Last updated: March 23, 2019
Topic: BusinessCompany
Sample donated:

In order to make a decision of whether or not to invest in the company Lamar Swimwear, Bob
Adkins must evaluate the current health and future potential of the business. This will be
performed by looking at a number of financial ratios drawn mainly from Lamar’s income
statements and balance sheets for the last few years. These will then be compared to averages for
the entire industry, to see how they stack up against the competition. The decision will be made
to invest only if Lamar is both internally stable with good growth potential, and a leader in its

Investment Decisions: Lamar Swimwear
When making investment decisions, one can look at a company’s financial data to judge both their health, and their competitiveness. A company’s health is their own stability, and is an insight as to whether or not they will continue to exist, and be profitable, in the future. This is generally judged by looking at their revenues, margins, and various ratios derived from their financial data. If these numbers show steady positive growth, the company is most likely healthy.

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No one should invest in a company that is not healthy, unless maybe they are buying it outright to try and turn it around, but even that would be very risky, and not the action we are evaluating for today. A company’s competitiveness is then judged by comparing their ratios and margins to direct competitors in their industry. This is usually done by looking at an average set of ratios for the entire industry and noting if the company in question is above or below average.

First thing in our evaluation we will look at the statements of cash flows for 2005 and 2006. Here we can find information such as net income, purchases, and any financing that was taken on. Right away we can see that Lamar’s net income has increased from almost $92K in 2005 to about $120K in 2006. This is good as it show that they took in 30% more net income than in the past year. Remember that steady positive growth is one of the key indicators of a company’s overall health. In the same time period that they saw this 30% growth in net income, Lamar only spent 8% more on operating activities, which is also a very good sign. With these numbers, Lamar took in $185K from operating activities in 2006, up 215% from 2005. That is very good.

We can see from their cash flows that Lamar’s yearly revenues are growing, however we
can also see Lamar growing in other respects. In 2005 Lamar purchased $115K of new facilities equipment. In 2006 they purchased more than five times that amount ($625K) of new facilities
and equipment. Generally, this is a good sign. Lamar definitely seems to have growing demand
for their product and therefore will need more equipment. However, it also poses a risk. Lamar
had to take on $430K of long-term financing to purchase their equipment. So, while they are are
seeing higher revenues, they have also taken on much more debt, although this was at least to
purchase capital facilities and equipment that will remain as assets in the company’s balance
sheet. As long as Lamar is able to use this new equipment to generate the revenue to cover the
fixed costs brought on by their new long term debt, then this will be just fine. However, this
massive new liability, equal to over five times their yearly net income, is a significant source of
risk when considering Lamar as an investment.

Something of concern within Lamar’s balance sheets for 2005 and 2006 is that they saw a
large increase in their accounts payable. In fact, they took on a greater increase in A/P than they
did in net income, which is not good. The almost 80% increase in accounts payable could, at first
look, mean that they are having trouble paying their bills. When you then see at how they spent
$625K on plant and equipment purchases, but only took on $430K in financing, is becomes clear
why they saw increased income with decreased operating expenses, yet still saw a negative cash
flow in 2006 when 2005’s had been positive. Instead of financing more of their equipment
purchase with a loan, they simply took on more A/P. This is probably not a good this because it
means they have much more short term liability. When we start to look at their liquidity ratios we
will see how much this contributes to their risk as an investment. A further question to ask about
this is why they did not finance all of their equipment and pay off their accounts payable. Could
they not get the financing? Seeing a company take on so much short and long-term debt in a single year is a red flag for investors.

The final result of analyzing Lamar’s 2005 and 2006 cash flows statements is that they are
most definitely growing. Their revenues have increased, and they have therefore taken on some
considerable long-term debt to finance new facilities and equipment. They have also sold $90K
of stock to finance purchases. The problem with Lamar’s growth is that at this point their debt is
growing much faster than their revenues. 2007 is going to be a very crucial year for them
because they now have a bunch of new equipment and with it a lot of debt to pay. This means
that the beginning of 2007 may be one of the riskiest times to invest in Lamar, maybe not quite
what Mr. Adkins wants. Now we will continue to analyzing their own internal ratios, going back
to 2004 this time, for a better perspective on the stability of their growth.

Since one of the first items looked at on the statements of cash flows was their net
income, let’s look at their actual profits margins first. Looking at the profitability ratios, we get a much clearer picture of Lamar’s actual growth over the past three years, which looks negative.

Their actual profit margin has fallen from 7.35% in 2004 to 6.38% in 2006, and was even lower in 2005.

Their gross profit margin fell in both 2005 and 2006, which is interesting since their net profit margin managed to rise in 2006 despite this. The fact that their gross profits have not seriously affected the net or operating profits probably means that they are at least optimizing internal processes and
spending, and attempting to maximize their internal rates of return. A very interesting third figure
in their profit margins are their operating profits, which, while decreasing in 2005, went back up
in 2006 to above the 2004 value. While this shows that the company is at least achieving an
increase in efficiency, or possibly just pricing their products better, it really has little meaning
when compared to their falling gross and net profit margins. Lamar’s return on assets and return
on equity have also fallen steadily over the past three years, and the return on assets is now not
much higher than that of a T-bill.

This all means that internally the company is not making much
money with their money, and that this situation is getting worse. In 2004 Lamar was a pretty
good looking company, but these “acceptable” number have now slipped in both of the last two
years. Looking at these ratios graphed, they look like almost flat lines. If this were a mature
company with already good looking number, that might be fine, but in Lamar’s case it means that
their profits are NOT growing, and if anything are losing ground. So while Lamar reports 25%
growth for 2005 and 2006, which by itself is not impressive for a new company, their profits are
still falling despite the growth.

Next we’ll examine how well, and efficiently, Lamar is using their assets. The accounts receivable turnover times per year has fallen from 7.06 in 2004 to 5.21 in 2006.This combined with their very high for merchandising companies in general, and every growing, average collection period (just shy of 70 days to collect an accounts receivable) could point to a weakness in the company. Lamar’s inability to quickly collect on sales will have a serious effect on their ability to use assets, as for much of the time a lot of assets are tied up in accounts receivable. This can be seen in their asset turnover times. Lamar has slowed down to not even earning the value of their total assets in a whole year, as is show by their 2006, 0.86 total asset turnover ratio.

The large number of fixed assets they took on in 2006 also has made their fixed asset turnover
fall drastically, but this is a less informative number since we know they bought a considerable
amount of fix assets in 2006.

Looking at their liquidity shows more bad signs. Liquidity ratios shows a company’s
current assets compared to their current liabilities. Higher numbers are generally better, although
if a company had very high ratios it would mean that they are not properly leveraging their
assets, and could be doing a lot more with them. Lamar does not have that problem. While we
saw that their revenue did increase dramatically from 2005 to 2006, these falling ratios of current
assets to liabilities show a weakening of the company. Having less liquidity means they are less
agile to respond to changing market conditions.

As far as how Lamar is actually using the massive amount of debt that they took on over 2005 and 2006 (over $700K), things do not look particularly good there either. The ratio of their debt compared to their total assets is increasing, meaning that they are taking on more liability compared to their assets each year. Generally, you would want to see this number stay stable or decrease as the company grows. Furthermore, they are making up for the cost of their investment money less and less each year, as show by the times interest earned ratio, which looks at earnings before interest compared to the interest paid. If Lamar was taking on the kind of debt they have been, but also making a lot more money because of it, then that would be OK.

However, they are not only taking on more and more debt, but they are making less and less use of it. Their fixedcharge coverage ratio, which shows how many times per year they earn enough to pay know ongoing payment obligations, such as loan payments, is at least positive and one of the only acceptable issues surrounding their debt. This number, which was 2.75 in 2006 means that they are making enough money to cover their absolute must-make payments.

A final aspect to look at, and something of particular importance to our investment decision, is the earnings per share and it’s growth rate. Earnings per share are the dividends paid yearly by a company for each share of stock issued. While we are not provided with this data, we are given the growth rate of these dividends for Lamar. These numbers have fallen, meaning that the stock holders are also feeling Lamar’s negative grown in that their dividends did not increase in 2006 as much as they had in the past. When looking to buy a stock for long-term investment, one wants to see steadily increasing dividends.

Having looked at Lamar’s ratios across time, let us now compare those same numbers to
industry averages to see how competitive they are. These numbers are graphically displayed
below, and the charts are reproduced in Appendix A.