Using https://www.sec.gov/edgar/searchedgar/companysearch.html, select two public traded companies in the same industry that have a recent 10-k.
COMPANY 01 – JP MORGAN:
COMPANY 02 – WELLS FARGO:
SOLVED CASE STUDY PART 1 ATTACHED AT THE END
Answer the following questions for each of the companies that you selected, except #3, is just for one of the two.
1. Tangible Assets:
- Are tangible assets significant for the companies? What proportion of total assets is held as tangible assets (PPE)? What exactly are the companies’ tangible assets? That is, what is their nature?
- Compare the two companies’ depreciation policies. Do they differ markedly?
- What is the relative size of tangible assets? How has this changed over the three-year period?
- Did the company increase tangible assets during the year? Was the increase for outright asset purchases or did the company acquire assets via a merger or acquisition?
- Compute PPE turnover for all three years reported on the income statement.
- Compute the average age of assets and percentage used up.
2. Short and Long-Term Debt:
Examine the debt footnote and consider the following questions:
- What is the common-size debt and how does that compare to published industry averages?
- What types of debt does the company have? Is it publicly traded? Are there bank loans? Other types of debt?
- When does the debt mature? Determine if there is a large proportion due in the next year or two. If so, can the company refinance given its current level of debt?
- What is the average interest rate on debt (interest expense/average total debt)? Compare it to the rates reported.
- Read the footnote and the MD&A to see if there are any debt covenants and whether the company is in compliance.
- For one of your two companies, prepare a forecasted income statement for the subsequent year. For example if you prepared Part I using a 10-K for the year ended December 31, 2020, prepare a forecasted income statement for the year ended December 31, 2021.
- Document your detailed and specific assumptions that you developed for each line item of the forecasted income statement. For example: Based on the average sales growth in the previous three years, I have assumed that sales would increase at XX%. Make sure to read the MD&A to see if they provide any guidance, but be creative and detailed.
4. Prepare a report (2 page minimum) describing 4-5 items from Case Study I and/or II, that you learned in analyzing your two companies and/or the overall process of financial statement analysis process discussed throughout the semester that you feel will be beneficial specifically to your future career progression. This should be a formal and professional looking document.
CASE STUDY PART 1 – ALREADY SOLVED
|Wells Fargo & Company|
|(all $ figures in millions)|
|Working Capital||Current Assets-Current Liabilities||$ (284,314.00)||$ (228,900.00)|
|Current Ratio||Current Assets/Current Liabilities||82.09%||85.13%|
|Quick Ratio||(Current Assets-Inventory)/Current Liabilities||NA||NA|
|Debt Ratio||Total Debt/Total Assets||90.24%||90.49%|
|Return on Assets||Net Income/Average Assets||1.04%||0.09%|
|Net Income as a Percent of Sales||Net Income/Total Revenue||25.81%||2.36%|
|Asset Turnover||Net Sales/Average Total Assets||0.04||0.04|
|Liabilities-to-Equity Ratio||Total Liabilities/Total Equity||9.25||9.52|
|Gross Profit Margin||Gross Profit/Total Revenue||94.71%||90.09%|
|Operating Expense Margin||Operating Expense/Total Revenue||68.57%||77.69%|
|Return on Equity||Net Income/Total Equity||10.65%||0.92%|
|DuPont Decomposition||Net Profit Margin x Asset Turnover x Equity Multiplier||10.77%||0.92%|
|Disaggregation of Return on Assets||Profit Margin x Asset Turnover||1.04%||0.09%|
|Accounts Receivable Turnover|
|Accounts Receivable as a percentage of Sales||Accounts Receivable/Total Revenue||47.59%||77.39%|
|JPMorgan Chase & Co|
|(all $ figures in millions)|
|Working Capital||Current Assets-Current Liabilities||$ (455,022.00)||$ (405,412.00)|
|Current Ratio||Current Assets/Current Liabilities||85.58%||85.56%|
|Quick Ratio||(Current Assets-Inventory)/Current Liabilities||NA||NA|
|Debt Ratio||Total Debt/Total Assets||92.14%||91.75%|
|Return on Assets||Net Income/Average Assets||1.30%||0.90%|
|Net Income as a Percent of Sales||Net Income/Total Revenue||39.72%||24.38%|
|Asset Turnover||Net Sales/Average Total Assets||0.03||0.04|
|Liabilities-to-Equity Ratio||Total Liabilities/Total Equity||11.73||11.12|
|Gross Profit Margin||Gross Profit/Total Revenue||92.42%||90.09%|
|Operating Expense Margin||Operating Expense/Total Revenue||58.63%||55.79%|
|Return on Equity||Net Income/Total Equity||16.43%||9.81%|
|DuPont Decomposition||Net Profit Margin x Asset Turnover x Equity Multiplier||16.86%||11.63%|
|Disaggregation of Return on Assets||Profit Margin x Asset Turnover||1.36%||0.96%|
|Accounts Receivable Turnover|
|Accounts Receivable as a percentage of Sales||Accounts Receivable/Total Revenue||84.29%||75.75%|
- What public accounting firm audited the financial statements and what is the date of their audit opinion?
JPMorgan Chase: The Audit Committee has appointed PricewaterhouseCoopers LLP (“PwC”) as the Firm’s independent registered public accounting firm to audit the Consolidated Financial Statements of JPMorgan Chase and its subsidiaries. The date of the opinion is March 1,2022.
Wells Fargo: KPMG has been the audit firm of choice for Wells Fargo for over 85 years. The date of the opinion is March 2, 2022.
- What are the largest assets included in the company’s balance sheet? Are you surprised that is the largest asset? Why would a company of this type have a large investment in that asset?
For both Wells Fargo and JP Morgan Chase, the biggest assets on the balance sheets are loans. As both companies have the majority of their business exposure in commercial and consumer loans, it is quite natural for their assets to be heavily skewed towards this particular line item.
- What is the largest expense in the company’s income statement? Does that surprise you? Review the Management’s Discussion and Analysis noting the company’s explanation for their expense variances. As a potential investor, are there any comments that may concern you?
Selling, General and Administrative Expenses is by far the largest income statement expense for both companies. It is worth noting that the bulk of this expense is attributable to Salaries and Wages. This is quite natural for a bank, the primary function of which is to sell financial services. Management’s Discussion and Analysis for both companies note that both compensation and non-compensation expenses have been rising. However, the two companies cite slightly different reasons for the rise in expenses. As a potential investor, it is definitely worthwhile to examine the cost structure of both companies and pin down the exact cost drivers and their medium-long term outlook.
• Who did you think are the main users of these financials? Select three items in the notes accompanying the financial statements and explain briefly the importance of these items to people making decisions about this company.
The main users of the annual report and financials most likely belong to one of the following groups: management, current/potential investors, analysts, regulators and tax authorities, competitors, employees.
Some of the more important notes to the financial statements are the clarifications of the economic and accounting techniques and assumptions used in order to come up with the comprehensive financial statements presented in the annual reports. In this regard, notes such as the basis of presentation, and/or the principles of fair value measurement are instrumental for anyone trying to assess the financial health of the firm.
Credit Risk Assessment
As a credit manager for a national bank considering extending a loan in the size of 10% of total assets of either Wells Fargo or JP Morgan, there are a number of key metrics to consider. In order to perform a high level credit risk assessment between the two firms, it is essential to base the opinion on the recent annual reports of the firms and their thorough analysis. In this regard, it is sensible to refer to Section I of this document to provide the data-driven foundation for this report.
When comparing the financial metrics for both companies for the two most recent years, there are several key areas where they differ. Firstly, let’s look at the liquidity side of both businesses. It is worth noting that for both firms, current liabilities exceed current assets. A current ratio smaller than 1 indicates a negative working capital balance and generally indicates that the company is not able to cover its current liabilities in the short term. Having said this, it is also important to note that such a situation is quite common in the banking industry and given the nature of the business, the companies are assumed to have easy access to various sources of financing which they can use to cover their liabilities. In this sense, it is only relevant to point out that while both Wells Fargo and JP Morgan have current ratios in the same range, JP Morgan seems to have a more stable current ratio from year to year. Same is true for the Net Working Capital values for both firms.
Secondly, to assess the strength of both banks’ business models, it is essential to look at the key margins calculated for each of the firms. JPMorgan shows a significantly higher Net Profit Margin compared to Wells Fargo, and also shows less volatility and higher growth from year to year. Gross Profit Margins are very similar for both banks but Wells Fargo reports a significantly higher value of Operating Expenses as a percentage of Total Sales. This points out to a competitive advantage for JP Morgan as it requires less operating costs per one dollar of generated revenue. In this sense, JP Morgan shows both a higher profitability, as well as higher efficiency in generating revenue.
Thirdly, it is important to look at the capitalization of both banks. This implies looking at the composition of the balance sheet and trying to assess the degree of leverage that both companies use in order to maintain their assets and generate revenue from those assets. In this regard, it is noteworthy to mention that Wells Fargo has slightly lower Debt-Equity Ratios meaning that it is less leveraged compared to JP Morgan. In this sense, we can infer that Wells Fargo is slightly safer when it comes to downside risk.
Overall, both companies show healthy performance when compared to industry standards and have a profitable track record in the past years. Having said this, JP Morgan seems to have achieved a much higher level of profitability, as well as operational efficiency when it comes to providing a wide range of banking and financial services to a large number of various customers. This is manifested by more robust financial performance metrics in the past years. It is however true that JP Morgan is slightly more leveraged than Wells Fargo at this point. Synthesizing all of the information presented above, my decision would be to extend a credit in the size of 10% of the company’s assets to JP Morgan rather than Wells Fargo, since the operational capabilities and year-year stable growth manifested by financial statements of the firm inspire a greater degree of confidence in the bank’s ability to repay its liabilities and weather any unforeseen difficulties that may arise in the future.
From the perspective of an investment broker evaluating the investment prospects in either JP Morgan or Wells Fargo, there are a number of key metrics that need to be analyzed in order to make an informed and evidence-based decision. It is important to note that we are considering a sizeable investment (i.e. 10% of outstanding stock), which will most likely make us one of the biggest investors in either of the firms. Hence, it is important to have a clear understanding of risks and growth prospects for both firms.
When it comes to evaluating the business potential of each bank and the strength of their respective business models, we can largely rely on the analysis performed in Section I of this document. To briefly reiterate the findings, it is safe to say that JP Morgan has demonstrated a better ability to generate profit per one dollar of revenue, as well as a better ability to generate revenue per one dollar of operating expense. This means that JP Morgan is more effective in generating sales and is more efficient when it comes to the overall business model. It is also worth noting that JP Morgan Chase is a much larger company when it comes to market capitalization compared to Wells Fargo ($381.53B vs $174.74B). When it comes to the robustness of the business model, Wells Fargo has an advantage of being better capitalized (lower Debt/Equity ratio), hence implying less downside risk.
Having mentioned some of the metrics pertaining to the business and operations of each bank, it is important to outline some assumptions in order to come up with a relevant investment recommendation. First of all, in the context of this report we ignore the relative difference in the investment amount that is due to the stock price and the number of stocks outstanding for each firm. Secondly, we assume that the investment is a long-term commitment and is aimed at long-term value creation rather than a short-term investment. In this sense, in addition to the current financial performance of the firms, we would need to carry out a comprehensive analysis of the industry, as well as growth prospects of each of the individual firms. Lastly, we would need to come up with an in-house valuation incorporating all of our research and compare it to the current market price in order to evaluate the merits of each investment. While such a thorough analysis is beyond the scope of this report, we nonetheless try to provide a high level investment recommendation that is subject to further scrutiny. In this sense, we have established that JP Morgan has better business performance and larger customer base and market penetration. In addition, it is important to talk about industry trends. While both banks have a very long history that trace back to the foundations of American banking traditions, they are currently facing significant pressure as the market is flooded with digital banks offering some or most of the services offered by traditional banks, but without the usual hassle. In this sense, traditional financial institutions are forced to keep up with these developments. It would be sensible to conclude that JP Morgan with its superior operational capacity and higher profit margins and assets can be better equipped to handle this challenge. In the short-medium term, the banking industry may benefit from rising interest rates with growing demand for housing showing no signs of slowing down.
Taking into account the high level analysis presented above, and also taking into account the fact that most equity securities have seen price drops in the wake of a global uncertainty regarding the war in Ukraine, this paper recommends buying 10% of outstanding stocks of JP Morgan Chase & Co, due to its established brand in the financial services industry and its current and projected financial performance.
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