In order to establish whether management is generating adequate operating profits, we need to examine the level of Talbots operating profits relative to its assets, otherwise known as its operating income return on investment (OIROI). The OIROI for Talbots is 23.

19%, which incorporates the operating margin profitability ratio, 12. 67%, and the asset turnover efficiency ratio, 1. 83.The OIROI for Ann Taylor is a mere 11. 84%, over 10% less than Talbots, and the OIROI for the industry is 16.13%, indicating Talbots is earning an above-average return on investment relative to its competition in the retail-apparel industry. Management is generating more income on $1 of assets than similar firms. The retail-apparel industry’s average operating margin is 7.

72% and asset turnover is 2. 09. Ann Taylor’s operating margin is only 7. 89% and asset turnover efficiency is 1. 50. Therefore, we can conclude Talbots excels over its competition when it comes to keeping costs and expenses in line relative to sales, as is reflected by a higher operating profit margin than its competitors.

Talbots’ higher operating profit margin indicates that management is more effective, than other firms in its industry, in managing these five driving forces: the number of units of products sold, the average selling price of each unit, the cost of manufacturing and acquiring the product, controlling general and administrative expenses, and controlling expenses in marketing and distributing the product. When we look at asset turnover, Talbots generates $1. 83 in sales per dollar of assets, whereas its competitor Ann Taylor produces $1.50 in sales from every dollar in assets.This may appear as a minor difference, however, the higher operating profit margin distinguishes Talbots from its competition with their 23. 19% operating income return on investment. To ascertain how the firm, Talbots, is financed, we need to find out whether the company finances its assets more by debt or equity. The long-term debt to equity ratio is 0.

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18 or 18% for Talbots, the industry average is 0. 39 or 39%, and its competitor Ann Taylor has a 0. 17 ratio.

The total debt to equity ratio for Talbots is 0.27 (27%), Ann Taylor’s is 17%, and the industry average is 44%. We can clearly see that Talbots uses significantly less debt than the average firm in the industry.

However, we see that Ann Taylor uses the least amount of debt financing. The second perspective we can look at is comparing the amount of operating income that is available to service the interest with the amount of interest that is to be paid. Times interest earned is the ratio used in computing the number of times a firm is earning its interest. In Talbots’ situation, the times interest earned ratio is 54.

34.The industry average is 18. 14 and the Ann Taylor ratio is 15. 74. These numbers indicate that Talbots is able to service its interest expense with no difficulty whatsoever. The company’s operating income could fall to as little as one-fifty fourth (1/54. 34) its current level and still have the income to pay the required interest. Talbots possesses a vast amount of operating income in comparison to its interest expense, whereas other firms in the industry do not even come close to Talbots’ debt capacity in this area.

In revealing the shareholders return on equity, we must turn our attention to net income and common equity. Talbots maintains a 22. 49% return on equity, which is above the industry average of 19. 11%. Talbots competitor, Ann Taylor, comes in with a measly 9. 85% return on equity. Clearly Talbots is earning its stockholders a good return on their investments. The owners of Talbots, Inc.

are more than receiving a return on their investment equivalent to what owners involved with competing businesses receive.Recall that Talbots is more profitable in its operations than its competitors, with an OIROI of 23. 19% and industry average of only 16. 13%. This fact suggests Talbots should have a higher return on common equity.

Talbots uses considerably less debt, and more equity, financing than does the average firm in the industry, which actually lowers the return on common equity. The more debt a firm uses, the higher its return on equity will be, provided that the firm is earning a return on investment greater than its cost of debt.Therefore, the competition, on average, provides a higher return for its shareholders by using more debt, not by being better at generating profits on the company’s assets. However, the more debt a firm uses, the greater the company’s financial risk, which means more risk for the shareholders as well. When evaluating the value of shares in a company we should turn our attention to the market to book ratio and the price-earnings ratio. The market to book ratio of a company is the market price per common share divided by the book value of equity per common share.For Talbots, the market to book ratio is 3.

18, for Ann Taylor it is 1. 57, and the industry average is 3. 99. Both of these companies are lagging behind the industry average. Talbots has a high market value and much lower book value (it is closer to the industry average) and Ann Taylor has a high book value in comparison to the market price, which makes the ratio much lower in its industry. To get a higher ratio, the market price must be much higher than the book value. As book value approaches the market price, the ratio will decrease.The price-earnings (P/E) ratio is the market price of common stock divided by the earnings per share.

Talbots P/E ratio is 14. 69, Ann Taylor’s is 21. 29, and the industry average is 19. 91. Here we see that Ann Taylor’s price-earnings ratio is above the industry average and this means its earnings per share are lower in comparison to market price. For Talbots, earnings per share are higher in relation to market price.

As the earnings per share increase, the price-earnings ratio decreases, assuming the market price does not increase as well.I believe the best source of capital for Talbots to finance its future growth is in equity. The company already boasts low debt to equity ratios and should continue to do so. When relying on debt to finance future growth, there remains the uncertainty of whether the company can pay off its debt. With equity as the financing mechanism, the return on equity may not be as high as if we were financing with debt, however, the financial risk will remain in a more comfortable zone.In fact, during the month of fiscal October 2002, the company completed the repurchase of common shares under its $50 million stock repurchase program announced in July 2002.

Talbots has acquired a total of 17,390,161 shares of its outstanding common stock at a cost of approximately $373 million under its stock repurchase programs first initiated in February 1995. The approval of the repurchase program to acquire up to an additional $50 million of common stock is consistent with Talbots commitment to enhance value to all shareholders.This is a reflection of the company’s strong cash flow, which will support ongoing store expansion plans, the payment of regular quarterly dividends and the stock repurchase program. Repurchased common shares are held as treasury shares, a portion of which could be used to fulfill the company’s requirements under its equity incentive and other benefit plans.

At November 2, 2002, the Company had 57,507,177 shares of common stock outstanding. Although the analysis of numbers for this company appears favorable, my decision to forego the purchase of this stock is based on factors other than the financial analysis.The retail-apparel industry is a fairly volatile industry.

When looking at the beta, which is a quantitative measure of the volatility and performance of a given stock relative to the overall market, the beta for Talbots is 1. 27 and the industry is 1. 25. A beta above 1 is more volatile than the overall market, while a beta below 1 is less volatile. Therefore, these numbers would indicate that for the Retail-Apparel industry, stock is more risky than the average common stock on the market.

Retail-Apparel sales fluctuate with changes in climate, oscillations in the economy, and the possibility of war and political instability. With a Middle East war at the forefront of our political nation and the slow economic conditions of today, all of which have an immense effect on the stock market and consumer spending, I would not recommend a purchase of stock in the Retail-Apparel industry. In today’s society, consumers are bargain hunters and refuse to shop in the absence of bargains.However, the attractive bargains do not spell out profitability for the providing companies. Consumers may flock to the mall for the holiday sales, but this does not necessarily mean the retail chains are making money.

We could argue that the holiday season will send sales soaring and stocks will gain momentum, but this will only create a temporary fix to an ongoing issue. Perhaps a few months down the road the political and economical environments could change for the better, but until then I say save your money for a more conservative, promising investment.