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Profitability Ratios

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The net profit margin is increasing in the three consecutive years considered. However, the modest gains could be attributed to the intense competition and high fuel costs. Based on the figures for net profit margin, they imply that British Airways could only gain 7. 93% profit on every pound of products and services sold. The P/E ratio of the market usually varies between 15-25 depending on market fluctuations. In general, a high P/E means high projected earnings in the future.

The P/E ratio would show that the company is projected to yield higher earnings. The P/E ratio implied that investors are willing to pay 3.97 times for every pound earned. The company did not reach the P/E ratio limits that are considered profitable. The low P/E ratio indicated the presence of certain risks on the company. For the Earnings yield calculations, in 2008, for every pence worth of stocks, the investor earns 25. 19%. This is a sharp improvement from the previous years’ earnings yield of 5. 25% and 11. 42 for 2007 and 2006 respectively. Investors had better returns on equity (ROE) in 2006 compared to 2007 to 2008. In 2007, ROE dropped by almost half but investors were able to gain back substantial equity in 2008 at 22. 88%.

After doing all the necessary computations to determine the current and possible future performances of British Airways, plc, it is recommended that the client be cautious in investing in the company’s stocks. There are several reasons why: The current ratio is of BA is below 1. This implies that the company may have some difficulty settling debts when it is demanded. The company has a narrow profit margin. However, when one compared the performance in the last three years, there is some improvements in profitability The stock prices have dropped sharply as a result of the current financial crisis.

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The volatility and uncertainty of the market might affect demand for air travel services. The price/earnings ratio of 2007 dropped sharply from the previous year’s 19. 059 to 3. 97. This is a cause for concern because this would spell a difference in the potential earnings of the money invested in the firm. In the findings, British Airways, plc is expected to weather the current financial crunch. The company has sound financial foundations and the investor can make some stock investments on the company on the following grounds: The company’s market position as one of the world’s largest airline company.

The worst scenario for the investor if the economic problem worsens is relatively flat earnings. Other Considerations It is not enough to rely solely on financial metrics to determine the viability of a business organisation. One must also consider prevailing factors that may play a significant role in the performances of British Airways. Valuable data could also be derived from political, economic and social events that may have effects on the performances of stocks. For example, one must be aware of the type of market structure it operates.

In general, the market structure of the airline industry is oligopoly. When “oligopolistic firm cuts its price, it is met with price reductions by competing firms; however, if it raises the price of its product, rivals do not match the price increase. For this reason, prices may remain stable in an oligopolistic industry for a prolonged period of time” (Oligopoly n. d. ). There are three models of oligopoly namely Cournot Competition, Stackelberg Competition and Bertrand Competition. Firms in Cournot Competition “simultaneously compete in terms of quantity supplied to the market” (Chapter 4: Oligopoly n.d. ).

In Stackelberg competition one or more firms are able to initially precommit themselves to a particular output level. The remaining firms observe this level of output and then simultaneously determine their own optimal output levels. Finally, in Bertrand competition firms simultaneously compete in terms of the price they charge consumers (Chapter 4: Oligopoly n. d. ). The airline industry is governed by the Bertrand competition principle where customers determine which company to patronize base on their price offerings.

In the Bertrand principle, the firm that offers the lowest price can expect more customers. If two firms are offering identical services, the firm with the lowest price will get the approval of price conscious customers. However, in reality such a situation will yield the Bertrand Paradox. It becomes a “paradox because it seems implausible to believe that so few firms would not find some way of colluding so as to move away from the competitive outcome, in order to earn supernormal profits” (Chapter 4: Oligopoly n. d. ).

For firms within the sphere of Bertrand competition to avoid getting into this paradox is for them to interact closely and frequently or sell differentiated products and services. One also needs to consider extreme events that affect stock market performances. Extreme events, according to Gettinby et al (2004) include a wide range of occurrences that can be catastrophic. They could be of natural causes such as earthquakes, storms, drought and other natural disasters. They could also be man-made such as air quality, share price movements, horse racing and other similar events.

Extreme events in the context of finance could be stock market crashes (p. 612). Studying extreme events in finance have become a concern of investors and risk managers (p. 613). Longin (1996) defined extreme events in finance as “the lowest daily return or the highest daily return (the maximum) of the stock market index over a given period” (p. 384)(qtd in Gettinby et al, 2004, p. 613). Danielsson and De Vries (1997) consider extreme events to “occur infrequently, and therefore will not exhibit time dependence or be related to a particular level of volatility” (qtd in Gettinby et al 2004, p.613).

While stock market crashes are significant events, efficient market hypothesis could only offer the possibility of disclosing information that could be damaging. However, post-crash analysis would only yield inconclusive results (Johansen, Ledoit & Sornette, 2000, p. 220). Not one but several consecutive events that build up over time are often the causes of market collapse. Overall, the extreme events will always pose a challenge for investors to overcome. With the right information, the investor can make wise decisions and avoid risky ventures.

Bibliography

  1. Basic Chart. 2008. [Online] Available at: http://uk. finance. yahoo. com/q/bc? t=2y&s=BAY. L&l=on&z=m&q=l&c=&c=%5EFTSE [Accessed 17 December 2008]
  2. British Airways. 2008. Annual Report and Accounts 2007-2008[Online] Available at: http://www. britishairways. com/cms/global/microsites/ba_reports/pdfs/BA_Report_2007_08. pdf [Accessed 12 December 2008]
  3. British Airways. 2005. Annual Report and Accounts 2004-2005 [Online] Available at: http://media. corporate-ir. net/media_files/irol/69/69499/AnnualReportandAccounts2004-2005. pdf [Accessed 12 December 2008]
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