Case Background
COMPANY HISTORY
Home Depot Inc., the largest retailer of home improvement products and third largest retailer in United States was established in 1978 in Atlanta, Georgia. The company revolutionized the do-it-yourself market in the United States. The stores of the company were warehouses and they sold large volume of goods at low prices. This company was regarded as the only company that successfully brought off the union of low prices and high service.
The financial and operating performance had been extraordinary throughout the decade of 1990s.The stock price and earnings per share had risen dramatically over the years. At the end of the decade this company was the largest home improvement retailer in the country and was planning to grow the number of stores.
Home Depot, Inc. was a growing company in a growing industry of home improvement products which cannot be drastically affected by economic vicissitudes. In the industry of home improvement products retailers this company had several well operated competitors. But being the largest and competent retailer Home Depot occupied the largest market share among them. The company pursued several growth initiatives to enlarge its market share and generate higher growth in earnings such as going after professional customers, changing store formats, adding to its product line, developing Internet business; which were associated with some risks as well.
CURRENT SITUATION
On October 12, 2000 the company announced that its earnings in the last two quarter of the year will be good deal lower than expected. And as a result the Company’s stock price experienced a one day drop of 28 percent causing a decline in the market value of the firm by $33 billion. The fall in the price of this company caused the stock prices of other retailers of the kind to fall as well.
The U.S. economy had a continuous growth since 1992 but the interest rate was raised for a total of 1.75 percent point which caused the softening of consumer demand. Home Depot, Inc. was not recession proof but the nature of its business protected it from being vulnerable to economic variability.
The decline in the stock price was primarily thought as the result of slowing economy but because of the nature of the business and growth initiatives undertaken it was not clear whether the phenomenon was primarily a function of slowing economy, a reaction to overvaluation of the stock or a reflection of possible problems with the company’s strategy for future.
Framework of Analysis:
The analysis part of this case can be segregated into four major sections:
1. Economic Analysis
2. Industry Analysis
3. Company Analysis and
4. Scenario Analysis
Economic Analysis – the first step of top-down approach of valuation process – has been done by addressing the following issues:
· The U.S. economy
· The Home Improvement Market
· Inflation, Interest Rates and Stock Values
· Estimation of Market Return (Rm)
The Industry Analysis includes:
· Competitor’s Analysis
· Porter’s Five Forces Model
The Company Analysis has been done in 6 major parts, consistent with the case requirements. They are:
· SWOT Analysis:
o Involves an examination of a company’s strengths, weaknesses, opportunities and threats.
· Financial Statements Forecast:
o Includes the forecasted income statement and balance sheet of Home Depot, Inc. for year ending in January 2oo1.
· Ratio Analysis:
o The areas of ratio analysis are Profitability, Leverage, Asset utilization & Liquidity ratios.
· DuPont Analysis:
o DuPont analysis is an expression which breaks ROE (Return on Equity) into three parts. This analysis enables the analyst to understand the source of superior (or inferior) return.
· Risk analysis:
o Risk analysis examines the uncertainty of income flows for the total firm and for the individual sources of capital. The total risk of the firm has two internal components-
Business Risk:
Business Risk is usually measured by the variability of firm’s operating income over time. Other useful measures of business risk are:
o Sales Variability
o Operating Leverage
Financial Risk:
Financial Risk is the additional uncertainty of returns to equity holders due to a firm’s use of fixed financial obligations. It can be measured by different leverage ratios and coverage ratios, such as:
o Financial leverage ratios
o Interest coverage ratio
o Cash flow to total debt
· Determination of Home Depot, Inc.’s Intrinsic Stock Value
Problem Statement- Determining the reasons of the company’s stock price decline.
The Scenario Analysis is a process of analyzing possible future events by considering alternative possible outcomes (scenarios). Here we considered three possible scenarios for Home Depot, Inc.’s intrinsic stock value by taking their growth plans into account. The scenarios are:
o The Optimistic Case,
o The Pessimistic Case and
o The Most Likely Case
Economic analysis:
Economic analysis is done to find out the general influences of aggregate economy or market that can significantly impact the returns for an individual stock. Studies have found a relationship between aggregate stock prices and various economic series such as employment, income, inflation or production. Therefore when assessing the future value of a security, it is necessary to analyze the outlook for the aggregate economy.
In our economic analysis for Home Depot, Inc. we will enumerate the situation of both the US economy and the home improvement market.
The U.S. economy:
The U.S. economy had experienced uninterrupted growth since 1992. Between June 1999 and May 2000, however the Federal Reserve had raised interest rates six times—for a total of 1.75 percentage point—in an effort to slow down the economy. This measures have resulted in somewhat lessening of overall consumer demand.
The Home Improvement Market:
Since 1981 till now, the home improvement industry in the U.S. had grown at an annual rate of about 6%, or slightly slower than the U.S. economy as a whole. However, with the expectation of some decline in the economy, economists predict an average nominal growth in the industry.
Following is the Home Improvement Research Institute’s projection of growth in U.S. market for home improvement products:
| Year | Percent Change over Previous Year |
| 2000 | 6.3% |
| 2001 | 3.2% |
| 2002 | 4.0% |
| 2003 | 4.4% |
| 2004 | 4.6% |
During the recent years, several factors such as, low interest rate, strong housing turnover, rising home ownership, and increases in disposable income has helped the home improvement industry to grow at a decent rate. But from March 1994 through February 1995, 30-year mortgage interest rates increased by an average of 24%. In May 2000, they had climbed to 8.6%, before falling a bit below 8% in the fall. Since Home Depot, Inc. has grown to occupy a large share of the market, these macroeconomic changes are going to have far greater impact on them.
Inflation, Interest Rates and Stock Values:
Although the relationship between inflation, interest rates and stock values is not direct and consistent the cash flows from stocks can change along with inflation and interest rates. If the interest rates rise due to an increase in the rate of inflation it is assumed that the corporate earnings likewise experience an increase in growth because the firms are able to increase prices in line with cost increase. In such case stock price can be fairly stable because the negative effect of an increase in required rate of return is partially or wholly offset by the increase in growth, which means that the return on stock increase in line with the rate of inflation.
Estimation of Market Return (Rm):
To conduct an economic analysis it is important to estimate the rate of return of the market. The rate of return is the function of nominal risk free rate and market risk premium and here a range of values are used for the risk premium.
The alternatives for NRFR are based upon the specification that it should be zero coupon, default free asset with a maturity that approximates the investor’s holding period. In this case there are different maturity Treasury securities yields given as of early October 2000 such as:
| Maturity | Yield |
| 1 month | 6.00% |
| 3 Months | 6.08% |
| 1 year | 6.18% |
| 5-10 years | 5.8% |
| 30 years | 5.83% |
In determining the risk free rate the belief is reflected that the typical investment horizon is longer than that implied by the bill. Assuming that most investors consider the intermediate time frame (5-10 years) a more appropriate investment horizon 5.8% is considered as the nominal risk-free rate.
Studies on equity risk premium suggests that it should be somewhere between 2.5% to 6.00% while using the current intermediary government bond rate as the estimate of the minimal NRFR. So on this case the market risk premium is determined within this range.
Industry Analysis
Industry analysis is done because it determines a firm’s business risk due to sales volatility and operating leverage and its profitability is impacted by competitive environment in the industry. Home Depot, Inc. is in an industry which is not susceptible to business cycle and consists of many other competitive home improvement firms. The major players in the home improvement industry in this case are described in the competitor’s analysis.
COMPETITOR’S ANALYSIS
Home Depot, Inc.:
Home Depot is the largest retailer of home improvement products and third largest retailer of any sort in United States. Home Depot had competencies that very few other retailers had and was one of the most successful retailers in American history. This company opened stores containing a huge assortment of building materials and home improvement products and that targeted individual homeowners and small contractors. The stores were warehouses and they sold large volumes of goods at low prices and they also provided knowledgeable customer services. At the end of 1999 was the largest home improvement retailer with a market share close to 24 percent and operated 930 stores with 21-22 percent growth in stores. After including the professional customers and heavy industrial sector in the company’s market of residential home repair and remodeling by do-it-yourself it estimated its market share 8.9 percent.
Lowe’s:
Among the home improvement retailers Home Depot’s principal competitor was Lowe’s and it was about half the size of Home Depot. It had annual sales of $16 billion and a market share of 10 percent. It operated 578 stores and planned to add more in the succeeding year. Lowe’s began to operate in rural towns with small stores and later it began to copy Hope Depot’s model, opening huge, warehouse-type stores in metropolitan markets along with special services for its customers. It sold some product lines that Home Depot did not and also tried to appeal more to women shoppers, with wider aisles and brighter lightning than Home Depot. In certain markets Lowe’s went on a though competition with Home Depot.
Mernards:
The next largest, Mernards was far smaller but geographically more focused. It had annual sales of about $4 billion and a market share of 2.5 percent, operated solely in several Midwestern states and was said to have a loyal customer base. In some areas Mernards had greater market share than that of Home Depot.
HomeBase:
HomeBase had annual sales of about $1.5 billion and a market share of 1 percent, operated solely in several western states. Its stores were as large as Home Depot’s and in certain areas it had a number of stores compared to Home Depot’s.
Hechinger:
Initially Home Depot’s most important competitor was Hechinger which was considered the premium home 9improvement chain and were known for very good customer services. When it tried to follow Home Depot’s warehouse format it lost out in market by market and in 1999 it went out of business.
PORTER’S FIVE FORCES ANALYSIS
Porter’s five forces is a framework for the industry analysis and business strategy development developed to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability.
The threat of the entry of new competitors:
Profitable markets that yield high returns will attract new firms. This results in many new entrants, which eventually will decrease profitability for all firms in the industry. Unless the entry of new firms can be blocked by incumbents, the abnormal profit rate will fall towards zero. The home improvement product industry is not susceptible to business cycle and is fairly protected from the vicissitudes of the economy. This industry has a growing potential making it an attractive profitable industry to start business and the more profitable the industry the more attractive it will be to new competitors. The government also does not have restricted policies for this industry which makes the entry barriers low. So, there is a threat of new entrants to the existing firms.
The intensity of competitive rivalry:
There are few home improvement product retailers in the whole industry so the degree of rivalry is moderate. Competitive rivalry is likely to be based on dimensions such as price, quality, and innovation. Technological advances protect companies from competition. Undertaking initiatives such as shifting to a different customer strategy, widening product categories, changing store formats, expanding the business internationally and initiating internet sales, a firm can have competitive advantage until other firms imitate it. Although the customer’s switching cost is low the market growth and increasing demand allows firms to match their expected sales and attract new customers and it is the growth in the market that decreases the degree of rivalry.
The threat of substitute products or services
The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives. For individual homeowners and professional customers such as contractors, electricians, plumbers, landscapers, property maintenance managers etc. there are no alternatives to home improvement products to repair homes and operating business respectively. Although the professional segment is apt to business cycle the threat of substitution products or services is very low in this industry.
The bargaining power of customers
The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer’s sensitivity to price changes. In the industry there are several retailers of home improvement products which leave customers with a lot of options for choosing. There is also a large number of customers for the home improvement products which lowers the bargaining power of the customers.
The bargaining power of suppliers
The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm. Suppliers may refuse to work with the firm, or, charge excessively high prices for unique resources. In this case the retailers of home improvement products are not dependent on one or few suppliers. They have a lot of suppliers in US for purchasing the materials. So the suppler switching cost for the retailers is low which reduces supplier’s bargaining power.
Company Analysis:
For company analysis of Home Depot, Inc. we discuss the SWOT analysis, Financial Statements forecast, ratio analysis and DuPont Analysis.
SWOT ANALYSIS
SWOT analysis involves an examination of a company’s strengths, weaknesses, opportunities and threats. Strengths and weaknesses involve identifying the firm’s internal abilities or lacks thereof. Opportunities and threats include external situations such as competitive forces, discovery and development of new technologies, government regulations and domestic and international economic trends. In this section we would present the SWOT analysis for Home Depot, Inc.
STRENGTHS
Home Depot, Inc. is the Largest Retailer of home improvement products. One of the most prominent features of Home Depot, Inc. that sets them apart from the rest of the industry is their superior customer service. Since beginning, Home Depot, Inc. was the only company that was known for its knowledgeable customer service. The company had built a strong base of trained employees through making the product knowledge training classes mandatory for all its salespeople. Home Depot, Inc. also provides special services such as renting trucks, propriety credit cards, provision for unsecured loans to make large purchase and brief courses (how-to clinics) to help customers in carrying out projects. There were also longer, four-week courses that were called Home Depot University.
Another exceptional strength of Home Depot, Inc. is its ability to sustain extraordinary financial and operating performance over the years. The company’s stock price had also risen dramatically. Between the fall of 1981 & End of 1999, stock price had risen at a compound annual rate of 29%.
Constantly evolving management style has proved to be a great strength of Home Depot, Inc. the company never seems to regard the way it operate as settled. The management evaluates new ideas on smaller scale before taking to entire store network.
One of Home Depot, Inc.’s potency is the ability to successfully utilize its capability through further expansion of operations and growth initiatives. They are planning on increasing the no. of stores annually by 21-22 percent so that by the end of 2003 the store no. will be over 1900. Redefining its industry has resulted in product sales to professional customers in addition to do-it-yourself (D-I-Y) customers. By 1999, Home Depot, Inc. increased its market share of professional customer sector from 4% to approximately 8.9%. Among growth initiatives Home Depot, Inc. is pursuing the likes of shifting to Triple Customer Strategy, Store Format Changes, Product Category Expansion, International Growth, and Internet Sales.
WEAKNESSES
Home Depot, Inc. was primarily involved in selling materials that ordinary people use for home improvement projects. But over the past years it has grown significantly. The growth plans point out some potential weaknesses of the company.
Satisfying the need of different customer groups is indeed a strenuous task. It has been observed that many other companies are doing better than Home Depot, Inc. in terms of product mix and focused customer strategy. Many regional wholesalers of electrical products, serving the professional customers, claim to offer better services than Home Depot, Inc. in terms of broader and deeper inventory, more knowledgeable sales help, and reliable delivery.
Another likely problem of the company is its inability to effectively handle Cross-Selling. To be successful in this feat the Home Depot, Inc. must be able to properly integrate different products within a given organizational structure.
OPPORTUNITIES
The proposed growth schemes present certain opportunities for the company. Redefining their market and shifting from D-I-Y to triple customer strategy is going to create more opportunity enhance the scope of Home Depot, Inc.’s operations and market presence.
Buy-it-Yourself (B-I-Y) Customers has opened the window for serving the new Market for installation services. The total U.S. market for this category is estimated at $75 billion. Home Depot, Inc. serves less than 2% of this market but plans to grow by 40% each year for the next five years.
Serving Professional Customers provides a Large Market potential and great propensity for Repeat Business. This strategy is anticipated to influence sales the most out of all of the initiatives.
Changing Product Categories would help in increasing product line, adding appliances to complement current offerings and vertically integrate supply chain.
International growth initiative is believed to be very important in the next five to fifteen years as it would allow the company to expand its realm of market presence globally.
The company also intends to possess the “world’s largest e-commerce” site in the industry through its process of developing its Internet Site.
THREATS
Along with the opportunities, the growth initiatives pose many threats to Home Depot, Inc.’s overall financial and operating performance as well. Moreover, macroeconomic factors have a greater impact on the company than before since it has gained a much larger portion of market share and increased its products and services.
Home Depot, Inc. was thought to be fairly protected from the vicissitudes of the economy. . Since Home Depot, Inc. has grown to occupy a large share of the market, the company has become much vulnerable to these macroeconomic changes. The U.S. economy had experienced uninterrupted growth since 1992. Between June 1999 and May 2000, however the Federal Reserve had raised interest rates six times—for a total of 1.75 percentage point—in an effort to slow down the economy. In May 2000, they had climbed to 8.6%, before falling a bit below 8% in the fall. This has been marked as the main reason the company’s earnings shortfall.
Another threat is the possibility of over-saturation of certain big city-markets. Home Depot, Inc. and its biggest competitor, Lowe’s are both planning on opening a lot of new stores in the next few years. This poses the threat of excess supply and falling of prices.
As Home Depot, Inc. plans to double the number of stores over the next 4 years, it is uncertain if the will be able to uphold its reputation for having the best customer service and most efficient employees.
Moreover, the professional segment and the Expo Design Center stores are going to be more sensitive to cyclical changes in the economy.
The international growth scheme presents the most complex challenges because of real estate, and logistics of the supply chain as well as the barriers of language and cultural differences.
FINANCIAL STATEMENTS ANALYSIS
The income statement and balance sheet of Home Depot, Inc. has been forecasted for year ending in January 2oo1. For this purpose following assumptions have been made.
· Sales have increased at a rate of 21%
· Operating expenses and operating profit will increase by the same percentage
· Assume that cash will increase at 21% per year
· Accounts receivable and inventories will also increase by the same percentage
· Assume accounts payable and other accrued liabilities will increase by 21% per year
· Total Debt and equity has been calculated in consistent with previous year’s debt to capital and debt to equity ratio.
· Long term debt has been kept same as previous year but interest expense has been increased by 1.75 percent points.
· Sighting a 21% annual growth of store number in future years, the property and equipments has been increased by that rate.
· Common Stock, Paid in Capital & Retained Earnings have been calculated in consistent with previous year’s ratio with total capital.
Income Statement
Home Depot, Inc.
Years ending January
| Year | 1999 | 2000 | 2001 | ||||
| (Forecasted) | |||||||
| Net sales | 30219 | 38434 | 46505 | ||||
| Cost of merchandise sold | 21614 | 27023 | 32788 | ||||
| Gross Profit | 8605 | 11411 | 13717 | ||||
| Operating expenses | |||||||
| Selling and store operating | 5341 | 6832 | 8265 | ||||
| Pre-opening | 88 | 113 | 136 | ||||
| General and Administrative | 515 | 671 | 872 | ||||
| Non-Recurring charge | |||||||
| Total Operating Expenses | 5944 | 7616 | 9273 | ||||
| Operating Income | 2661 | 3795 | 4444 | ||||
| Interest and Investment Income | 30 | 37 | 38 | ||||
| Interest Expense | 37 | 28 | 28 | ||||
| Interest, net | 7 | 9 | 10 | ||||
| Earnings Before Income Taxes(39% Tax Rate) | 2654 | 3804 | 4454 | ||||
| Income Taxes | 1040 | 1484 | 1737 | ||||
| Net Earnings | 1614 | 2320 | 2717 | ||||
| Diluted EPS | 0.71 | 1.00 | 1.16 | ||||
Balance Sheet
Years ending January
| Year | 1999 | 2000 | 2001 | |||
| ASSETS | (Forecasted) | |||||
| cash & equivalents | 62 | 168 | 203.38 | |||
| short term investments | 2 | 2 | ||||
| receivables | 469 | 587 | 710.27 | |||
| Merchandise Inventories | 4293 | 5489 | 6641.69 | |||
| Current Assets | 109 | 144 | 174.24 | |||
| Total Current Asset | 4933 | 6390 | 7731.58 | |||
| Properties & Equipment | ||||||
| land | 2739 | 3248 | 3930.08 | |||
| Buildings | 3757 | 4834 | 5849.14 | |||
| Furniture | 1761 | 2279 | 2757.59 | |||
| Leasehold | 419 | 493 | 596.53 | |||
| Construction in progress | 540 | 791 | 957.11 | |||
| Capital lease | 206 | 245 | 296.45 | |||
| 9422 | 11890 | 14386.9 | ||||
| Less: Accumulated depreciation | 1262 | 1663 | 2014.166 | |||
| Net Properties & Equipment | 8160 | 10227 | 12372.73 | |||
| Costs in excess of Fair value | 268 | 311 | 376.31 | |||
| others | 104 | 153 | 185.13 | |||
| TOTAL ASSETS | 13465 | 17081 | 20665.75 | |||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
| Accounts Payable | 1586 | 1993 | 2411.53 | |||
| Accrued Salaries | 395 | 541 | 697.89 | |||
| Sales Tax | 176 | 269 | 325.49 | |||
| Other Accrued Expense | 586 | 763 | 984.27 | |||
| income tax payable | 100 | 61 | 71.37 | |||
| Current part of Long term Debt | 14 | 29 | 90.08396 | |||
| Total Current Liabilities | 2857 | 3656 | 4580.634 | |||
| long term debt | 1566 | 750 | 750 | |||
| Other Accrued Expense | 208 | 237 | 286.77 | |||
| Deferred Income | 85 | 87 | 105.27 | |||
| Minority Interest | 9 | 10 | 12.1 | |||
| Total Long term Debt | 1868 | 1084 | 1154.14 | |||
| Stockholders’ Equity | ||||||
| Common Stock | 111 | 115 | 139.1348 | |||
| Paid in Capital | 2817 | 4319 | 5225.42 | |||
| Retained Earnings | 5876 | 7941 | 9607.561 | |||
| Other | -64 | -34 | 267.1 | |||
| TOTAL STOCKHOLDERS’ EQUITY | 8740 | 12341 | 14930.98 | |||
| Total Liabilities & Stock holder’s Equity | 13465 | 17081 | 20665.75 | |||
RATIO ANALYSIS
From above financial statements following ratios can be found.
| year | 1999 | 2000 | 2001 | |||
| Profitability | ||||||
| Profit Margin (%) | 6.00% | 6.04% | 5.84% | |||
| Return on equity (%) | 26.13% | 24.94% | 18.20% | |||
| Return on assets (%) | 22.20% | 18.02% | 13.15% | |||
| Leverage | ||||||
| Debt/Equity Ratio | 0.54 | 0.38 | 0.38 | |||
| Debt/Total capital | 0.35 | 0.28 | 0.28 | |||
| Asset utilization | ||||||
| Sales/Assets | 3.7 | 2.99 | 2.25 | |||
| Liquidity | ||||||
| Current ratio | 1.73 | 1.75 | 1.75 | |||
The profitability ratios show a fall in profit growth in the forecasted year. The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. The debt-to-capital ratio gives users an idea of a company’s financial structure, or how it is financing its operations, along with some insight into its financial strength. The higher the debt-to-capital ratio, the more debt the company has compared to its equity. Home Depot, Inc. remains free of too much debt burden. The current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. Home Depot, Inc. can cover all of its current obligations with its current assets efficiently96
DUPONT ANALYSIS
DuPont analysis is an expression which breaks ROE (Return On Equity) into three parts. This analysis enables the analyst to understand the source of superior (or inferior) return.
ROE = (Profit margin)*(Asset turnover)*(Equity multiplier)
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
= (Net Profit/Equity)
DuPont analysis tells us that ROE is affected by three things:
– Operating efficiency, which is measured by profit margin
– Asset use efficiency, which is measured by total asset turnover
– Financial leverage, which is measured by the equity multiplier
The DuPont Break down of Home Depot, Inc
| profit margin | asset turnover | equity multiplier | ROE | Operating ROA | |
| 2000 | 5.84% | 2.25 | 1.38 | 18.20% | 13.15% |
| 1999 | 6.00% | 3.70 | 1.18 | 26.13% | 22.20% |
| 1998 | 5.40% | 3.70 | 1.14 | 22.70% | 19.98% |
| 1997 | 4.80% | 3.60 | 1.13 | 19.50% | 17.28% |
| 1996 | 4.80% | 3.50 | 1.12 | 18.80% | 16.80% |
| 1995 | 4.70% | 3.50 | 1.29 | 21.30% | 16.45% |
| 1994 | 4.90% | 3.80 | 1.15 | 21.50% | 18.62% |
| 1993 | 4.70% | 3.40 | 1.25 | 19.90% | 15.98% |
| 1992 | 4.80% | 4.60 | 0.97 | 21.50% | 22.08% |
| 1991 | 4.70% | 4.80 | 1.62 | 36.50% | 22.56% |
| 1990 | 4.40% | 5.60 | 1.29 | 31.90% | 24.64% |
| 1989 | 4.10% | 5.80 | 1.23 | 29.20% | 23.78% |
| 1988 | 3.90% | 5.80 | 1.06 | 23.90% | 22.62% |
| 1987 | 3.80% | 5.50 | 1.59 | 33.20% | 20.90% |
| 1986 | 2.90% | 3.50 | 2.64 | 26.80% | 10.15% |
Return on Equity
Return on Equity measures the rate of return on the ownership interest (shareholders’ equity) of the common stock owners. It measures a firm’s efficiency at generating profits from every unit of shareholders’ equity (also known as net assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate earnings growth. Home Depot, Inc. has had a decent to high return on equity ranging from 18.80% to 36.50%. Our forecasted ROE for year 2000 shows a fall in ROE from 26.13% to 18.20%.
Profit Margin:
The profit margin of Home Depot, Inc. has been steadily growing over the years. The forecasted profit margin for year ending in 2001 shows a slight decrease from 6% to 5.84%.
Asset Turnover:
Asset turnover is a financial ratio that measures the efficiency of a company’s use of its assets in generating sales revenue or sales income to the company. The higher the number the better. Home Depot, Inc.’s Asset Turnover has been high in the initial years but slowed down in the recent years, which is reflected in the slowing down of ROE after the initial years. The forecasted turnover drops to 2.25 from previous years 3.7.
Equity Multiplier:
The company’s leverage ratio (Assets ÷ Equity), which is equal to the firm’s debt to equity ratio + 1. This is a measure of financial leverage.
Except for the 1st year, company’s equity multiplier has been pretty decent, which means Home Depot, Inc. has been fairly independent in managing their own financing.
Return on Assets
The return on assets (ROA) percentage shows how profitable a company’s assets are in generating revenue. This tells us what the company can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control. Home Depot, Inc. has had a decent to high return on Asset ranging from 10.15% to 24.64%. Forecasted ROA for year ending in 2001, drops to 13.15%.
RISK ANALYSIS
Risk analysis examines the uncertainty of income flows for the total firm and for the individual sources of capital. The typical approach examines the major factors that cause a firm’s income flow to vary. More volatile income flows mean greater risk.
The total risk of the firm has two internal components- Business Risk & Financial Risk.
Business Risk:
Business Risk is the uncertainty of operating income caused by firm’s industry. It is usually measured by the variability of firm’s operating income over time.
Business Risk = ƒ (Coefficient of Variation of Operating Earning)
The business risk of Home Depot, Inc. is calculated below.
| 1990 | 1991 | 1992 | 1993 | 1994 | 1995 | 1996 | 1997 | 1998 | 1999 | |
| NOPAT | $167 | $240 | $346 | $439 | $609 | $722 | $932 | $1159 | $1618 | $2315 |
| Sales | $3815 | $5137 | $7148 | $9239 | $12477 | $15470 | $19535 | $24156 | $30219 | $38434 |
| Standard Deviation Of NOPAT = | $ 681.0143 | ||
| Mean of NOPAT = | $854.7 | ||
| CV of NOPAT = | 0.796788 | ||
Besides overall Business Risk, it is insightful to examine other factors that contribute to operating earnings.
Sales Variability:
Sales variability is the prime determinant of operating income variability. The variability of sales is mainly caused by firm’s industry and is largely outside control of management.
Sales Variability = ƒ (Coefficient of Variation of Sales)
The Sales variability of Home Depot, Inc. is calculated below.
| Standard Deviation Of Sales = | $11472.44 | ||
| Mean of Sales = | $16563 | ||