To choose the best option for investment, one should calculate a number of indexes for all the companies and compare them.
First, one has to analyze the value of Operating Income Margin. This ratio shows the amount of profits the company receives from every dollar of sales and is necessary to analyze the companys pricing strategy and operating efficiency. (Goldie, 2011)
For the first company, Operating Income Margin rose from 9.41% in 2008 to 10.11% in 2010. So the index of the growth is 0.7% for the period of three years.
For the second company, OIM rose from 10% to 11.06%. The index increased by 1.06% for the period of three years.
The average Operating Margin is 10.50%.
In comparison with the average value through the industry in 2010, the first company had a lower rate, while the second firm had a higher index.
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Of course, the investor cannot judge the condition of a company only by its incomes. However, the growth of the Income Margin shows that the level of profitability of both companies had increased, but one can see that the performance of the second company was much better.
The second vital index is the Net Income Margin. Net Margin is the ratio of net income to sales. It shows the correlation between the amount of dollars earned by the company and its profits. This index can vary from industry to industry. Therefore, it is significant to compare it to the industrys average ratio.
For the first company, NM went up from 4.71% to 5.26% for the period of three years.
For the second company, index rose from 5.01% in 2008 to 5.65% in 2010.
The average Income Margin in 2010 was 5.5%.
The index of second company is higher than the average one. From the available data, the investor can see that both companies showed a stable growth of the Income Margin Rate for the whole period, so the price of their shares should not be exposed to negative fluctuations.
The third index that the investor should analyze is the Current Ratio. It is also known as the working capital ratio or a liquidity ratio, and it shows the ability of a company to discharge its obligations with the current assets. (Singh, 2011)
The working capital ratio of the first company rose from 1.09 to 1.14 for the period of three years.
The Current Ratio of the second company rose from 1.30 in 2008 to 1.40 in 2010. The index of growth was 0.1.
The average index in this industry in 2010 was 1.25.
As it was mentioned earlier, the working capital ratio can be used to measure the companys financial health. A high ratio shows that the company has more abilities to discharge all its obligations. In this situation, both companies have normal values. However, the second one had better performance in comparison with the first company and with the average rate. On the other hand, if the ratio is higher than 3, it may be a sign that the company uses its assets inefficiently. That is why it is important to analyze all available data to make the final decision.
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The fourth index that the investor should analyze is the Earnings per Share. It is a financial index which is calculated as the ratio of net income to Shares Outstanding. (Goldie, 2011) This rate is used to evaluate the investment attractiveness of the company by its effectiveness.
Earnings per Share for the first company changed from $2 in 2008 to $2.5 in 2010.
Earnings per Share for the second company changed from $2.1 to $3 for the period of three years.
The average Earnings per Share index of this industry in 2010 was $2.75.
Thus, one can make a conclusion that second company uses its capital to generate incomes more efficiently and is a better option for the investor.
The fifth index investor should take into account when making a decision is the Price-to-earnings ratio. This ratio shows the amount of money investor should invest to receive one dollar of the companys income.
For the first company, Price-to-earnings ratio rose from 16 in 2008 to 20 in 2010.
For the second company, PE Ratio rose from 18.1 to 20.7 for the period of three years.
The average rate in 2010 was 20.
One can see that the second company had a higher PE Ratio. However, the growth of this index for the first company is more significant than for the second one. Considering that a higher P/E presupposes that the company could be expected to grow revenue more quickly compared to the companies with lower P/E, an investor can pay more money in the hope of future earnings. But a lower P/E may be a sign that the company is undervalued and has all chances to generate greater profits in the near future. In such situations the investor has to make an important decision: he can choose slow but stable growth or take a risk in the hope of possible sufficient profits.
It is important to understand that reliance on any single financial ratio or index may be dangerous. An experienced investor always gathers all available data and only after a thorough analysis makes his final choice. (Singh, 2011)
Having performed all calculations and studies, one can make an accurate and informed decision. Unequivocally, the second company is a better choice for the investor. This company showed a stable growth during the whole analyzed period. The Current Ratio of the second company is 1.4 which significantly decreases the risks of bankruptcy, as well as the P/E ratio. Thus, considering all the indexes calculated above, the second company is a reasonable choice for the investor.