Investment Ratios Essay
Presently Dollar Tree Store is a low-geared company. This is indicated by the gearing ratio, which is less than 50%. Low gearing in an organization means that the ratio of debt in relation to equity is low, implying that the corporation is mainly financed by equity. A low-geared company is usually a less risky company because the interest commitments derived from loans are lower. In practice, shareholders can survive a year or two without dividends as is actually happening in Dollar Tree Store.
However, if an organization fails to pay the interests due on time, legal proceedings will probably arise putting the business enterprise into liquidation. In finance it is frequently advisable to invest in a low-geared company when the financial performance is diminishing because the reductions will be spread among a higher number of investors and the risk of bankruptcy from interest payment defaults is low as already stated in the previous paragraph. In the profitability section we noted that the profits decreased by a low percentage.
Being a low-geared company is a favorable aspect for shareholders because the profit loss per shareholder is spread more. It is important to note at this stage that the organization did not pay dividends
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Yet, in 2006 the firm suffered a decrease in cash and cash equivalents of $40,698,000. However as already stated in the liquidity section a sound cash balance is still kept by the firm. In this respect, it is important that in the next financial year, the organization plans and sets an amount of money to be distributed as dividends to equity holders. Such action may induce a positive reaction in the capital market. A financial ratio that compliments the comment above is the significant decrease that arose in the price earnings ratio.
The Price Earnings Ratio is a performance indicator that shows the market’s confidence in a particular organization. The higher the ratio the greater the confidence of investors that profits will grow strong in the nearby future. In the case of Dollar Tree Store, the market assurance in the company is diminishing influentially as revealed by the decrease in this ratio. A main factor which is directing such loss of trust in the company is the absence of dividends. In finance theory it is frequently contended that the higher the risk the greater the expected return.
Investment in common stock of organizations is a very risky investment because ordinary shareholders are the last individuals paid in instances of bankruptcy. Therefore individuals selecting such investments would expect a high return in line with the aforesaid principle. As noted in the previous paragraph, Dollar Tree Store has failed to paid dividends for the last three years. Thus shareholders have not been given any return during such period, which is eventually leading to a decrease in demand for common stock of this company, directing to a fall in the market value of the share price.
As recommended appropriate action should taken this year. The interest cover, which signifies the capability of the organization to pay for the interest cost derived from long term borrowings or other financial obligations decreased by 8. 38 times during the year. This is a negative effect on the stability of the organization. Upon examination of the balance sheet one can notice that the long term liabilities remained quite stable during the years.
The reason for such decrease is disclosed in note 6 of the financial statements. It states that during 2006 Dollar Tree Store utilized an interest rate swap with a financial institution, which required a fixed interest rate obligation payable to such institution. In exchange, this financial organization will pay Dollar Tree Store variable interest rates that approximate the variable floating rate obligation. Indeed the total other income in the profit and loss account increased by 22. 43% during the year.