of the companies that are listed in the AIM Company are shown in the table above. For instance, in the case of Helius Energy, the interest coverage ratio for the company is -1.3254. This shows that the company’s earnings in the current financial period cannot cover the interest accrued on the debts. . In essence, the negative interest coverage shows that the companies use its earnings in the expansion of business operations. The positive interest coverage ratio, as in the case of Eaga, Geg among others, shows that the companies do not use its earnings effectively in the expansion of the business operations. In addition, the listed companies gearing ratio is based on the debt-equity analysis of the companies. Its calculation is given by: Debt to Equity ratio = Total Debt / Total Equity The table below analyzes the gearing ratio (debt-equity ratio) of the listed companies. Listed company in AIM Debt to Equity ratio (Gearing ratio) Eaga -0.01631 Real good food -0.38194 GTL Res -2.73766 Wynnstay -0.16895 Accsys 0 Eleco -0.24033 TEG group -0.12484 Hydro International -0.454559 Geg 0 Helius energy -0.00252 Ceres power holdings 0 Clipper Wind Power 0.061849 The financial leverage or gearing ratio analyzes the solvency of the business in terms of its long-term obligations. Unlike the case of liquidity ratio where only short term liabilities and assets are put into consideration, gearing ratio incorporates the debt-equity ratio of the listed companies; preferably long term ones. The gearing ratio is in line with Porters model and the analysis of the company’s growth rate. The company reported a loss in its net income. This has been facilitated by the increased overreliance on debt and equity financing in ensuring that the company grows. Taking case for Helius Energy Company, the various analyses will be given as; Liquidity ratios Current ratio = current assets / current liabilities = 4709/1227 = 3.84 The industry current ratio is 2. Quick ratio = (current assets – inventory) / current liabilities = 3615/1227 = 2.95 The industrial ratio for quick ratio is 1. Financial leverage/ Gearing ratios Debt ratio = Total Debts / Total Assets = 1241 / 6060 = 0.21 Interest coverage = EBIT / Interest charges = 1545 / 897 = 1.72 Profitability ratios Gross Profit margin = {(Sales – Cost of Goods sold) / Sales} * 100 = {3293 / 5367} * 100 = 61.4% Return on Assets = Net Income / total Assets = 1539 / 6060 = 25.4% Return on Equity = Net Income / Shareholder Equity = 1539 / 26262 = 5.86% Dividend Policy Ratios Dividend Yield= Dividends per Share / Share Price = 1.87 / 18.25 = 10% Payout Ratio = Dividends per Share / Earning per Share EPS = (Net profit before tax – preference dividends) / No. of shares = (1545-0) /31916 = 0.05 Therefore = 1.87/0.05 = 37.4 Interpretation Profitability ratios Generally, majority of the companies’ performances in regard to profit yield has been adverse over the past few years. Most of the companies have reported an income loss over its prior periods and as such is not able to meet the shareholders requirement. Other competitors in the same field perform adequately with a positive reported income implying that the shareholders and overall strategic goal for the company is met with ease. According to Porter Bulge, the decrease and also relatively constant profits indicates that the company is in its growth stages. This is quiet evident in this scenario as the Company is trying to expand its operations to outside US and UK territories. This ahs made it not to yield the required profits as most of the funds are directed towards establishing a secure market in the new environment that it has vested its interest on. In regard to the size of the company, LIDCO Group plc enjoys relatively large market share as the company’s operations, in comparison to other companies in the field, is perceived to be in a competitive advantage front. The company’s of 67.39% shows that revenue outlay recorded for the period is extremely high and as such the profit recorded will be high in the near future. In addition the Porter’s hypothesis suggests that for a growing company the sales are also affected adversely and in the long run the company will experience a fall in the overall sales. In the case of LIDCO Group plc, the changes in sales for the year ended January 2010 is as follows; Percentage change in the sales for the period ended January 2010: = (sales revenue for 2010 – sales revenue for 2009) / sales revenue for 2009 = (5367000 – 4532000) / 4532000 = 0.1842 * 100 = 18.42% The company experienced an increase in the sales outlay. This shows that the company’s strategized in marketing and promoting its activities in order for the public and the potential consumers to be aware of the availability of the products and services. The percentage change in the Gross profit for the company is given as; = (Gross profit for 2010 – gross profit for 2009) / gross profit for 2009 = {(3293000 – 3020000) / 3020000} * 100 = 9.04% Over the current period of transaction, the company experienced a slight increase in the gross profits reported in the financial statements of LIDCO Group plc. This, according to Porter’s bulge hypothesis, is articulated to the increased expansion operations as the company is willing to grow and invest in cross border markets. In the case of profit before tax, LIDCO Group plc reported a loss in the net income. = (loss before tax for 2010 – loss before tax for 2009) / loss before tax for 2009 = {(1545 – 1770) / 1770} *100 = 12.71% The company reported a percentage decrease in the net loss of income. This shows that the growth nature of the company’s operations are gaining root as such in the near future the company will report an increasing net gain in the income. In addition the company’s share price increased from 7.00p for the period ending February 2009 to approximately 18.25p for the period ending February 2010. This was due to the reputation of the company as a whole. Despite this increases, during the year the company recorded highs and lows in its operations. For instance there was a low of 6.00p and a highs of26.00p for the year ending February 2010. Limitations of the study The study did not put into consideration the comparison with other companies listed in other corporations other than AIM. For effective and reliable results, more listed companies in the UK would have been selected in order to enhance comparability. For instance, the selected companies listed in AIM were not among the top achieving companies that were achieving high market share in the economy. In the data of up to December 2009, the top listed companies in AIM were: Rank Company Market capitalization (Million GBP) 1 Playtech 961 2 African Minerals Limited 732 3 KSK Power Ventur 708 4 European Goldfields Limited 654 5 London & Stamford Property 606 6 Gulf keystone Petroleum 480 7 Western Coal corp. 463 8 Coal of Africa Limited 448 9 Datatec Ltd. (Dl) 374 10 Medusa Mining 370 Retrieved from; www.bloomberg.com In addition, the listed companies in AIM may have failed to disclose all the relevant information that might have been material in determining whether the Porters bulge hypothesis holds. Such vital information may be perceived by managers to be private and upon release to the public; the competitors may use it to their own advantage. Conclusion The loss in net income for the companies listed in AIM shows that the companies are not focused in maximizing the shareholders’ wealth or, generally, in profit maximization. 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