Executive Summary
As the Chief Investment Officer of an investment firm, one of my duties is to review companies’ financial information and advice the management on whether or not to accept investment offers. The company that is being investigated is Mr. DIY Group (M) Bhd, which engages in low-cost retailing for Home Improvement.
Some of the parts it focuses on include hardware, household, electrical, furnishing, car accessories, stationery and sports, toys, gifts, computer and mobile accessories, and jewellery and cosmetics. The company is in the process of raising funds from the capital market through the issuance of new shares and offers for the sale of existing shares. The prospectus was issued on 6th October 2020. To ensure the success of the subscription of the shares, the owners and management intend to conduct a roadshow for all categories of investors as well as for the analyst.
The analysis has focused on various elements represented in the prospectus, including market capitalization, net profit percentage, gearing ratio, and price-to-earnings ratio. One of the findings is that Mr. DIY Group (M) Bhd’s shares are valued at a price-to-earnings ratio of 31.6 times. There is no particular number that shows how expensive a stock is. However, stocks with a price-to-earnings ratio of below 15 are regarded as cheap, whereas those above 18 are seen as expensive. Using this same logic, it is safe to state that the firm’s stocks are expensive. A high figure means that the stock’s price is high relative to earnings as well as probably overvalued. Apart from that, it has been determined that Mr. DIY Group (M) Bhd is average in terms of net profit percentage.
The net profit percentage is the ratio of after-tax profits to net sales. It reveals the remaining profit after all costs of production, administration, and financing have been deducted from sales, and income taxes recognized. A good margin will vary considerably by industry, but as a general rule of thumb, a 10% net profit margin is considered average, a 20% margin is considered high, and a 5% margin is low. Mr. DIY posted a net profit of RM317.57 million, a 14% year-on-year increase from RM308.33 million.
The company in discussion seems to be a mid-cap since its market capitalization is at about $2.1. Mid-cap companies have a market capitalization of between $2 billion and $10 billion. Such firms are established and operate in a sector anticipated to experience rapid growth. They carry an inherently higher danger than large-cap since they are not as established but are attractive for their growth potential. The purpose of this paper is to review the prospectus of Mr. DIY Group (M) Bhd, recommend an investment decision and give justifications.
Background
The Mr. DIY Group (M) Bhd is a company involved in home improvement, which intends to raise funds through selling shares. Being the Chief Investment Officer of an international investment firm, it is my duty to analyse the prospectus of the company and advise on whether or not to buy the shares. With regard to investing, there is no shortage of models on what makes the markets tick or what a specific market move means (Moloi & Marwala, 2020).
There are various firms, businesses, or organisations that raise finances, including debt capital, equity capital, and retained earnings (Moloi & Marwala, 2020). In the case of the company in discussion, the management has chosen equity capital, which is from external investors.
Investors should understand that the two greatest factions on Wall Street are split along the theoretical lines between efficient market theory’s supporters and those who trust the market can be defeated. Even though this is a basic split, many other theories try to explain as well as affect the market, and the actions of investors in the markets (Spulbar & Minea, 2020). The efficient markets hypothesis is among the theories in investment that remain a topic for discussion.
The EMH dictates that the market price for shares integrates all the known data concerning that stock (Choudhary & Ahuja, 2021). This suggests that the stock is correctly valued until a future occurrence changes that valuation (Choudhary & Ahuja, 2021). Since the future is unpredictable, adhering to the theory is better than owning various stocks and profiting from the general market rise. Those who oppose the theory point to Warren Buffer and other investors who consistently beat the market by discovering irrational prices within the overall market.
The second theory of investing is the fifty-percent principle which forecasts that before continuing an observed pattern will undergo a price correction of one-half to two-thirds of the change in price. This means that in the event a stock has been on an upward trend and gained twenty percent, it will drop by ten percent before rising again (Fauziah & Panggabean, 2019).
In most instances, the rule is applied to short-term trends on which technical analysts and traders purchase and sell (Fauziah & Panggabean, 2019). The correction is thought to be a natural part of the trends as it often results from skittish investors taking their profits early to avoid getting caught in a true reversal of the trend later. In case the correction exceeds fifty percent of the price change, it is regarded as an indicator that the trend has failed and reversal is premature.
The third theory is greater fool theory which proposes that one profits from investing as long as there is a greater fool than oneself to purchase the investment at a greater price. This suggests that they could make money from an overpriced stock as long as someone else will pay more to get it from them. Eventually, you run out of fools as the market for any investment overheats (Hashim et al., 2018). Investing based on the greater fool theory means ignoring valuations, earnings reports, and every other data. Ignoring data is as risky as paying too much attention to it, and thus, individuals supporting the theory could be left at a disadvantage.
The fourth theory of investment is the odd lot theory which utilises the sale of odd lots. The odd lots refer to small blocks of sticks held by individual investors. They serve as a sign of when to purchase into a stock. An investor following the theory buys when small investors sell. The key assumption is that those small investors are often wrong. The odd lot theory is a contrarian strategy according to a simple form of technical analysis (Spulbar & Minea, 2020).
The success of an investor heavily relies on whether he chehappencks the fundamentals of companies that the theory points toward. Small investors cannot be right or wrong every time, and therefore, it is essential to distinguish odd lot sales that are happening from a low-risk tolerance from odd lot sales that are due to greater issues. An individual investor is more mobile than the big funds and hence can respond to severe news faster. This means that odd lot sales can be an indicator to a wider sell-off in a failing stock rather than a mistake on the part of a small-time investor.
The fifth theory of investment is the prospect theory which is as well called loss-aversion theory. It dictates that an individual’s perception of gain and loss is skewed. The meaning of this is that there is greater fear of losing among people than their motivation toward gaining (Board et al., 2018).
In case individuals are given a choice of various prospects, they will select the one that they believe has less chance of ending in a loss instead of the one that provides the most gains. If a person is offered investment chances, one returns five percent every year and another returns twelve percent, loses two percent and returns six percent in the same year, the first one will be chosen. It is likely that they will put an irrational amount of importance on the loss whereas ignoring the gain which is of greater magnitude.
In the above-mentioned example, both options produce the net total return after a period of three years. Prospect theory is essential for fiscal professionals as well as investors. Even though the risk or reward trade-off offers a clear picture of the amount someone must take to accomplish the desired returns, the theory shows that few people understand emotionally what they realise intellectually. For a financial professional, the challenge is in suiting a portfolio to the client’s risk profile instead of reward desires (Board et al., 2018). For the investor, the struggle is to overcome the disappointing forecasts of prospect theory and become brave to get the returns one expects.
The sixth theory of investment is rational expectations theory which dictates that the players in the economy will act in a manner that aligns with what is logically anticipated in the future. An individual will invest based on what they rationally believe will occur in the future. By doing that, they create a self-fulfilling prediction that aids in causing the future event. Even though this concept has become vital to economics, its usage is doubtful (Spulbar & Minea, 2020).
For instance, an investor thinks a stock will rise, and by buying it, this act causes the stock to rise. This same transaction can be framed outside of rational expectations theory. An investor notices that a stock is undervalued, purchases it, and watches as other investors notice the same thing, thus raising the price to its proper market value. This highlights the main issue with rational expectations theory as it can be modified to explain everything but does not tell anything.
Method of Analysis, Findings and Comments
Price-to-Earnings Ratio
Before choosing to purchase shares of a company, it is proper for investors to review the prospectus. One of the findings is that Mr. DIY Group (M) Bhd’s shares are valued at a price-to-earnings ratio of 31.6 times. There is no particular number that shows how expensive a stock is. However, stocks with a price-to-earnings ratios of below 15 are regarded as cheap whereas those above 18 are seen as expensive (Amiputra et al., 2021). Using this same logic, it is safe to state that the firm’s stocks are expensive. A high figure means that the stock’s price is high relative to earnings as well as probably overvalued.
Conversely, a low price-to-earnings ratio would have meant that the current stock is low relative to earnings. The P/E ratio is used for valuing companies and measures their current share price relative to the earnings per share. It is used by analysts and investors to establish the relative value of a firm’s shares in an apples-to-apples comparison (Amiputra et al., 2021). It can as well be used to compare and contrast an organisation against its historical record or compare aggregate markets against each other over a period.
Generally, a high price-to-earnings implies that investors are anticipating higher earnings growth in the future as compared to firms with a lower P/E. A low price-to-earnings can either indicate that an organisation may currently be undervalued or is doing significantly well relative to its previous trends. When a company has no earnings or posts losses, the price-to-earnings ratio in both cases is expressed as not applicable (Amiputra et al., 2021).
Though it is possible to compute a negative P/E, this is not the usual convention. The P/E ratio can be seen as a way of standardising the value of $1 of earnings throughout the stock market. In theory, by taking the median of P/E ratios over time, someone could formulate something of a standardised P/E ratio which can be viewed as a benchmark and utilised to show whether a stock is worth purchasing or not.
The P/E ratio in essence reveals the dollar amount investors can anticipate to invest in a firm in order for them to receive a $1 of the company’s earnings. This is the reason why the P/E is at times called the price multiple since it indicates how much an investor is willing to pay per dollar of earnings (Sulistiawan & Rudiawarni, 2019). In the event a company was currently trading at a price-to-earnings multiple of 20x, the interpretation is that investors are willing to pay $20 for $1 of current earnings. The ratio assists them to determine the market value of a stock.
Market Capitalization
Another finding after reviewing the prospectus is that Mr. DIY is valued at a market capitalization of RM10 billion, which is higher than several public-listed banks on Bursa Malaysia, including AmBank Bhd. Market capitalization refers to the total value of a publicly traded firm’s outstanding common shares owned by stockholders (Kumar & Kumara, 2021).
An investor utilises the figure to establish a company’s size rather than sales or total assets figures (Cerkovskis et al., 2022). In an acquisition, the market cap is utilised to determine whether or not a takeover candidate represents a good value to the acquirer. Comprehending what a firm is worth is an essential task and usually difficult to quickly and correctly ascertain.
Market capitalization is an easy technique of approximating a company’s value by extrapolating what the market thinks it is worth for publicly traded firms. In such a case, simply multiply the share price by the number of available shares (Cerkovskis et al., 2022).
After companies go public and start trading on the exchange, their price is determined by supply and demand for the shares in the market. In case there is a high demand for the shares as a result of favourable factors, the price would rise. In the event the company’s future growth potential does not look good, stock sellers could cause a decline in the price. The market cap thus becomes a real-time approximate of the company’s value.
Market Cap and Investment
Given the simplicity as well as effectiveness for risk evaluation, the market cap can be a useful metric to determine which stocks are interesting and the way to diversify portfolio with companies of various sizes. Large-cap companies usually have a market capitalization of $10 billion or above (Cerkovskis et al., 2022). Such firms have often been operating for a long time and they are major players in well-established sectors. Investing in them does not necessarily result in great returns in a short time but over the long haul, they reward investors with a consistent increase in share value as well as dividend payments.
Mid-cap companies have a market capitalization of between $2 billion and $10 billion. The company in discussion seems to be a mid-cap since its market capitalization is at about $2.1 billion. Such firms are established and operate in a sector anticipated to experience rapid growth. They carry an inherently higher danger than large-cap since they are not as established but are attractive for their growth potential (Kumar & Kumara, 2021).
Apart from large-cap and mid-cap companies, there are those that are described as small-cap. These are ones that have a market capitalization of between $300 million and $2 billion. They are mostly younger and could serve niche markets and novel industries (Kuvshinov & Zimmermann, 2022). Analysts regard them as higher-risk investment as a result of their age, their size, and markets they serve. Additionally, they are more sensitive to economic slowdowns and thus, the prices are more volatile and less liquid than more mature and larger firms.
Gearing Ratio
Another finding after reviewing the Mr. DIY Group (M) Bhd is that it has a gearing ratio of 1.34 times. The figure results from the retail group’s total borrowings standing at RM608.85 million as of June 30. It is stated that upon listing, the gearing will decline to 0.22 with borrowings of RM153.85 million (Zhang et al., 2019). A gearing ratio is a financial ratio that compares some form of owner’s equity to debt or funds borrowed by the firm. Gearing is a measurement of the entity’s fiscal leverage, which illustrates the extent to which a company’s activities are financed by shareholders’ funds against creditors’ funds.
An optimal ratio is mainly determined by the company relative to others within the same sector. Nevertheless, there are various guidelines for good and bad ratios. For instance, one that is higher than 50% or 0.5 is usually considered highly geared or levered. Due to that, the firm would be at a greater financial risk since during times of lower profits and higher interest rates, the firm would be more susceptible to loan default and bankruptcy. Mr. DIY Group (M) Bhd seems to fall in the category of a high gearing ratio (Zhang et al., 2019). A gearing ratio that is lower than 25% or 0.25 is regarded as normal for well-established firms.
The gearing ratio indicates the financial risk related to the company. In case a firm has too much debt, it can fall into fiscal distress. A high ratio implies a high proportion of debt to equity whereas a low ratio suggests the opposite. Capital that comes from creditors is riskier than the money that is from the owners since the former still have to be paid irrespective of whether or not the business generates income.
Both investors and lenders scrutinise gearing ratios as they reflect the amount of risk involved with the organisation (Zhang et al., 2019). One that has too much debt is highly likely at risk of defaulting or going bankrupt particularly if the loan has variable interest rates and there is a sudden jump in rates. Nevertheless, debt financing is not necessarily a bad indicator (Amiputra et al., 2021). If invested well, it can aid in expanding the company operations, add new products or services, and boost profits.
Conversely, a firm that never borrows might miss an opportunity to grow by failing to capitalise on a cheap form of financing, in the event the interest rates are low. It is essential to compare and contrast a company’s gearing ratio to others in the same sector (Zhang et al., 2019). Those that are capital intensive or have plenty of fixed assets such as industrials, are likely to have more debt versus those with less fixed assets. For instance, utilities would usually have a high gearing ratio but might be regarded as acceptable since it is a regulated sector.
Net Profit Percentage
Another finding about the company is that for the financial year ended Dec 31, 2019 (FY19), Mr. DIY posted a net profit of RM317.57 million, a 14% year-on-year increase from RM308.33 million. The net profit percentage is the ratio of after-tax profits to net sales. It reveals the remaining profit after all costs of production, administration, and financing have been deducted from sales, and income taxes recognized (Husain & Sunardi, 2020).
A good margin will vary considerably by industry, but as a general rule of thumb, a 10% net profit margin is considered average, a 20% margin is considered high, and a 5% margin is low. This means that Mr. DIY Group (M) Bhd is average in terms of net profit percentage.
When one looks only at revenue, they are not focusing on the big picture costs of running a business or its profitability. Similar to how you can’t just look at your individual income to assess your personal financial wellbeing. It is vital to look at all expenses and get a clear idea of what money is coming in and what is going out. Net income can give you an overall idea of the health of a business, because it shows profits after all deductions are taken out.
If there are major differences between gross and net income, it can be a warning sign. It could mean that expenses are too high, income is too low, or both. It is important to note that net income is just one metric to look at and it can vary from business to business (Husain & Sunardi, 2020). Net income numbers can change drastically from one business to another based on how they choose to fund their companies and assets. Net income also does not include capital expenditures.
A given business could have a pretty high net income relative to their earnings but in reality be haemorrhaging cash. Investors can review financial statements with net income to determine the financial health of a company with which they are investing. Net income is also relevant to investors, as businesses use net income to calculate their earnings per share. Earnings per share is the net profit divided by the number of outstanding shares. If the company has issued any preferred stock, they will subtract those preferred dividends as well. EPS should increase yearly to signal that a company is profitable; the total value of EPS at any given time is less important than regular growth.
Recommendations and Justifications
As the Chief Investment Officer, I would recommend the management and the board to reject the investment offer by Mr. DIY Group (M) Bhd. From the findings and analysis, it is clear that the firm’s stocks are overvalued according to the price-to-earnings ratio (Xu et al., 2018). Apart from that, the company is a mid-cap since its market capitalization is at about $2.1 billion meaning it is associated with a high risk. Additionally, it falls in the category of a high gearing ratio. Lastly, it is average in terms of net profit percentage.
It has been mentioned above that a low price-to-earnings ratio would have meant that the current stock is low relative to earnings. The P/E ratio is used for valuing companies and measures their current share price relative to the earnings per share. It is used by analysts and investors to establish the relative value of a firm’s shares in an apples-to-apples comparison (Xu et al., 2018). It can as well be used to compare and contrast an organisation against its historical record or compare aggregate markets against each other over a period.
Generally, a high price-to-earnings implies that investors are anticipating higher earnings growth in the future as compared to firms with a lower P/E. A low price-to-earnings can either indicate that an organisation may currently be undervalued or is doing significantly well relative to its previous trends. When a company has no earnings or posts losses, the price-to-earnings ratio in both cases is expressed as not applicable (Xu et al., 2018).
Though it is possible to compute a negative P/E, this is not the usual convention. The P/E ratio can be seen as a way of standardising the value of $1 of earnings throughout the stock market. In theory, by taking the median of P/E ratios over time, someone could formulate something of a standardised P/E ratio which can be viewed as a benchmark and utilised to show whether a stock is worth purchasing or not. Regarding market capitalization, large-cap companies usually have a market capitalization of $10 billion or more.
Such firms have often been operating for a long time and they are major players in well-established sectors. Investing in them does not necessarily result in great returns in a short time but over the long haul, they reward investors with a consistent increase in share value as well as dividend payments. Mid-cap companies have a market capitalization of between $2 billion and $10 billion (Warue et al., 2018). Such firms are established and operate in a sector anticipated to experience rapid growth. They carry an inherently higher danger than large-cap since they are not as established but are attractive for their growth potential.
Apart from large-cap and mid-cap companies, there are those that are described as small-cap. These are ones that have a market capitalization of between $300 million and $2 billion. They are mostly younger and could serve niche markets and novel industries. Analysts regard them as higher-risk investment as a result of their age, their size, and markets they serve (Warue et al., 2018).
Additionally, they are more sensitive to economic slowdowns and thus, the prices are more volatile and less liquid than more mature and larger firms. An investor utilises market capitalization to establish a company’s size rather than sales or total assets figures. In an acquisition, the market cap is utilised to determine whether or not a takeover candidate represents a good value to the acquirer. Comprehending what a firm is worth is an essential task and usually difficult to quickly and correctly ascertain.
With regard to gearing ratio, the information above shows that the metric is a financial ratio that compares some form of owner’s equity to debt or funds borrowed by the firm. Gearing is a measurement of the entity’s fiscal leverage, which illustrates the extent to which a company’s activities are financed by shareholders’ funds against creditors’ funds. An optimal ratio is mainly determined by the company relative to others within the same sector (Warue et al., 2018). Nevertheless, there are various guidelines for good and bad ratios. For instance, one that is higher than 50% or 0.5 is usually considered highly geared or levered.
Due to the above, the firm would be at a greater financial risk since during times of lower profits and higher interest rates, the firm would be more susceptible to loan default and bankruptcy. Mr. DIY Group (M) Bhd seems to fall in the category of a high gearing ratio. A gearing ratio that is lower than 25% or 0.25 is regarded as normal for well-established firms (Warue et al., 2018). The gearing ratio indicates the financial risk related to the company. In case a firm has too much debt, it can fall into fiscal distress.
A high ratio implies a high proportion of debt to equity whereas a low ratio suggests the opposite. Capital that comes from creditors is riskier than the money that is from the owners since the former still have to be paid irrespective of whether or not the business generates income. Both investors and lenders scrutinise gearing ratios as they reflect the amount of risk involved with the organisation (Warue et al., 2018). One that has too much debt is highly likely at risk of defaulting or going bankrupt particularly if the loan has variable interest rates and there is a sudden jump in rates.
Lastly, similar to how you cannot simply check at individual income to assess personal financial wellbeing, it is vital to consider every expense and get a clear idea of what remains. Net income can give you an overall idea of the health of a business, because it shows profits after all deductions are taken out.
If there are major differences between gross and net income, it can be a warning sign. It could mean that expenses are too high, income is too low, or both. It is important to note that net income is just one metric to look at and it can vary from business to business (Warue et al., 2018). Net income numbers can change drastically from one business to another based on how they choose to fund their companies and assets. Net income also does not include capital expenditures.
A given business could have a pretty high net income relative to their earnings but in reality be haemorrhaging cash. Investors can review financial statements with net income to determine the financial health of a company with which they are investing. Net income is also relevant to investors, as businesses use net income to calculate their earnings per share (Warue et al., 2018).
Earnings per share is the net profit divided by the number of outstanding shares. If the company has issued any preferred stock, they will subtract those preferred dividends as well. EPS should increase yearly to signal that a company is profitable; the total value of EPS at any given time is less important than regular growth.
References
Amyputra, S., Kurniasari, F., & Suyono, K. A. (2021). Effect of earnings per share (EPS), price to earnings ratio (PER), market to book ratio (MBR), debt to equity ratio (DER), interest rate and market value added (MVA) on stock prices at commercial banks registered in 2016-2019 Indonesia Stock Exchange. In Conference Series (Vol. 3, No. 2, pp. 200-216). Web.
Board, J., Delargy, P. R., & Tonks, I. (2018). R & D Intensity and Firm Finance: A US–UK Comparison. In New Technologies and the Firm (pp. 321-342). Routledge. Web.
Cerkovskis, E., Gajdosikova, D., & Ciurleo, C. F. (2022). Capital structure theories: Review of literature. Ekonomicko-Manazerske Spektrum, 16(1), 12-24. Web.
Choudhary, M. S., & Ahuja, H. (2021). Inclusion of psychological factors in financial theories: transformation from traditional finance to behavioural finance. NVEO-Natural Volatiles & Essential Oils Journal| NVEO, 14331-14338. Web.
Fauziah, S. N., & Panggabean, R. R. (2019). Factors affecting the integrity of manufacturing company financial statements in Indonesian Stock Exchange and Malaysian Stock Exchange. Fauziah, SN and Panggabean, RR (2019). Factors affecting the integrity of manufacturing company financial statements in Indonesian Stock Exchange and Malaysian Stock Exchange. International Journal of Recent Technology and Engineering, 8(4), 2252-2259. Web.
Hashim, S. L. M., Ramlan, H., & Rosly, M. A. M. (2018). The impact of macroeconomic variables towards the Malaysian stock market. Global Business and Management Research, 10(3), 314-315. Web.
Husain, T., & Sunardi, N. (2020). Firm’s value prediction based on profitability ratios and dividend policy. Finance & Economics Review, 2(2), 13-26. Web.
Kumar, M. P., & Kumara, N. M. (2021). Market capitalization: Pre and post COVID-19 analysis. Materials Today: Proceedings, 37, 2553-2557. Web.
Kuvshinov, D., & Zimmermann, K. (2022). The big bang: Stock market capitalization in the long run. Journal of Financial Economics, 145(2), 527-552. Web.
Moloi, T., & Marwala, T. (2020). Introduction to artificial intelligence in economics and finance theories. In Artificial Intelligence in Economics and Finance Theories (pp. 1-12). Springer, Cham. Web.
Spulbar, C., & Minea, E. L. (2020). Critical conceptual analysis on modern finance theories. Ovidius University Annals, Economic Sciences Series, 20(2), 1081-1086. Web.
Sulistiawan, D., & Rudiawarni, F. A. (2019). Is price to earnings ratio (still) useful for trading strategy? In Proceedings of the 10th Business & Management Conference, Paris (pp. 109-116). International Institute of Social and Economic Sciences. Web.
Warue, B. N., Charles, B. J. M., & Mwania, P. M. (2018). Theories in finance discipline: A critique of literature review. The University Journal, 1(2), 113-146. Web.
Xu, X., Chen, X., Jia, F., Brown, S., Gong, Y., & Xu, Y. (2018). Supply chain finance: A systematic literature review and bibliometric analysis. International Journal of Production Economics, 204, 160-173. Web.
Zhang, D., Zhang, Z., & Managi, S. (2019). A bibliometric analysis on green finance: Current status, development, and future directions. Finance Research Letters, 29, 425-430. Web.