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BSB107 (Financial Performance & Responsibility) Semester 1, 2023

Assignment 1b – Choosing an Investment Wisely

[15 MARKS OUT OF 100 MARKS TOTAL]

Learning Outcome: To be able to carry out an effective financial statement analysis to make sound financial decisions about an equity investment.

Rationale: Financial accounting calls for all companies to create a statement of financial position, an income statement, and a cash flow statement. These statements contain financial information about all aspects of a firm’s operations, forming the basis of financial statement analysis.

Financial statement analysis is a technique used by both insiders (the managers and directors of the firm) and outsiders (the providers of funds—debt and equity) to assess the past, current, and to some extent, the future financial health of a company. It is used to compare current performance with past performance and to compare and benchmark the performance of the company against its competitors (or industry).

As one popular investment advice website argues “Financial statement analysis is critical in making effective stock investment decisions. If you do not research your stock investments, you essentially engage in glorified gambling. The balance sheet, income statement, cash flow statement and statement of owners' equity each offers unique insights into the firm. Combined, they can give you a good sense of a company's overall financial picture.”

Clearly Warren Buffet agrees. In a recent book ‘Warren Buffett and the Interpretation of Financial Statements’, the authors noted that “Financial statements have signs about a firm’s future performance. Warren Buffett is on a constant search for such cues. And, this has placed him among the list of the world’s wealthiest people. Hence, seeing how he interprets financial statements is very helpful. He computes appropriate ratios from the financial records. Then he uses these ratios to identify the most promising firms.” 

Assessment (Individual): You have just won a major lotto prize and have $1million dollars to invest. Long-term growth (LTG) is your investment strategy that aims to increase the value of your investment over a multi-year time frame.  You have narrowed your choice down to 2 companies – KMD Brands and Premier Investments.

The following ratios have been calculated in the Excel spreadsheet provided for this assignment.  Based solely on your analysis of the following ratios, decide which of the two companies would be the better investment for you to achieve your investment goal.

Ratio Categories/Ratios:

Profitability Ratios

i. Net profit margin

ii. Return on equity

Investment Ratios

iii. Earnings per share

iv. Price earnings (P/E) ratio

Liquidity Ratios

v. Current ratio

vi. Inventory turnover

Solvency Ratios

vii. Debt to asset ratio

viii. Cash debt coverage

1. Using Excel charting facility, plot the time series of each ratio for each category of ratio on a separate graph for each company. You will have 8 graphs in total (e.g. 1 graph for KMD Brands profitability ratios, 1 graph for Premier Investments profitability ratios etc).                     (6 marks)

2. As the old adage says, “numbers don’t lie.” From the ratio analysis, can you identify one sign (red flag) that indicates a potential problem with each company’s financial statements that may adversely affect your pursuit of long-term capital growth? Explain your answer briefly. (max 100 words- 10% tolerance)                                                        (4 marks) 

3. Which company is your preferred choice of investment given your desired goal of long-term capital growth? Provide sound arguments to support your decision. Your arguments should include reference to what the categories of ratios (you may also comment on the individual ratios if a particular ratio/s have influenced your decision) and their movement over time (based on the graphs) tell you about the potential for each company to provide you with long-term capital growth. (max 250 words – 10% tolerance)                                             (5 marks)

Your answers to the above questions should be uploaded as a Microsoft Excel Spreadsheet (StudentName_StudentNumber_Assignment1B.xlx) on Canvas by the due date. The Rubric for this assessment piece is available on Canvas.

Best of luck!