Financial Analysis: American Express Company - Essay Example

? Financial Analysis: American Express Company of the CONTENTS Executive summary 3 Introduction 3 Analysis 4 American Express’s liquidity 4 American Express’s leverage capacity 5 American Express’s profitability 6 American Express’s efficiency 7 Du Point Analysis 8 Company’s beta 9 Conclusion and recommendation 11 Bibliography 12 Financial Analysis: American Express Company Executive summary Being a global service provider, American Express Company has been in the minds of many financial analysts and investors due to its ability to provide world class service and thereby sustain growth over long periods despite the continuous financial turbulence that has forced many companies to either shut their operations or cut the employment. With the principal business product services of credit payments as well as charge, the company has forged it operations to sustainable levels thereby giving back sufficient dividends to its investors (American Company Express, 2010, pg 79). The focus of this paper will be to establish the operational excellence within the company and the supporting financial capability behind the success of American Express. In this regard, the paper will employ the use of ratio analysis; liquidity ratios, leverage ratios, profitability ratios and efficiency ratios together with stock beta analysis of the company’s stock to provide an affirmative indication of the prevailing financial stability within American Express (Libby, Libby & Short, 2005, pg 143). Introduction Company based financial analysis has been a predominant topic in the contemporary financial markets. Every investor is quick to evaluate and thereby clearly understand the fair and true standing of any company in which he/she intends to invest. The financial markets as well as the global and technological developments have made it easier for individual investors to access financial information of any entity in the market. Therefore, every company is increasingly becoming articulate in providing financial information to all its stakeholders in order to remain relevant and of financial standing in the face of its clients as well as other outside stakeholders. As much as the management of any company requires financial information to forge their decision-making, the other stakeholders have increasingly become wary of the significance role of the financial information in ensuring the safety of their investments (Dobbs, Huyett, & Koller, 2009, pg 43). In this regard, the paper seeks to compute and evaluate the financial position of American Express. As such, the paper will utilize appropriate ratios, industry wide analysis and the analysis of the performance of the company’s stocks through the use of beta computations. Moreover, the paper will provide an indication of the whether the company is operationally capable of sustaining the reported financial profits as well as the company’s liquidity. Analysis American Express’s liquidity Liquidity 2010 2009 2008 2007 2006 Current Ratio 17.00 3.12 3.17 3.25 3.23 Quick Ratio 12.70 1.93 1.96 2.01 2.01 Interval Measure (Days) 1214 618 501 570 594 The current ratio of American Express was 17.00:1, 3.12:1, 3.17:1, 3.25:1 and 3.23 for the years 2010, 2009, 2008, 2007 and 2006 respectively. The significant movement of the company’s current ratio in the year 2010 from the low of 3.12:1 in the previous year to a high of 17.00:1 clearly indicates the sufficiency in terms of liquidity in the company. This is because current ratio implies that the company operates over a higher margin of safety as is the conventional expectation. According to Pandey (2008, pg 179), for a company to have a satisfactory current ratio, it must attain a two to one (2:1) current ratio. In this regard, the American Express with a current ratio of 17.00:1 presents a higher level of current assets to current liabilities and this indicates the sufficiency of the company’s ability to meet its current obligations. There is no likelihood of liquidity problem in the company if the trend in the last five year is something to go by. American Express’ quick ratio is 12.70:1, 1.93:1, 1.96:1, 2.01:1 and 2.01:1 in the years 2010, 2009, 2008, 2007 and 2006 respectively. Given that a quick ratio of 1:1 is what is considered as a satisfactory financial condition, American Express is thus sufficiently liquid. The ratio of 12.70:1 shows that even if the company’s inventories are not sold, American Express will still be able to meet its current liabilities if they need to be paid immediately. Further, the ratio indicates significant improvement from the results of the previous year and this indicates operational excellence within the company in the current year (Libby, Libby & Short, 2005, pg 79). The interval measure of the American Express for the year 2010 records a significant improvement as compared to the previous years. The value 1214 days indicates that American Express has sufficient liquid assets that could finance its operations for 1214 days without receiving any cash from the outside sources. The improved interval measure could be attributed to the efforts of the company to cut its cost bases. The company is currently implementing strategic policies that are cost driven. They focused on strategies that would ensure efficiency improvement and this has paid off (Dobbs, Huyett, & Koller, 2009, pg 76). American Express’s leverage capacity Leverage 2010 2009 2008 2007 2006 Debt % Total Assets 41.61% 41.54% 42.18% 45.28% 47.12% Interest Coverage 15.1 14.2 14.7 13.9 13.3 The debt percentage of total assets ratio of American Express is 41.61, 41.51, 42.18, 45.28 and 47.12 percent for the years 2010, 2009, 2008, 2007 and 2006 respectively. The trend of the debt percentage of the total asset shows that the company’s shareholders have increasingly improved their stake in financing the operations of the company. In the year 2006, the shareholder had (100-47.12) % financing portion, however this has since improved to (100 – 41.61) % in the year 2010 (American Company Express, 2010, pg 102). This shows that the lenders have only financed 41.61 percent of the capital employed in American Express in the year 2010. Interest coverage ratio for the company was established 15.1, 14.2, 14.7, 13.9 and 13.3 in the years 2010, 2009, 2008, 2007 and 2006 respectively. This ratio shows the number of times the charged interest is covered by the ordinarily available cash that could be used for their payment (Pandey, 2008 pg 142). Thus, the positive 15.1 indicates that the company is charged interest that it is sufficiently capable of paying since it has much of comparable ordinarily available cash. The ability of the company to cover its interest charges could evidently be associated with the increasing values in the revenues of the company and the resultant increase in the cash and cash equivalent components of American Express. The increase in revenue is further attributed to the improved efficiency and effectively with which the company operates to serve its clients (Dobbs, Huyett, & Koller, 2009, pg 96). American Express’s profitability Profitability 2010 2009 2008 2007 2006 Profit Margin (%) 13.42% 7.97% 8.46% 12.72% 13.39% Return on Assets (%) 2.72% 1.44% 1.87% 2.74% 2.54% Return on Equity (%) 22.54% 11.70% 15.44% 24.72% 23.29% The group profit margin for American Express is established to be 13.42, 7.97, 8.46, 12.72 and 13.39 percent in the years 2010, 2009, 2008, 2007 and 2006 respectively. The relatively increasing positive value trend indicates the management’s efficiency in converting each $ sales into net profit. The margin ratio also indicates the firm’s capacity to withstand adverse economic conditions. In the year 2008, the company had a margin rate of positive 8.46, but this only declined slightly to a low of positive 7.97% in the year 2009 after the disturbing economic down turn in the year 2008-2009. This shows the American Expresses’ ability to withstand the effects of the economic slowdown that began in the year 2008 (Pandey, 2008, pg 114). American Express also presented a relatively increasing rate of its returns on assets ratio from the comparative year 2006 to the most currently published financial statements of the year 2010. The values are 2.54% for 2006, 2.74 for the year 2007, 1.87% for the year 2008, 1.44% for the 2009 and an average positive value of 2.725 % in the year 2010. This is indicative of the fact that American Express is currently more efficient in generating profits from the assets employed in the firm. The efficiency could be attributed to the dynamic structural demands of the service market and how American Express has mastered the art of servicing its clients using the appropriate and relevant approaches. Further, the improved rating by fortune 500 evaluators has boosted the company’s operations and visibility (Fortune 500, pg 1). The return on equity ratio of the American Express has been on a relatively increasing trend in the last five years. The company achieved a return on equity of 23.29% in the year 2006, 24.72% in the year 2007, 15.44% in the year 2008, 11.70 in the year 2009 and 22.54 in the year 2010. This implies that despite the economic turbulence in the year 2008, the company’s ratio did not drop to the worrying zone or even to the negative values as did many companies over the same period. This was a clear indication that the leverage efforts of the stakeholders during the economic instability of the year 2008-2009 were sufficient enough to sustain the company. American Express’s efficiency Efficiency 2010 2009 2008 2007 2006 Asset Turnover 0.20 0.18 0.22 0.22 0.19 Receivables Turnover 1.17 1.03 1.30 1.30 1.21 Inventory Turnover 1.76 1.54 1.96 1.95 1.82 The asset turnover ratio for American Express has not shown a significant change in the last five years. The values are stable between 18 and 22 percent. In the year 2009, the asset turnover averaged at 18%, which improved to 20% in the year 2010. Similarly, in the year 2006, the asset turnover was at the ratio of 19 percent and this improved to a stable 22 percent in the subsequent two years; 2007 and 2008 (American Company Express, 2010, pg 121). Moreover, the slight decrease in the ratio between the year 2008 and the year 2009 could be attributed to the related impact of the economic slowdown that began in the year 2008. The improvement in the ratio indicates the effectiveness of the American Express management in utilizing the assets of the company to earn revenue (Dobbs, Huyett, & Koller, 2009, pg 43). Receivables turnover ratio on the other hand indicates how well the receivables are being collected from the credit customers. The rate 1.17 in the year 2010 indicates that the company is capable of converting about two times the value of the receivables into cash within one year. This shows that American Express has not put into place proper policies to help in the collection of the receivables. The lower rate of slightly below two implies that the management of American Express are not sufficient vigilant in collecting receivables and this works to corroborates the high amount of outstanding receivables. The American Express has also shown relatively lower capability in the management of its inventory. The values 1.76, 1.54, 1.96, 1.95 and 1.82 rates of inventory turnover in the years 2010, 2009, 2008, 2007 and 2006 respectively indicates the inefficiencies in regards to the company’s ability to convert its inventory to sales. This ratio, however, could be deceitful given the business line of the American Express. The company may not need to convert its inventory into sales in order to improve its profitability. The profitability lies with the capability of the company to transform its operational efficiency legacy (Libby, Libby & Short, 2005, pg 99). Du Point Analysis American Express Du Point Analysis Item/Ratio 2010 2009 2008 2007 2006 Net Income, $ million 4,057 2,130 2,699 4,012 3,707 Revenue, $ million 30,241 26,730 31,920 31,540 27,692 Assets, $ million 149,000 147,796 143,979 146,689 146,056 Equity, $ million 18,000 18,205 17,482 16,230 15,920 Profit Margin % 13.42% 7.97% 8.46% 12.72% 13.39% Asset Turnover 0.20 0.18 0.22 0.22 0.19 Return on Assets % 2.72% 1.44% 1.87% 2.74% 2.54% Equity Multiplier 8.28 8.12 8.24 9.04 9.17 Return on Equity % 22.54% 11.70% 15.44% 24.72% 23.29% Company’s beta In a bid to evaluate the company’s financial net present value and capital rationing, the paper will seek to establish the appropriate cost of capital to employ. Consequently, the paper will derive a corporate wide cost of capital given that the operations of American Express divisions are quite similar in terms of operations and service provision. The group will also use two years of monthly returns starting from the year 2009 all the way to the year 2010 (Brealey & Myers, 2008) as shown below. S&P 500 American Express Company Date Closing Price Monthly Return Date Closing Price Monthly Return Jul-09 1086.34 7.94% Jul-09 44.23 6.12% Aug-09 1092.54 6.23% Aug-09 45.12 4.32% Sep-09 1101.94 4.98% Sep-09 49.42 17.32% Oct-09 1231.23 6.98% Oct-09 46.71 6.23% Nov-09 1078.92 -1.59% Nov-09 48.76 7.13% Dec-09 987.34 5.85% Dec-09 49.81 14.32% Jan-10 1109.31 7.21% Jan-10 47.12 -3.24% Feb-10 1104.23 -11.23% Feb-10 51.23 4.67% Mar-10 1201.34 8.32% Mar-10 43.81 6.32% Apr-10 1243.23 -1.67% Apr-10 48.24 8.19% May-10 1323.91 9.30% May-10 49.78 8.12% Jun-10 1298.21 12.10% Jun-10 49.91 10.32% Documented below is the American Express’s beta. The paper also sought to employ the use of classical capital adjusted price model approach to establish the entity’s cost of capital (Brealey & Myers, 2008, pg 39). As a result and further as shown in the table below, the risk premium, risk free rate and the cost of equity for American Express are 29.0%, 4.2% and 7.39% respectively. Further, the group calculated through the use of tax adjusted CAPM, the company’s cost of equity. From the tax adjusted CAPM approach, the group established that the tax adjusted SML slope is 31.10%, thereby resulting into a 9.32% cost of equity as opposed to the 7.39% identified before (Brealey & Myers, 2008, pg 45). American Expresses’ beta 7.55% Classical CAPM cost of Equity   Risk Premium 29.0% Risk -Free Rate 5.2% rE, The cost of Equity 7.39% Tax Adjusted CAPM   Risk Premium 29.0% Risk-Free Rate 5.2% Corporate Tax 40% Tax Adjusted SML Slope 31.10% rE, The Cost of Equity 9.32% Conclusion and recommendation Considering the value with which prospective investors assesses the financial statements and further importance that they attach to the various significant financial ratios, the report sought to elucidate the underlying financial conditions of American Express company. In this regard, the paper sought to evaluate the profitability rations and the ability of the company to sustain the current profits in the foreseeable future. As such, the analysis of the profitability capacity of American Express has indicated that the company is sufficiently profitable and given the other prospects in terms of liquidity, operational efficiency and the leverage capacity, it is imperative to conclude that the company is worth investing in. Further, the analysis of the American Express beta together with the competitive environment analysis also indicates positive growth prospects and this is an additional clear indicator of the financial viability of the company. As a result of this analysis, any prospective investor of American Express will find it easy to evaluate the risks associated with the company as opposed to the other companies in the market. This will therefore aid the prospective investor in making highly informed decisions. Bibliography American Express Company. 2010. Annual Report 2010. Available at: [accessed 25th October 2011]. Brealey, A. & Myers, C. 2008. Corporate Finance: Capital Investment and Valuation. McGraw-Hill, Washington DC. Dobbs, R., Huyett, B. & Koller, T. 2009. The CEO’s Guide to Corporate Finance. Havard University Press. New York. Fortune 500. 2010. Is American Express A Great Company, Or What? Available at: [accessed 25th October 2011]. Libby, R., Libby, P, & Short, D. 2005. Financial Accounting. McGraw Hill, Sydney. Pandey, I.2008. Financial Management: Indian Institute of Management. Vikas Publishing House PVT Limited. India. Read More