Principles in carrying out the evaluation and determination
In its simplest form one is useful it accomplishes its purpose. If a nail has choice on whether to be stricken by hammer to fasten something compared to being destroyed when put in a box to rust to oblivion, it is believe that the nail would rather choose the first since it its nature to be used in fastening things. To allow it rust without being used would result too many cost waster from its production and sale. In the same way, the Hermes principles should be viewed the same way: has it attained its designed purpose for Marks and Spencer?
If the answer is no, then there is no use of such principles. But if the answer is yes, then it is indeed very useful to such effect. After applying the same in the first part, it could be deciphered that Hermes principles are pointing to one target—that is the attainment of maximized value of the firm. The question that will have to be answered is: Is it within the company’s nature to maximize its shareholder value? The answer appears to be in the positive. Marks & Spencer does have company plans on how to attain long term value that would sustain it in increasing shareholders’ wealth.
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The company’s claim to be engaged in doing everything in building a sustainable business for the long-term is one of the strongest pieces of evidence of Hermes principles that target shareholder value. Marks and Spencer has decided to attain generating shareholder value through consistent profitable growth while it guarantees its valued customers to always put their faith to the company to do what is necessary for them (Marks and Spencer, 2008). The company has also expressed its long term plan by having its profitable growth in its operations.
It may be recalled that this paper has looked into the profitability of the business. Hence this is again another evidence of the Hermes principles’ usefulness as profitability cannot be detached if maximized value is the target. The usefulness of the Hermes principles is its effect on decisions made in the past in relation to the behaviour of its stocks in the stock market, as show in the following graph: Figure 2 Graph of Stock Price for M&S: Source: MSN (2008)
As could be gleaned above, the increase from 23% ROE in 2004 to 43% returns on equity for both 2005 and 2006 and 41% in 2007 were very evident by the positive reaction from the investors in terms of increase in prices. To have a rate of just 20% would be already high since accounting figures are conservatives since they are based on book value basically. So that a jump from 23% to 43% and maintaining the said rate for at least that level for more or less three years will become a wonder on the part of investors around the world who are all interested to make the best of their money.
What is puzzling however was a sudden fall near the end of 2007 despite the still very high ROE in 2007. The possible explanation for this is a possible realization of overvaluation of the stocks. This explanation appears to have some support in a valuation conducted earlier where present price level of 383. 37p per share is already more or less the proper value of stock price for Marks and Spencer. It was found in the valuation, that the intrinsic value of stock is 383. 37pper share as against the quoted price of 373p per share from the London Stock Exchange (Telegraph. co.
uk, 2008). There is a little undervaluation of about 14p per share which is already negligible. Not to be forgotten in this paper is a limitation that could change values a computed because of the influence of old data that was designed to formula a model to predict increase in the value of dividends for purposes of applying the constant growth model. The valuation of stocks when applied to Marks and Spencer, involved assumptions for annual growth rate of 1. 5% for the dividend per share , which should be lower than the average historical rate of 15% for the years 2003 to 2007.
This is a reality of model which should explain reality. If the conditions do not exist then the model cannot not function. The critical requirement of the model as found in the paper is that the dividend growth rate must be lower that the cost of capital so that if dividends increased by big amounts it cold assumed that there are in fact good earnings for the previous years as basis of dividends. Given this limitation of the model decision makers are warned to study its reasonability.
It can therefore be inferred that the benefit of a theory or model is its being capable to explaining reality and therefore its predictive value would be paramount. On the other hand conditions change and what happened yesterday may not necessarily happen tomorrow hence models could be limited also in great respects. In evaluating the usefulness of Hermes principles, it should be emphasized that stockholders incur risks that it said that overtime earnings in stocks are definitely higher than in bonds but there is a greater risks in stocks than in bonds.
Based on this simple reality, stock investments which involve the use of models could only amount to best predictions and there are great possibilities for failure as nobody could really foresee the future. Precisely then, these principles are useful in the sense that they at least used in trying to forecast what will happen in reality that asserting that the primary consideration of investors is wealth or value maximization if they are to remain as investors.