Documente Academic
Documente Profesional
Documente Cultură
Executive Summary
This financial analysis report examines two high profile competitors, Dell and Hewlett
Packard (HP), within the computer/technology industry in order to evaluate company
performance and financial health. Overall company strategies were reviewed and considered
along with the financial analysis to come to a conclusion for recommendation of investment. The
reports introduction gives an overview to the computer/technology industry and expands on the
strategies executed by Dell and HP. The financial analysis covers both companies common-size
income statements and balance sheets, comparative income statements and balance sheets, and
various financial statement ratios such as liquidity, capital structure and solvency, return on
investment, operating performance, asset utilization and market measures from year 2006 to year
2010. A pro forma look ahead estimated financial performance is generated for each company and
assumptions explored that helped derive the financial data for the pro forma. Conclusions are drawn
from the above stated financial analysis as well as areas for improvement and investment
recommendations.
Dell and HP are both well known companies competing in an ever evolving and expanding
industry. The industry is in every segment from personal to educational to professional. HP is a more
mature company having been founded in 1939, but Dell made waves throughout not only the
computer/technology industry but in multiple industries for its ability to rethink distribution and
customized sales direct to customers. While both companies offer both products and services, HP has
a slightly more diverse portfolio and is a bit more brand recognized as a trusted and quality company.
From years 2006-2010, Dell was able to keep downward pressure on the growth of cost of goods sold
while HP had strong growth in their sales and net profit. Through this time span, Dell secured a
lower liquidity risk for its shareholders when compared to HP. The marginal operating performance
on average for HP was stronger than Dells operating performance. Only HP is a dividend generating
stock with Dell choosing to not participate in this option for its investors. Dells approach is that
instead of paying out a dividend, those funds are used to reinvest into the company to produce higher
profits and overall create a stronger more financially fit company. Both strategies work to entice
investors as both companies are doing well in the market. HP higher sales revenue and dividends
paid out along with a strong and reputable brand name make it an attractive investment but Dells
revolutionary process thinking along with its growth potentials, recent strategic acquisitions, low
liquidity risk, and good return on investment makes a good case for potential investors to pursue.
Table of Contents
Introduction4
Computer/Technology Industry..4
Dell vs. HP Strategies..4
Objectives4
Financial Analysis..5
Common-Size Analysis...5
Common-Size Income Statement Analysis.5
Common-Size Balance Sheet Analysis6
Comparative Analysis..7
Comparative Income Statement Analysis7
Comparative Balance Sheet Analysis..8
Financial Ratio Analysis..9
Liquidity...9
Capital Structure and Solvency..10
Return on Investment 10
Operating Performance..10
Asset Utilization.11
Market Measures12
Summary of Financial Performance & Suggestions for Improvement..12
Projected GAAP Income Statements and Balance Sheets and Assumptions Used.......13
Conclusions and Recommendation for Investment..15
References.16
Appendices17
Introduction
Computer/Technology Industry
The computer/technology industry has many key players with two of the major
competitors being Dell and HP. The computer industry has come a long way since its first
inception with the invention of Electronic Numerical Integrator and Computer in 1946. This
industry is comprised of many items such as computers, monitors, printers, scanners,
mainframes, servers, electronic computer components, networking and workstations to name a
few. The industry started a major growth phase in the 1980s with the production of the personal
computer and has grown every since with many new products introduced. Innovations within this
industry have had positive rippling effects to outside industries, from manufacturing to banking.
While the United States market is fairly saturated and mature, the computer/technology industry
is very much in the growth phase on a global basis. The drivers behind this growth are both
innovations in technology and especially increased consumer spending in Asia and Africa. The
international value of this industry is expected to grow and surpass $620 billion in 2011, roughly
a 27% increase from 2006. Dell and HP possess major market share within the
computer/technology industry due to brand name loyalty, advanced supply chain management
techniques and producing innovating products for an affordable price.
Objectives
The primary objectives for this financial analyst report are to compare two major
companies within the computer/technology industry, Dell and HP. Suggestions for company
improvement will be discussed as well as recommendations for investment. A pro forma
financial analysis for each companys expected performance for 2011 will be conducted and
assumptions that lead to these figures. The companys performance will cover the years spanning
from 2006 through 2010, with analysis of each companys common-size income statement,
common-size balance sheet, comparative income statement, comparative balance sheet and
financial statement ratios.
Financial Analysis
Common-Size Analysis
Common-Size Income Statement Analysis
The common-size income statement for Dell shows a relatively flat history for cost of
goods sold compared to sales from 82.27% in 2006 to 82.49% in 2010. Dells five year average
for cost of goods sold to sales was 82.23%, which is bit higher than HP cost of goods sold to
sales five year average of 75.96%. This in turn gives HP higher gross revenue than Dell most
likely through means of obtaining raw materials and goods at lower costs, giving HP greater
ability for an increased profit margin. This increased profit margin can allow for HP to offer
more discounts then Dell may be able to afford, or increase spending in areas of investment for
the company.
Another area of interest within the common size income statement is related to selling,
general and administrative to sales. Overall through the years 2006 to 2010, Dell saw an increase
in this area growing from 9.05% in 2006 to 12.22% in 2010. Meanwhile, HP experienced the
exact opposite effect, with this category declining from 12.29% in 2006 to 9.99% in 2010.
According to Dells annual report, the major increase was due to the acquisition of Perot
Systems. It also appears that over the last five years, Dells strategy of products directly to
customers has been adopted by many competitors, allowing the competitors to decrease some of
their overhead and commissions paid to retailers, all the while increasing sales. In the same time
span as competitors partially adopted the strategy that made Dell prominent, Dell began to place
more products in retail stores to compete directly on the front lines with its competition, as
mentioned in their Managements Discussion and Financial Analysis meetings. This approach
has caused a good percentage of the sales revenue to go to retailers and distributors, thus
straining the ability to maximize net income for the present.
Research, development and engineering for Dell as a percentage to sales were 0.82% in
2006 and slightly grew to 1.18% in 2010. HP research, development and engineering to sales is
roughly 3 times the amount that Dell dedicated; however, HP has drawdown their research,
development and engineering to sales from 3.92% in 2006 to 2.35% in 2010. The five year
average in this category for Dell was 0.99% and HP was 3.04%. Even with HPs much higher
research, development and engineering to sales percentage than Dell, HP has a higher operating
expense, but since their cost of goods sold to sales is lower, it gives HP the edge in producing a
higher operating income than Dell.
Overall net income to sales decreased for Dell throughout 2006 to 2010, with a major
decrease happening in 2010 and overall having a five year average of 4.51%. In 2006 the net
income to sales was 6.46%, then in 2009 it dropped to 4.06%, but in 2010 was when the major
drop happened, resulting in net income being just 2.71%. The main contributor to the drop in net
income to sales was from operating expenses, with one component being the increase in
research, development and engineering, but the primary increase coming from the selling,
general and administrative category. Increased operating expenses are reflective of Dells push
of broadly branching out into the retail market. HPs net income to sales remained flat during the
same time span, with a five year average of 6.88%. The basically net zero increase in net income
can be attributed to the economic downturn, and its rippling effect on customers.
decreased slightly over the years, and by 2010, HP had a gap of current assets to current
liabilities of only 4%. Potential investors will focus on this close margin because HP may start to
become too heavily leveraged, which could hinder their ability to expand. It could also pose the
problem of decreasing the percentage amount that HP reinvests back into the company, due to
using assets to pay off short term liabilities.
Within Dells current assets, short term investments to total assets decreased from 8.67%
in 2006 to 1.11% in 2010. Many of these short term investments had matured and were sold. The
additional cash on hand helped decrease accounts payable, which decreased from 42.44% in
2006 to 33.80% in 2010. Reducing its liabilities strengthens Dell financial health, yet further
liquidity and asset utilization ratio test should be conducted to determine if their more solid
financial standing is long term or simple a one year over year change. Dells inventory to total
assets remained mainly the same over the five year span with 2.53% in 2006 and 3.12% in 2010.
This is a reflection Dells strategy of keeping on hand inventory levels low and only producing
the amount able to quickly sell. HP inventory to total assets changed substantially from 9.45% in
2006 to 5.19% in 2010. The drop in inventory percentage to total assets is a representation of HP
improved strategy to minimize holding periods by taking delivery of inventory and
manufacturing immediately prior to sale or distribution of product to customers. It is also
reflective of the aggressive discounting that HP conducted as a result of the economic downturn.
Dells long term debt to total liabilities and shareholders equity increased substantially
from 2.69% in 2006 to 10.15% in 2010 with average long term debt of 4.71%. The major
increased indicates that the company was dependant on long term debt to finance its acquisition
of Perot Systems in 2010. HP long term debt to total liabilities and shareholders equity followed
the same path by increasing from 3.04% in 2006 to 12.26% in 2010. This increased in total debt
is explained in their annual report as being spending on acquisitions and share repurchases. Debt
to equity ratios are needed to be further evaluated to determine the risk factor for this increased
level of liabilities.
Comparative Analysis
Comparative Income Statement Analysis
Dells net revenue sharply declined from 2008 to 2010, going from 6.47% to (13.42%),
as a result of the economic downturn, as individual customers put off luxury purchases such as
computers and commercial customers put off bulk computer orders for a later to be determined
date. On average, the net revenue growth was 1.86% while cost of goods sold was 2.05%. Cost
of goods sold increased faster than sales, lowering its potential gross profit. Even though selling,
general, and administrative was reduced substantially from 2008 level of 26.73% down to
(8.97%) in 2010, its growth rate averaged 9.45%, which outpaced net revenue on average. The
drop in selling general and administrative was due to decreases in compensation, advertising
expenses and improved controls during the downturn. The growth rate of cost of goods coupled
with the economic downturn, found Dell with a (31.91%) operating income for year 2010. A
large decrease in the market yield of over 200 basis points from 2009 was the cause for the
(210.45%) for investments and other income n 2010. Net income average was (10.78%) over
years 2006 to 2010, with major causes for this being lower sales due to economic downturn,
decreases in investments, increases in tax liabilities and higher cost of a hedging program.
Much like with Dell, the economic fallout had its effects on HP. Their net revenue
severely decreased from 13.50% in 2008 to (3.22%) in 2009. The dollar depreciation to the euro
played a large part in this drop for its European sales. However, unlike Dell, HP rebounded in
2010, increasing sales up to 10.02%, which can be attributed mostly in part to HPs acquisition
of EDS. HPs annual cost of goods averaged 7.84%, which was lower than their net revenue
average of 7.96%. This led to a more favorable net income on average, indicating HPs ability to
better control its operating income through successful marketing or more effective investment
approaches over the years.
Dells accounts receivable rate of growth was 11.90% on average, growing faster than the
companys average sales rate, 1.86%. This relates to the increase in the collection period in days
also increasing over this five year span.
The category of property, plant and equipment grew for Dell at an annual rate of 6.12%,
with the majority of this growth happening in years 2006-2008. Plant, property and equipment
declined in years 2009-2010, (14.66%) and (4.22%) respectively, which coincides with the
companys declining sales growth over these same years.
On average, Dells total liabilities grew 11.36% annually, compared to its total liabilities
and shareholders equity growth rate average of 8.21%. This highlights the companys candidacy
for potentially becoming a long-term solvency risk.
10
slightly leaner production manner than HP and is able to quickly move inventory through its
distribution networks. The quicker a company is able to sell its inventories, the quicker the clock
begins to receive payment to be able to pay back money owed on inventories acquired and sold,
and not have to increase your working capital financing.
Capital Structure and Solvency
Debts to Equity Ratios
Dells five year average of total debt to equity was 5.23, compared to HP lower average
ratio of 1.65. This shows that Dell had more debt (creditors) financing than equity (shareholders)
financing. Long term debt for to equity on average for Dell was 0.29 and HP was 0.22. While
many feel that debt from creditors is more harmful because of the interest paid on the principle
borrowed, the advantage here is that once the creditor is paid back, they are gone and off the
payroll. Whereas equity financing involves more shareholders owning parts of the company,
which reduces the dividend payout per shareholder as well as waters down earnings per share.
Dells approach to being more heavily financed through debt than equity may be in an attempt to
keep earnings per share at an increased level.
Return on Investment
Return on Assets and Return on Common Equity
An important ratio is the return on assets ratio for its ability to measure earnings per
dollar from its assets. The five year average for return on assets of Dell was 13.06% while HPs
was 9.07%. This higher percentage for Dell reflects a more efficient use of its assets and higher
earnings from products sold per company asset. Both companies have strong return on assets that
goes to show the loyal base of customers each brand name of the two companies has.
Return on common equity is another important profitability ratio. This ratio measures the
earnings success of its capital investments through common shareholders. The return on equity
for Dell averaged 81.46% while HP averaged 23.91. An observation of this profitability measure
shows that Dell is possibly much more attractive for potential investors for its ability to
effectively manage and use funds generated through shareholders equity.
Operating Performance
Profit Margin Ratios
Dells gross profit margin average of 17.77% was lower than HPs average of 24.04% HP
controls a larger portion of the computer market as represented through this ratio. Dell also
11
posted lower operating profit margins and pretax profit margin compared to HP. Dells higher
selling, general and administrative expenses are cause for lower operating and pretax profit
margins, partly due to new retail and certain global distribution relationships. As expected from
the precursors above, net income was also lower for Dell when compared to HP. Dell needs to
encroach more forcefully into HPs large market share to positively influence its sales. Operating
expense components should be addressed as well to find cost savings measures to increase
operation income in order to ultimately increase its net income.
Asset Utilization
Cash Turnover
The measure of how efficient a company utilizes its cash and cash equivalents to create
sales revenue is depicted with the cash turnover ratio. In respect to this ratio, Dell averaged 5.60,
while HP averaged 7.09. This showed that HP used its cash and cash equivalents more efficiently
to build revenue. On the other hand, it shows that HP used its cash and cash equivalents while
Dell refrained from using its cash and cash equivalents, as evident in the common size analysis,
showing that Dell retained on average 31.77% of cash and cash equivalents to assets while HP
averaged 12.41%.
Inventory Turnover
Inventory turnover represents how fast companies turn their inventories into sales
revenue. Dell had a much slower inventory turnover on average, 58.38, than HPs 11.86. Over
the past five years more companies have became better at the Dell model of sales direct to
customers which has overall effected Dells sales as evident in the comparative analysis showing
on average Dell grew sales by 1.86% while HP grew at 7.96%. Also, HP has become more
efficient in their inventory distribution cycle and the amount of inventories held in relation to
total assets, dropping from 9.45% in 2006 to 5.19 by 2010. Dells turnover ratio was directly
affected by its increase in inventory to total assets growing from 2.53% in 2006 to 3.12 % by
2010. The increase in Dells inventories to total assets percentage coupled with declining sales
growth over the past five years was a cause for their much higher inventory turnover rate.
Total Assets Turnover
Total assets turnover measures how efficiently a company utilizes total assets to create
sales revenue. On average, Dells ability to generate more profit from its assets was roughly
12
double that of HP, being 2.15 to 1.07 respectively. This shows that for overall assets held, Dell
had a better record of generating sales.
Market Measures
Price to Earnings Ratio and Earnings Yield
The price to earnings for Dell on average was 16.35, lower than HPs 18.52. From this
statistical ratio, HP is able to show that its investors have higher expectations of their company
performance by being committed to paying a higher price per share to own HP stock over the
past five year time span. However, with Dell showing better results when it came to liquidation
and return on investment, they are able to portray to potential investors that they are the better
buy at a lower price per share when compared to HP.
Earnings yield represents the amount of earnings generated for every dollar invested.
Here, Dell has a better showing on average with 7.02% compared to HPs 6.25%. This ratio can
be another point of persuasion that Dell is the better buy for it being properly priced when
talking of earnings yield over the years 2006 to 2010.
13
Dells liquidity and return on investment ratios are quite strong, but need to improve their
operating performance. Integrating work processes and striving to become more efficient as well
as develop strong relationships with raw material vendors will be key to increasing this area of
interest. If they are able to increase their profit margins within their operating performance, it
will give a higher net income and possibly increase asset utilization. Improvement from these
areas could give Dell the option to increasing price per share and earnings yield from their
already healthy positions.
HPs area of improvement is with its collection period. Currently, the collection period is
too long and is causing HP to use its working capital funds to pay for its inventories sold that
they have yet to collect payment on. The days to sell inventory should be addressed as well,
either reduce inventory produced are enhance buyer incentives for HP products even further than
current level to move the products more quickly off the shelves.
14
HP pro forma income statement in many areas are similar to that of Dells, again largely
attributed to the fact that the economy is exiting one of the worst recessions in decades. Sales
increased with companies beginning to purchase to update their business use products, which
also increases your cost of goods sold. Purchased intangible assets and restructuring charges
increased within operating expenses largely due to the acquisition of Palm a year earlier. Overall
net income increased with help from added tax provisions provided through government
incentives to help the economy recover as well as lower sour investments declines in what is
hopefully the last year impact from the recession. The comparative and common size analyses
were also used as baselines for the pro forma development.
Dells pro forma balance sheet shows an increase in cash and cash equivalents from the
previous year, partly due to the large premium they paid for Perot Systems in 2009. Cash and
cash equivalents has been increasing since the acquisition was complete to stay firm in being
able to cover their short term liabilities. Increased sales in 2011 lead to an increase in accounts
receivables as it did to a slight increase in Dells inventories. Property, plant and equipment also
increased as the economy begins to enter pre-recessionary times and sales increase. Purchased
intangible assets had a major increase largely due to recognizing the assets from finalizing the
acquisition of Perot Systems. Dells increase in inventories and an increase in accounts
receivable lead to the increase in accounts payable for their current liabilities. Overall their long
term debt increased as Dell prefers financing over issuing shareholders equity to fund long term
projects. Overall the balance sheet of Dell increased from the previous year in large part due to
increased sales and an improved economy.
HPs pro forma balance sheet reflects a decrease in cash and cash equivalents that can be
explained from their purchase of the Palm Company in 2010. HPs increased sales volume lead
to an increase in accounts receivable and inventories stock as well as to their expansion of their
property, plant and equipment assets. Purchased intangible assets increased as a result of their
acquisition of the Palm Company. Increased accounts receivable and inventories lead to an
increase in accounts payable. The improved economy generated more sales and HP added to
their workforce causing for an increase in their employee compensation and benefits. Long term
debt increased as results of recent acquisitions of EDS and Palm Company over the past three
years. Overall the balance sheet of HP increased from the previous year in large part due to
increased sales and an improved economy.
15
Wahlen, J., Baginski, S., and Bradshaw, M. (2010). Financial Reporting, Financial Statement
Analysis, and Valuation: A Strategic Perspective. 7th ed., South-Western College Pub
Investopedia (n.d.). Retrieved from http:// www.investopedia.com
Yahoo! Finance (n.d.). Retrieved from http://finance.yahoo.com
Yahoo! industry center (n.d.). Retrieved from http://biz.yahoo.com/ic
Google Finance (n.d.). Retrieved from http://www.google.com/finance
Dell, Inc. and Subsidiaries. (Jan 2010). Form 10-K.
Dell, Inc. and Subsidiaries. (Jan 2009). Form 10-K.
Dell, Inc. and Subsidiaries. (Jan 2008). Form 10-K.
Dell, Inc. and Subsidiaries. (Jan 2007). Form 10-K.
Dell, Inc. and Subsidiaries. (Jan 2006). Form 10-K.
Hewlett-Packard Company and Subsidiaries. (Jan 2010). Form 10-K.
Hewlett-Packard Company and Subsidiaries. (Jan 2009). Form 10-K.
Hewlett-Packard Company and Subsidiaries. (Jan 2008). Form 10-K.
Hewlett-Packard Company and Subsidiaries. (Jan 2007). Form 10-K.
Hewlett-Packard Company and Subsidiaries. (Jan 2006). Form 10-K.
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30