DB10,DQ1: Profit MJargin and Financial Well Being. and DQ2 : Stock Market Favor, - Essay Example

DQ1 The profit margin ratio is calculated by dividing net income by total revenues (Garrison & Noreen). The information that was given about the company indicates that the firm had a profit margin of 10%. Based on this information an investor knows that the firm had a positive net income which is a good indicator. This information alone is not sufficient to determine whether the company is a bad or good investment. As an analyst I would need more information to make an investment decision. For example it would be good to know the industry average profit margin to compare it with the 10% the firm achieved.

A good database that has information regarding the industry average of different financial ratios such as profit margin is the Dun & Bradstreet database. Performing other ratio calculations to test other aspects of the business such as leverage, efficiency, or market ratios can also help in the analysis. The investor must evaluate the annual report of the firm in particularly the financial statements. The income statement provides information regarding the profitability of the company. The use of vertical and trend analysis can provide a better understanding of the financial performance of the firm.

Horizontal or trend analysis compares key results from the income statement against the performance of previous years such as sales, gross profit, and net profit. DQ2 The price earnings (P/E) is a measure or index that shows whether a stock is expensive or cheap in relation to the firm’s current earnings. The current ratio is calculated dividing the market price per share of a stock by the earnings per share (EPS). A high price earnings ratio implies that investors are expecting higher earnings growth in the future compared to corporations that have lower price earnings ratios (Investopedia).

In the example illustrated in the question General Motors had a P/E of 8.0 and Microsoft Corporation had a P/E of 38.0. The stock market would favor Microsoft because its P/E is much higher than General Motors. The P/E ratio of Microsoft shows that investors have a much higher earnings expectations for Microsoft than for General Motors. A better analysis can be made on the P/E of these companies by comparing the results to the industry standard. Work Cited Page Garrison, R., Noreen, E. (2003).

Managerial Accounting (10th ed.). Boston: McGraw Hill Companies. Investopedia.com. 2011. “Price-Earnings Ratio – P/E Ratio” 2 June 2011.