There are many approaches one could use to analyze the health, stability as well as financial performance of a business entity. One such approach involves a thorough review of the financial statements of the concerned entity. Regarded the leading personal computers manufacturer in the world, Hewlett-Packard - HP amongst other things concerns itself with the manufacture as well as development of both computer hardware and software. In this text, a thorough financial review of HP will be conducted in an attempt to determine the viability of the company's stock as an investment option.
Hewlett-Packard: Background Information
As I have already pointed out in the introductory section, HP is regarded one of the world's largest manufacturers of personal computers. Together with its subsidiaries, HP provides "products, technologies, software, applications and services to individual customers, businesses enterprises, including customers in the government, health, and education sectors" (Mergent Online, 2013). To serve its large customer base, the company makes use of a number of segments which according to Mergent Online (2013) include "the Personal Systems; Services; Printing; Services; Enterprise Servers, Storage and Networking; Software; HP Financial Services; and Corporate Investments." Over time, the company has maintained a leadership position in the marketplace by amongst other things embracing innovation and superior customer service. Some of its key competitors include but they are not limited to the International Business Machines Corporation -- IBM, Accenture Plc., and Dell Inc.
Key executives of HP include but they are not limited to Ms. Margaret C. Whitman, and Ms. Catherine A. Lesjak. They are both the CEO and CFO respectively. Founded 74 years ago, HP currently has its headquarters in Palo Alto, California. The company operates in the Diversified Computer Systems industry.
Financial Statement Review
In this section, I will make use of a number of financial ratios to determine not only the financial stability but also the projected future performance of HP. Further, in addition to using the DuPont system to compute the return on equity (ROE), I will also compute the value of the economic value added. It is the information derived from this section that will act as the basis for my recommendation on whether or not HP's stock is worth purchasing. It should also be noted that in seeking to analyze the performance of HP using the aforementioned ratios, I will from time to time relate HP's performance to that of IBM, one of its key competitors in the Diversified Computer Systems industry. The relevance of such a comparison cannot be overstated when it comes to the determination of how HP is fairing on in relation to its competitors in the industry.
Table 1: Liquidity Ratios
The liquidity ratios computed in the table above will help us determine HP's ability to settle its obligations (short-term) should they suddenly become due. To begin with, we have the current ratio which according to Stittle and Wearing (2008, p.84) is "one of the most significant indicators of liquidity." Throughout the two years under consideration, HP's current ratio has been above 1. Essentially, a current ratio of more than 1 means that the current assets of an entity are actually more than its short-term liabilities. The reverse is true. Looking at HP's current ratio, it is clear that the company would not face any significant challenges were its short-term obligations to suddenly become due. It also means that HP would not face any significant challenges in securing short-term credit from creditors. Understandably, short-term creditors require that a business have a high current ratio. This is their way of reducing their risk. It should however be noted that an excessively high current ratio could be an indicator that the firm is not making use of its assets in an efficient way. In HP's case, its current ratio is neither excessive nor too low. This is more so the case taking into consideration IBM's current ratio which also seems to fall within the same range as that of HP. In that case, the solvency of HP is not under any threat.
It should however be noted that during the computation of the current ratio, inventory is included as part of current assets. The problem with the inclusion of inventory in this case is that some components of inventory may prove hard to liquidate at short notice (Smith, 2010). Further, some of the said components may have liquidation values that are largely uncertain. For this reason, the quick ratio is often considered a more accurate indicator of the short-term liquidity of an entity. This is particularly the case given that it largely takes into consideration only those assets regarded most liquid. Based on the quick ratio values I have computed in table 1 above, it is clear that the current ratio had overestimated HP's financial ability to settle its obligations in the short-term. Unlike the quick ratios of IBM during the two years under consideration, the quick ratios of HP fall below 1. In that regard therefore, should HP find it difficult to turn its inventory into cash, it could find it challenging to settle its obligations (short-term) were they to suddenly become due.
Table 2: Financial Leverage Ratios
Unlike the liquidity ratios I have discussed above, financial leverage ratios seek to chart the long-term solvency of a business entity. The above debt ratios will help us determine the portion of assets HP has funded using debt. With a debt ratio of 0.8 and 0.7 for the years 2012 and 2011 respectively, it is clear that HP has not relied on significant amounts of debt to fund its assets. For instance, taking into consideration the most recent financial period, i.e. 2012, HP's debt ratio of 0.8 indicates that the company's assets exceed its debts. The company does not therefore face any risk in terms of debt-load.
The debt-to-equity ratio on the other hand is used to measure the degree to which a business makes use of both debt and equity to fund their assets (Arora, 2009). For this reason, a high debt-to-equity ratio could be an indicator that the company has been utilizing a lot of debt to fund its growth. Given that this particular ratio is largely industry specific, it would be prudent to compare the debt-to-equity ratio of HP with that of IBM. During the two years under consideration, HP has consistently had a lower debt-to-equity ratio than IBM. Taking IBM as a representative of other HP competitors in the Diversified Computer Systems industry, one could conclude that although it appears aggressive in the utilization of debt to fund its growth, HP is well within industry standards. A debt-to-equity ratio of two or three is also common for large public companies. It should however be noted that if HP continues being aggressive in its utilization of debt to fund or finance growth, the additional interest expense could trigger volatility in earnings at some point. On the other hand however, if the company's management uses the debt efficiently, it could significantly increase earnings. Indeed, the company could end up generating more earnings than it could have possibly generated without making use of debt.
Table 3: Asset Management Ratios
Receivables turnover ratio essentially measures how effective a business is in the collection of monies owed to it. In that regard therefore, a high receivables turnover ratio is always desirable to a lower one as it indicates that an entity is collecting its credit sales at an efficient rate. In comparison to IBM, HP appears more efficient in the collection of its credit sales. It is also important to note that within the two years under consideration, HP has shown an increase in the receivables turnover ratio -- an indication that the company could have further enhanced its credit collection policies.
When it comes to the inventory turnover ratio, Ramagopal (2008) points out that this particular ratio is critical in the determination of stock velocity. HP's lower inventory turnover ratio in comparison to that of IBM should be taken to be an indicator that HP is experiencing poor sales.
Table 4: Profitability Ratios
Return on Assets
Gross Profit Margin
Profitability ratios are some of the most commonly used ratios in the determination of how successful a firm is in profit generation. To begin with, we have return on assets - a ratio which according to Tracy (2008, p.289) is a "capital utilization test." In comparison to IBM, HP has not been efficient in the utilization of its assets to generate profits. This is particularly the case given that it has had a significantly low ROA…