THE “BIG THREE” OF THE AUTO INDUSTRY: ANALYZING AND PREDICTING PERFORMANCE 2005 Mountain Plains...
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THE “BIG THREE” OF THE AUTO INDUSTRY: ANALYZING AND PREDICTING PERFORMANCE 2005 Mountain Plains Management Conference Session 3: Pedagogy October 14, 2005; 1:15 p.m. − 3:00 p.m.; Cedar City, Utah Professor Robert M. Hull (Corresponding Author) Nicholas Avey, MBA Student (Presenter) School of Business, Washburn University, 1700 SW College Avenue, Topeka, KS 66621 Phone : + 1-670‑231‑1010; FAX: + 785‑670‑1063 E‑mail addresses: [email protected](R. Hull) & [email protected](N. Avey) Published in Proceedings: Mountain Plains Management Conference, October 2005 Published in Working Paper Series: Washburn University Working Paper Series, October 2005
THE “BIG THREE” OF THE AUTO INDUSTRY: ANALYZING AND PREDICTING PERFORMANCE 2005 Mountain Plains Management Conference Session 3: Pedagogy October 14,
THE BIG THREE OF THE AUTO INDUSTRY: ANALYZING AND PREDICTING
PERFORMANCE 2005 Mountain Plains Management Conference Session 3:
Pedagogy October 14, 2005; 1:15 p.m. 3:00 p.m.; Cedar City, Utah
Professor Robert M. Hull (Corresponding Author) Nicholas Avey, MBA
Student (Presenter) School of Business, Washburn University, 1700
SW College Avenue, Topeka, KS 66621 Phone: + 1-670 231 1010; FAX: +
785 670 1063 E mail addresses: [email protected] (R. Hull)
& [email protected] (N. Avey) Published in
Proceedings: Mountain Plains Management Conference, October 2005
Published in Working Paper Series: Washburn University Working
Paper Series, October 2005
Slide 3
We analyze the financial performance of three leading
automobile manufacturers (referred to as the Big Three). The
analysis incorporates the use of leading finance web sites with
traditional and newer financial ratio methods. The end purpose of
the analysis is to estimate future profitability of the Big Three.
From a pedagogical standpoint, the paper offers instructors a skill
that will enable them to impart knowledge of an analytical approach
for investing. This approach can be used by business students and
practitioners alike when analyzing a firms performance. As a
byproduct, this paper includes a class exercise that goes beyond
just the Xs and Os of financial ratio analysis by requiring
students to integrate their financial ratio findings with online
sources offering economic and industrial analysis and analysts
predictions. Abstract JEL Classification:I22 (Financial Education);
G10; G30 Key Words:Financial Analysis, Financial Ratio Analysis
DuPont Model, ROE, Big Three
Slide 4
Purpose The purpose of this paper is to learn and apply the
information found in (1) leading finance websites and (2) the
methods of financial analysis. We do this in the context of
analyzing firm performance for the Big Three of the automotive
industry: Ford Motor Co., General Motors and DaimlerChrysler.
Slide 5
Choosing among the Big Three: Which will be the Best?
Slide 6
Major Focus A major focus of this papers analysis of Big Three
performance involves financial ratio analysis. This focus is
justified because investors make decisions based on what financial
ratios indicate. All parties concerned with financial ratio
analysis need to understand how accounting- base ratios can be used
to assess relevant revenue and costs factors. A key tool used in
this papers financial ratio analysis is the DuPont Model. By using
this model, we are able to focus on how profitability, asset and
leverage ratios impact a firms return on equity (ROE) separately
and interactively. A healthy ROE is what stockholders desire. Even
from a book standpoint, if ROE is not healthy for long periods of
time, then a shareholders investment is underperforming.
Slide 7
Within our paper is a pedagogical application designed to help
business students learn a professional tool of analysis by learning
how ROE and other valuation metrics are influenced by various
categories of financial ratios. This papers application provides a
skill that teachers can use to impart knowledge (National Board for
Professional Teaching Standards, 1998). The skill is imparted in
the context of analyzing a firms performance through economic,
industrial and financial ratio analyses and the use of finance
websites. The end result is that educators can practice their
profession at a higher level consistent with excellence in
university teaching (Johnson, 1991; McKeachie, 1994).
Slide 8
Teaching outcomes from the application include: (1) students
will delve deeper into financial ratio analysis by examining and
comparing accounting variables drawn from financial statements; (2)
students will apply the DuPont Model and other valuation metrics in
conjunction with economic and industrial indicators to make
predictions about investment possibilities; and, (3) students will
become familiar with prominent financial websites including those
that feature analysts predictions. TEACHING OUTCOMES
Slide 9
Organization of Paper Section I gives an introduction. Section
II provides an analysis of the economic and industrial factors
influencing investment in the automotive sector. Section III
presents financial ratio methodologies and metrics that apply
financial data for Big Three firms from 20002004. In particular,
this section illustrates how the ROE is impacted through changes in
variables encompassing profit management, asset management and debt
management. Section IV offers a class exercise with questions and
solutions. Section V provides summary statements.
Slide 10
Leading Indicators Two leading indicators to help us assess the
growth of the economy are the Consumer Confidence Index (CCI) and
Gross Domestic Product (GDP). The automotive industry is one of the
last industries to follow the growth of the economy as consumers
will wait until their incomes have increased from the growth. Two
leading indicators used to analyze the automotive industry are the
Durable Orders Index (DOI) and Automotive Sales Index (ASI). The
overall conclusion from looking at four leading economic and
industrial indicators is that there is a positive outlook for the
automotive industry. Thus, investors can be optimistic about
investing in the automotive sector.
Slide 11
FINANCIAL RATIO ANALYSIS Financial ratio analysis consists of
various methodologies. In our paper, we discuss (1) long- standing
traditional methods as epitomized by the DuPont Model and (2)
relatively more recent valuation methods as represented by economic
value added (EVA), return on invested capital and free cash flow.
Blumenthal (1998) and Firer (1999) indicates that traditional
approaches typified by the DuPont Model will continue to dominate
financial analysis for some time including the newer metrics like
EVA. Financial ratios must be interpreted properly and cautiously
because of inherent accounting-based limitations and unethical
manipulation.
Slide 12
A Description of the DuPont Model Below we define the key
DuPont ratios in Exhibits 14 and show their influence on ROE.
Margin Management (Data from Income Statement): Net Profit Margin
(NPM) = Net Income / Sales = NI / S (1) Asset Management (Data from
Balance Sheet): Asset Turnover (AT) = Sales / Total Assets = S / TA
(2) Debt Management (Data from Balance Sheet): Financial Leverage
(FL) = Total Assets / Stockholders Equity = TA / E (3) where
Financial Leverage can also be referred to as the Equity Multiplier
(EM). When we multiply out the above three equations, we have: ROE
= NPM * AT * FL = (NI / S)*(S/TA)*(TA/E). Canceling out from the
denominators and numerators for S and TA, we get: ROE = NPM / E.
(4)
Slide 13
Exhibit 5: Trend Analysis for Recent Valuation Metrics
including EVA EExhibit 5 supplies trend analysis for recent
valuation metrics. Below we define the relevant variables used in
the metrics deployed. NOWC (Net Operating Working Capital) is Cash
& Equivalents + Accounts Receivables + Inventories Accounts
Payables Accrued Expenses. OLTA (Operating Long Term Assets) is Net
Property, Plant & Equipment. TOC (Total Operating Capital or
Invested Capital) is NOWC + OLTA. NOPAT (Net Operating Profit after
Tax) is Operating Income (or EBIT) times (1T) where T is the
corporate tax rate estimated as Income Taxes divided by Pre-Tax
Income. ROIC (Return on Invested Capital) is NOPAT divided by the
prior years TOC. EVA (Economic Value Added) is NOPAT minus the
quantity consisting of the WACC times the prior years TOC. FCF
(Free Cash Flow) is NOPAT minus the quantity consisting of this
years TOC minus the prior years TOC.
Slide 14
Inspecting Analysts Assessment Internet sites provide details
to inspect analysts assessment and can be used in conjunction with
financial ratio analysis to make predictions about investment
possibilities. Sites include: http://finance.yahoo.com
http://www.hoovers.com/free
http://moneycentral.msn.com/home.asp
Slide 15
Class Exercise: Assessing the Big Three Having presented
information on the state of the economy and auto industry in
Section II and financial ratio analysis in Section III, we
incorporate this information into a class exercise that includes
analysts assessment. Question 1 asks for an economic and industrial
analysis. In regards to Questions 24, we indicate that students are
provided with the DuPont Model flow chart. This flow chart is found
in Exhibit 1 and can also be sent electronically through contacting
us at [email protected]. We can also supply Excel spreadsheets
with data that computes results in Exhibits 25. We can give more
details on liquidity, profitability, coverage, and asset management
ratios, dividend data, and hand-outs with background information on
the Big Three firms. The exercise is best done in groups given
there are three firms to analyze. If done individually, the
instructor can assign one of the three firms per student.
Slide 16
Question 1. Type in key search words (e.g., leading indicators,
consumer confidence index, and so forth) to explore the internet
for information on the economy and the auto industry. One website
you may find is http://www.briefing.com. Click on the free Silver
Index to find links related to Consumer Confidence (CCI), Gross
Domestic Products (GDI), Durable Goods Orders (DGO), and Auto Sales
(AS). Below we summarize its four key indices and links. CCI:
http://www.briefing.com/Silver/Calendars/EconomicReleases/conf.htm
GDP
http://www.briefing.com/Silver/Calendars/EconomicReleases/gdp.htm
DGO
http://www.briefing.com/Silver/Calendars/EconomicReleases/durord.htm
ASI
http://www.briefing.com/Silver/Calendars/EconomicReleases/auto.htm
After you accustom yourself with Internet resource materials,
perform an economic and industrial analysis to help gain insight on
the investment opportunities in the automobile industry. In your
analysis, include your predictions for the auto industry.
Slide 17
Solution 1 Answers will change over time as economic and
industry conditions change. An answer found at the time of this
writing (August 2005) and which can be easily obtained from the
internet links given above. Investing in the auto industry should
give good payoffs in the future as the economy and industry outlook
appears good. Consumer confidence, gross domestic product and
durable order indices suggest that the economy is slowly gaining
ground. The auto industrial outlook looks good as buyer discounts
continued to lift summer 2005 auto sales. July 2005 sales exploded
as General Motors employee-discounts' were replicated by Ford and
DaimlerChrysler. This trend for the auto industry should continue
given that personal income is up 7% and interest rates remain
relatively low. Perhaps, most relevant, the automotive industry is
one of the last industries to follow economic growth. Thus, given
the expectations of an expansionary period in the economy, the
upward movement in auto sales is likely to continue. We predict
that the auto industry will make gains in the upcoming years making
the automotive sector a good investment choice. For additional
details see Section II on the Analysis of the Economy and
Industry.
Slide 18
QUESTION 2 Using the DuPont Model flow chart provided, perform
a DuPont ratio analysis of the Ford Motor Co. using financial
statement data from one of the many online sources that exist. For
example, you can go to one of the following (1)
http://finance.yahoo.com, (2) http://www.hoovers.com/free, or (3)
http://moneycentral.msn.com/home.asp. If you choose the latter, you
can do the following. Go to http://moneycentral.msn.com/home.asp;
type in F by Name or Symbol and hit the enter key; click on
Financial Results; click on Statements. You will get the financial
data needed to perform computations for the variables given in the
DuPont Model flow chart. Money Central will give financial data for
five years and that should be long enough to find a trend
representative of Fords ROE. In your DuPont financial ratio
analysis explain any changes in ROE over time in terms of margin
management, asset management, and debt management.
http://moneycentral.msn.com/home.asp
Slide 19
Solution 2 Exhibit 2 has numbers and conclusions based on
financial data for Ford Motor Company from 20002004. The bottom of
the Exhibit 2 gives conclusions on the roles of margin management,
asset management, and debt management in explaining Fords change in
ROE.
Slide 20
EXHIBIT 2: DuPont Analysis of Ford MotorCompany
Slide 21
Question 3. Repeat Question 2 using General Motors Corporation.
GM is now the ticker symbol if you follow the sequence of steps
given above for using the Money Central website. Solution 3. See
Exhibit 3 for numbers and conclusions based on financial data for
General Motors Corporation from 20002004. Question 3 Solution
3
Slide 22
EXHIBIT 3: DuPont Analysis of General Motors Corporation
Slide 23
Question 4. Repeat Question 2 using DaimlerChrysler
Corporation. DCX is now the ticker symbol if you follow the
sequence of steps given above for using the Money Central website.
Solution 4. Exhibit 4 has numbers and conclusions based on
financial data for Daimler-Chrysler Corporation from 20002004.
Question 4 Solution 4
Slide 24
EXHIBIT 4: DuPont Analysis of DaimlerChrysler Corporation
Slide 25
Make a prediction as to the investment opportunities for the
Big Three auto companies using your DuPont answers in the three
previous questions. Using the same data gathered to generate the
DuPont analysis, compute trends over time for the following
valuation metrics: Return on Invested Capital, Economic Value Added
and Free Cash Flow. You can assume a WACC of 10 percent for your
computations. What do these metrics tell you? Do further internet
research to find out what analysts are predicting. As an
illustration, if you choose the Money Central website, you can type
in the ticker symbol and then choose such categories as Stock
Rating, Earnings Estimates, Analyst Ratings and Insider Trading to
get information. Question 5
Slide 26
From the DuPont analysis found in Exhibits 24, we see that the
ROE for Ford has shown a positive five-year trend increasing from
11.65% to 15.74% for 20002004. The trend for General Motors is
discouraging falling from 15.81% to 7.59%. DaimlerChryslers trend
has been steady but low (3.24% to 3.33%). The DuPont analysis
suggests: Ford is #1; Daimler-Chrysler is #2; General Motors is #3.
In regards to valuation metrics and analysts predictions, the next
three overheads (from Exhibit 5) contain possible answers based on
research at Money Central. As seen there, the trend analysis for
valuation metrics give some mixed results. However, in Exhibit 5,
one will find a number of categories that suggests ranking similar
to the DuPont analysis. For example, StockScouter predicts the
following: Ford is #1; DaimlerChrysler is #2; General Motors is #3.
Solution 5
Slide 27
Exhibit 5. TREND ANALYSIS FOR VALUATION METRICS FOR FORD MOTOR
COMPANY Ford Motor Company20042003200220012000 NOPAT (Net Operating
Profit After Tax): Pre-Tax Income*(1T) 9,6228,1676,6792,33812,850
ROIC (Return On Invested Capital): NOPAT / TOC prior year
5.79%5.95%19.64%5.69%29.01% EVA (Economic Value Added): NOPAT
(WACC*TOC prior year ) 6,9925,5613,2781,7698,419 FCF (Free Cash
Flow)1,70120,69296,5959,40316,081 NOWC (Net Operating Working
Capital)129,508124,14599,3448843,562 Operating Long Term Assets
(Property, Plant & Equipment, net)
44,55141,99337,93533,12137,508 TOC (Total Operating Capital or
Invested Capital)174,059166,138137,27934,00541,070 RANKING: #1.
Valuation Metrics indicate mixed results but ROIC, EVA & FCF
are a bit better the past 5 years than GM & DC. From
http://moneycentral.msn.com/home.asp, we can gather information
including the following as of August 2005. There have been 84 more
major holders buying than selling. Institutional ownership is 41%.
Earnings have been higher than expected and predictions indicate
5.9% increase over the next 5 years. For the most part,
recommendations by analysts are hold but a few are strong buy.
StockScouters rating is 8 on a scale of 10. We predict that Ford
will exceed most other investments in the next 5 years (including
GM & DC).
Slide 28
Exhibit 5. TREND ANALYSIS FOR VALUATION METRICS FOR GENERAL
MOTORS CORP. General Motors Corporation2004200320022001 2000 NOPAT
(Net Operating Profit After Tax): Pre-Tax
Income*(1T)20,54710,4017,6394,37210,665 ROIC (Return On Invested
Capital): NOPAT / TOC prior year 8.22%5.41%4.27% 3.37%6.86% EVA
(Economic Value Added): NOPAT (WACC*TOC prior year
)4,4508,82910,2318,5984,882 FCF (Free Cash Flow)
8,74747,2725,96644,62036,432 NOWC (Net Operating Working Capital)
240,246211,761154,326143,78695,725 Operating Long Term Assets
(Property, Plant & Equipment,
net)39,02038,21137,97334,90833,977 TOC (Total Operating Capital or
Invested Capital) 279,266249,972192,299178,694129,702 RANKING #3.
Valuation Metrics indicate mixed results but ROIC, EVA & FCF
(like DC) appear to be slightly worse than Ford for the last five
years. From http://moneycentral.msn.com/home.asp, we can gather
information including the following as of August 2005. There have
been 144 more major holders buying than selling. Institutional
ownership is 80%. Earnings have been higher than expected and
predictions indicate 5.2% increase over the next five years. For
the most part, recommendations by analysts are for hold but a few
are for a strong sell. StockScouters rating is 4 on a scale of 10.
We predict that GM will perform at an average level for the next 5
years.
Slide 29
Exhibit 5. TREND ANALYSIS FOR VALUATION METRICS FOR DAIMLER
CHRYSLER CORP. DaimlerChrysler Corporation20042003200220012000
NOPAT (Net Operating Profit After Tax): Pre-Tax Income*(1T)
4,6111,2126,0181182,325 ROIC (Return On Invested Capital): NOPAT /
TOC prior year 2.51%0.75%4.13%0.07%N.A. EVA (Economic Value Added):
NOPAT (WACC*TOC prior year ) 13,77517,2718,54015,686N.A. FCF (Free
Cash Flow)4,12224,4888,99412,569N.A. NOWC (Net Operating Working
Capital)102,117111,82892,83676,80188,692 Operating Long Term Assets
(Property, Plant & Equipment, net)
82,24072,04067,75668,77969,339 TOC (Total Operating Capital or
Invested Capital)184,357183,868160,592145,580158,031 RANKING #2.
Valuation Metrics indicate mixed results but ROIC, EVA & FCF
(like GM) is a bit worse than Ford. From
http://moneycentral.msn.com/home.asp, we can gather information
including the following as of August 2005. There have been 5 more
major holders buying than selling. Institutional ownership is 22%.
Earnings have been higher than expected and predictions indicate
6.1% increase over the next 5 years. For the most part,
recommendations by analysts are for hold. No analysts recommend
selling. StockScouters rating is 6 on a scale of 10. We predict
that DC will moderately exceed most other investments in the next 5
years.
Slide 30
Final Ranking for Big Three #1 #2 #3
Slide 31
Concluding Statements This paper has presented an approach to
analyze financial performance. The approach has been incorporated
within a class exercise so that instructors can impart an analytic
skill. Summary results of the analysis found in Solutions 15 are
given below. First, the economic and industrial outlook indicates
the auto industry should provide investors with sound returns in
the future. Second, the three DuPont analyses suggest that Ford has
outperformed General Motors and DaimlerChrysler for the past five
years in terms of ROE. In particular, the best trend belongs to
Ford. Third, metric analyses reinforces the conclusions of DuPont
analysis and also indicate that the performance for DaimlerChrysler
has been both lower and less risky the last five years. Fourth,
while precise forecasts can be a matter of opinion and what aspects
are being emphasized, there is a consensus from internet sources
that the auto industry will do well and that Ford is the best bet
followed by DaimlerChrysler and then General Motors. Thus internet
sources confirm the results of financial ratio analysis. Fifth, if
expectations for General Motors are poorer, then market efficiency
suggests that its stock price already reflects this. Thus, if one
wants to be adventurous (and take on a little more risk), General
Motors may yield a chance for greater returns as its stock price
may react more positive as the markets become more buoyant.