In 1995, AB Capital and Investment Corporation was tapped by the UP Foundation, Inc.

(UPFI)
to manage an equity fund of 2.5 million pesos, which is a small portion of their 260-million-peso
endowment fund. The interests earned from the fund, which is used to support the professorial
chair requirements of the University, has dropped due to a decline in the returns of treasury bills
– that being the bulk of UPFI’s investments. In response to this, the investment committee of
UPFI has proposed that some portion of the fund be invested in the Philippine stock market,
which was observed to have experienced an increase of more than 150 percent in 1993. In line
with this, Patricia Tan of AB Capital was tasked to design a portfolio for the fund in which she
plans to include mostly “blue chips” and other sound “second liners”, thereby taking into
consideration UPFI’s conservative stance. So far, Patricia Tan has come up with an analysis of
the various stocks included in the portfolio as preparation for a possible inquiry from the
investment committee on the fund’s performance.
In the same year, Peter So was hired by AB Capital and Investment Corporation and assigned to
handle the remaining companies which have not yet been analyzed by Patricia Tan. These
companies include Jollibee Foods Corporation (JFC), Ayala Land, Inc. (ALI), and Philippine
Long Distance Telephone Company (PLDT).
As of late, Peter has already submitted a report which included an analysis of the companies’
respective industries and a description of the companies’ operations, management and business
prospects. Peter So was also able to perform financial ratio analyses on the three companies.
However, Patricia Tan thought that a cash flow analysis, which would provide information on
the long-term viability of the companies and its ability to generate positive cash flows and pay its
obligations, should also be included in the report. “An evaluation and a comparison of these
statements have to be made across the companies we are studying because some of these
companies may still be dropped from the list if the analysis shows some financial weaknesses in
this area,” Patricia told Peter.
Main Problem
Which of the three companies should AB Capital and Investment Corporation include in its
portfolio for UPFI?
Areas of Consideration
It is important to note that UPFI is simply looking for a stable investment. Since their previous
investments in treasury bills have begun to deteriorate, they feel the need to revisit their
investment options. This is what the stock market is offering them – an opportunity to earn
steady returns for their relatively constant financial needs. AB Capital and Investment
Corporation must remember that investing in the stock market is something new to UPFI; hence,
they are only willing to set aside a small amount from its fund for such an investment. However,
it is very probable that UPFI would be willing to raise and shift its investments into the stock
market once it experiences good, steady returns from it. Contrastingly, UPFI would also be
reluctant to raise its investments, if not completely avoid the stock market in the future if ever it
experiences less than favorable returns.
Analysis of Data
The primary goal of AB Capital and Investment Corporation in analyzing the three companies is
to determine which of the three can assure a steady return to UPFI (in the form of cash
dividends) each year. Only secondary to this is whether or not these companies have the capacity
for further growth. In going about these analyses, we first calculated the dividend payout ratio of
each company. Such a ratio is effective in determining what percentage of a company’s net
income it actually uses for giving out cash dividends.
PLDT’s dividend payout ratio from 1992 to 1994 experienced a steady rise, with 1994’s ratio
amounting to almost 21%. Compared with Ayala Land, whose payout ratio slowly declined
through the years, and Jollibee, who only started to give out dividends to its shareholders in
1994, PLDT, on the offhand, was the obvious choice for UPFI’s needs. However, the dividend
payout ratio only takes into consideration the actual amount of dividends paid. It fails to consider
how many shares of stock a company actually has, and thus leaves this finding less to be desired.
The number of shares of stock a company has directly affects how much actual cash dividends a
shareholder receives. Despite PLDT’s relatively high payout ratio, a shareholder will still receive
a small cash dividend if it has to share the total amount of dividends paid out with countless of
other shareholders. It can also be observed from the cash flow statements of PLDT that it has
also continued to issue more and more stocks (preferred and common) each year.
Although a more suitable ratio such as cash dividends per share or earnings per share which
would more clearly pinpoint the better investment cannot be arrived at due to a lack of
information, other forms of analysis must be undertaken.
Thus, we proceeded to perform vertical and horizontal analyses of the cash flow statements of
each company. It is necessary that a company be able to generate positive cash flows in order to
pay out dividends. Accordingly, the greater amount of cash generated by a company by the end
of the year, the more cash dividends it can give out to its shareholders.
Through the use of a horizontal analysis on the net cash flow of the three companies through
1992 to 1994, it can be observed that only JFC has maintained a constant positive cash flow in
each year considered. ALI, although negative in the previous two years, has been able to
compensate with a sharp rise in its cash flows to a 709% increase by the year 1994. PLDT, on
the other hand, has a fluctuating cash flow, alternating from being positive in one year to being
negative in the next. Further inquiry into the natures of these cash flows will lead to the
components of these cash flows – net cash flows from operating, investing and financing
activities – and its proportion to total net cash flow.
By determining the relative proportion of the cash flows provided and used by the different
activities of the companies, we can clearly see how a particular total net cash flow comes about.
From the data above, we can observe that both ALI’s and PLDT’s total net cash flow is
composed mostly of cash provided by financing activities. ALI’s cash flow, in particular, despite
being positive by the end of 1994, is actually being fueled by a large positive cash inflow from
its financing activities. This proportion of 85.21% of total net cash flow is significantly larger
than an inflow of only 35.31% provided by operating activities. Going a step further, it can also
be observed that much of these cash inflows came from additions to long-term debt and issuance
of new stock. This simply means that much of the positive cash flows attained by ALI and PLDT
are temporary, unlike that of a company whose influx of cash is mostly hinged on those provided
by operating activities. JFC’s net cash provided by operating activities carries all of the weight of
its total net cash flow. From 1992 until 1994, JFC has enjoyed cash inflows solely attributed to
its operating activities, which lies in stark contrast with that of ALI and PLDT.
Proceeding now to analyzing the potentials of the companies for future growth, we necessarily
take into consideration the investment decisions of each company. From the cash flow
statements, we perform a horizontal analysis through 1992 to 1994 so as to obtain a clearer
picture of each company’s expansionary actions.
As we can observe from the table above, JFC has been able to maintain increasing additions to
investment which is necessarily essential for a company’s future growth. Unlike that of ALI and
PLDT, whose investments through 1992 to 1994 have been somewhat fluctuating, JFC has
managed to increase its investments by 59% on 1993 from 1992’s 144,490,178 peso amount, and
by another 100% the following year. Taking a look at the Table 4 above which reflects the
different cash flows provided by the operating and financing activities of the three companies, it
could also be observed that JFC’s investing activities can be serviced solely by the cash inflows
provided by its operating activities. However, this cannot be said of the other two companies
which tend to rely on the cash inflows provided by its financing activities to supplement its
investing activities. Furthermore, if we were to take a look at the overall investing trends of the
three companies, we can deduce their respective outlooks towards investing. JFC always
maintains a total investment amount that is less than the total amount of cash inflows it receives
from its operating activities. It hardly calls on its financing to provide for any additional cash.
PLDT, on the other hand, tends to perform huge investments per year, raking up cash inflows
from its financing activities which surpasses what it actually earns from its operating activities.
ALI, which appears to be the loose canon among the three, invests irregularly each passing year.
Recommendation
In performing analyses relating to the companies’ ability to give steady returns and their
potential for further growth, it is in UPFI’s best interests and our recommendation that only JFC
and PLDT should be included in their portfolio. JFC is a relatively conservative company which
can assure its investors of continued stability. It invests reasonably each year, indicative of stable
growth in the future. It hardly relies on liabilities and debts for its cash requirements; thus, it
does not also need to worry about the resulting obligations which come with such a reliance.
Also, since JFC merely obtains majority of the cash used for its investments from its operating
activities, it has the ability to sustain continuous expansions in investment. Although it has only
started to give out cash dividends in 1994, it shows promise that if ever it does continue to give
out dividends, its returns would be very stable.
PLDT is the perfect complement to JFC stocks. As a stockholder of PLDT, one can be assured
of receiving cash dividends each year. Although the actual amount of cash dividends is still in
the dark (due to a lack of information), its high payout ratio relative to the other two companies
reflect PLDT’s concern for satisfying its shareholders’ financial needs. Despite PLDT’s heavy
reliance on financing activities for its cash requirements, it has its investments to show for it.
PLDT is currently making huge investments in property, plant and equipment which could in the
future translate to an explosive growth in PLDT. Furthermore, investing in more than just one
company allows for risk aversion which would highly coincide with UPFI’s conservative stance
in investing.
The main reason why we recommend excluding ALI from UPFI’s portfolio is its tendency to be
unstable. Offhand, ALI’s fluctuating investing activities seems to indicate that it is still testing
out the waters with regards to investments. Compared with the investing actions of the two other
companies, ALI seems to be lost in the dark when it comes to investing. However, we must
remember that real estate industries such as ALI are very much dependent on real estate prices,
which in turn, is greatly influenced by the economic conditions of the country. If the economic
conditions of the country at present were bad, then ALI investments would also be adversely
affected. Thus, it can be deduced that ALI’s future growth would be similarly unstable.
Moreover, ALI’s 1994 cash flow statements indicate a large inflow of cash coming from its
financing activities (mostly from long-term borrowings).
However, unlike PLDT which invests what it had borrowed, ALI has yet to show for its
borrowings. All in all, ALI’s cash flows from 1992 to 1994 have been less than favorable with
respect to cash dividends. It has been constantly negative, until 1994 when it managed to borrow
a large amount leaving its net cash flow extremely positive. And lastly, despite being able to give
cash dividends each year, the total amount of which relative to its net income has actually been
decreasing through the years.
So that JFC can become better investment options for shareholders, it should continue giving out
cash dividends as it did in 1994. Also, it should try to handle its idle assets more effectively. The
cash flow statements of JFC reflect a large amount of cash held simply idle in the company. If
ever some of this cash is not needed for its operating activities, it should consider making more
investments. This would facilitate greater growth in the future. PLDT, on the other hand, should
take caution in its borrowings. These borrowings will indeed finance its planned investments;
however, it also entails having to pay large obligations each year. Such obligations can go out of
control and greatly affect investor confidence on the company. The irregularity of ALI’s net cash
flows and investing activities can have detrimental effects on interested investors. If these
companies can address these weaknesses, then maybe all three companies can be considered as
good investment options for UPFI.