The primary goal of every investor is to maximize his returns. To determine the right company to invest in an investor require analyze the performance of a company using various tools which include the financial ratios analysis, cash flow analysis, risk analysis, stock valuation and time value of money. This paper provides a detailed analysis of an investor who has 100,000 and is in differenced between saving the money in a saving account or investing it in stocks of 3M company which is a manufacturing and mining company producing over 55, 000 products.
Use of Financial Ratios
The liquidity ratios shows the ability of affirm to meet its short term debts as and when they fall due. They include, the current ratio and the quick asset ratio (Harrison & Horngren, 2001).The current ratio shows the number of times the assets of a company meets the short term liabilities. The current ratio of the 3M Company has been fluctuating between 1.7 in 2013 and 1.56 in 2015. This up and down ratio is not healthy for a company and may put off a potential investor. In addition, the ratio is below two times which means in case the firm is faced with bankruptcy case, the ownership of the firm would be lost to the creditors.
The quick asset ratio show the number of times the short term debts are paid using the most liquid assets of the company. These include all current assets except the closing inventory since it is less liquid as compared to the other short term assets such as cash and accounts receivables (Brigham & Houston, 2004).The ratios show the company was able to pay its debts 1.18 times in 2013 and 1.05 in 2015. The decrease shows poor performance. Though the ratio is slightly above one time, an investor would be skeptical on investing in the company.
The other form ratios that the investors would be interested in are the investment ratios. These include the return on investment ratio. This shows the percentage of profit that was generated by the assets of the company. This is calculated as net income/ total assets * 100
The second investment ratio is the return on equity. This shows the percentage of profit that was generated by the equity owned by the company. This is arrived at as net income/ equity* 100.
The investment ratios indicate a positive growing trend. This means the returns of the investors are growing and hence attracting the investor to invest in the company.
The financial ratios of the company 3M have been summarized in the table below.
Cash Flow and Financial Planning
Cash flow refers to the available funds for the business to run its operations. Its availability determines the ability of a business to remain a going concern for the foreseeable future. The cash flows are the net of earnings before interest and taxes plus depreciation less taxes. Higher operating cash flows of a business are preferred in a business to enable it to continue funding its operations (Paramasivan & Subramanian, 2009).The cash and cash equivalents of the 3M Company have grown over the three years studied, in year 2013, the company cash and cash equivalent balance was, $ 1798, 2014, $ 1897 while 2015 was $ 2581. This shows a positive growth.
Time Value of Money
The second tool that may be used to analyze the investment is the use of time value of money. Time value states that funds have more worth now than in the future. To determine the value of funds in the future, money is discounted using the prevailing cost of capital or the discounting factor. The funds owned by the investor is meant to be invested in a saving account that will generate an interest return of 5% per annum therefore the amount that he will receive in future is worth $ at the present.
P (1 + r n) n (t) = A the present value of the 100,000 to be received in five years’ time will be 127, 628 less the invested amount the investor will have a net present value of $27, 628. The investor will be able to generate an extra $ 27, 628 from his original investment of $ 100,000.
Stock Valuation
Stock valuation refers to the theoretical value of a stock of a company. It includes the intrinsic value of a stock which may be measured I using the free cash flow method, Dividend discount model or the use of residual income model. To measure to measure the stock valuation of the 3M Company the discount dividend model will be used.
Value of stock = dividend per share / discount rate- growth rate.
The value of stock of 3M Company for year 2013= 3.93 2014 = 3.96, 2015 = 3.56
Risk and Required Rate Of Return
Risk refers to the occurrence of the unknown outcomes this affects the amount of returns from investment of a company. Investments are affected by to types of risks which include the diversifiable risk which affects all investments and non- diversifiable risk which selectively affects some investments (Deventer, Imai, & Mesler, 2013). To determine which stock to invest in, the investor relies on his risk attitude, for risk takers they undertake risky stocks since they generate high returns while risk averse and risk neutral investors undertake less risky investments.
The required rate of return of an investment refers to the rate of return required by the investors. This is arrived using the weighted cost of capital which means adding the cost of debt, cost of equity and the cost of preference shares.
Conclusion
Investing in stocks will allow the investor to grow his wealth from the stocks of the company. This will also allow the investor diversify his risk unlike saving in a savings account. Using the $ 100,000 he will be able purchase 25,641 stock if he buys them in year 2013. Each share will earn him $ 7.72 therefore in total year 2013 he would have earned $25, 641* 7.72 = $197, 949. When compared to his amount of investment of $ 1000,000 he would earn an extra $ 97,949. Therefore the investor would rather invest in stocks instead of saving the money in a savings account.
Holding the money in saving account would deny the investor the chance to earn from the annual dividends of the stocks hence lowering the amount of wealth owned. The investor thus needs to purchase shares in 3m company in order to enjoy the returns associated with owning stocks in publicly traded companies such as 3M Company.
References
Brigham, E. & Houston, J. (2004). Fundamentals of financial management. Mason, Ohio: Thomson/South-Western.
Deventer, D., Imai, K., & Mesler, M. (2013). Advanced financial risk management. Singapore: Wiley.
Harrison, W. & Horngren, C. (2001). Financial accounting. Upper Saddle River, NJ: Prentice Hall.
Paramasivan, C. & Subramanian, T. (2009). Financial management. New Delhi: New Age International (P) Ltd., Publishers.
