Download - Hcl- Profitabilty Ratios

Electronic copy available at: http://ssrn.com/abstract=1672242

ANALYSIS OF THE PROFITABILITY RATIOS OF HCL1

COMPANY PROFILE: HCL

Company overview

HCL Enterprise is a leading Global Technology and IT enterprise that comprises two

companies listed in India - HCL Technologies & HCL Infosystems. The 3-decade-old

enterprise, founded in 1976, is one of India's original IT garage startups. Its range of offerings

spans Product Engineering, Custom & Package Applications, BPO, IT Infrastructure

Services, IT Hardware, Systems Integration, and distribution of ICT products. The HCL team

comprises approximately 45,000 professionals of diverse nationalities, who operate from 17

countries including 360 points of presence in India. HCL has global partnerships with several

leading Fortune 1000 firms, including leading IT and Technology firms.

HCL Technologies is one of India's leading global IT Services companies, providing

software-led IT solutions, remote infrastructure management services and BPO. Having made

a foray into the global IT landscape in 1999 after its IPO, HCL Technologies focuses on

Transformational Outsourcing, working with clients in areas that impact and re-define the

core of their business. The company leverages an extensive global offshore infrastructure and

its global network of offices in 18 countries to deliver solutions across select verticals

including Financial Services, Retail & Consumer, Life Sciences & Healthcare, Hi-Tech &

Manufacturing, Telecom and Media & Entertainment (M&E). For the quarter ended 31st

December 2007, HCL Technologies, along with its subsidiaries had last twelve months

(LTM) revenue of US $ 1.65 billion (Rs. 6715 crores) and employed 47,954 professionals.

Born in 1976, HCL has a 3 decade rich history of inventions and innovations. In 1978,

HCL developed the first indigenous micro-computer at the same time as Apple and 3 years

before IBM's PC. This micro-computer virtually gave birth to the Indian computer industry.

The 80's saw HCL developing know-how in many other technologies. HCL's in-depth

knowledge of Unix led to the development of a fine grained multi-processor Unix in 1988,

three years ahead of Sun and HP.

HCL's R&D was spun off as HCL Technologies in 1997 to mark their advent into the

software services arena. During the last eight years, HCL has strengthened its processes and

applied its know-how, developed over 30 years into multiple practices - semi-conductor,

1 Tarumoy Chaudhuri, Student pursuing B.B.A. L.L.B. (Hons.) at National Law University (Jodhpur).

Electronic copy available at: http://ssrn.com/abstract=1672242

operating systems, automobile, avionics, bio-medical engineering, wireless, telecom

technologies, and many more.

Today, HCL sells more PCs in India than any other brand, runs Northern Ireland's

largest BPO operation, and manages the network for Asia's largest stock exchange network

apart from designing zero visibility landing systems to land the world's most popular

airplane.

INTRODUCTION TO RATIO ANALYSIS

When it comes to investing, analyzing financial statement information (also known as

quantitative analysis) is one of the most important elements in the fundamental analysis

process. At the same time, the massive amount of numbers in a company's financial

statements can be bewildering and intimidating to many investors. However, through

financial ratio analysis, they will be able to work with these numbers in an organized fashion.

Purposes and Considerations of Ratios and Ratio Analysis

Ratios are highly important profit tools in financial analysis that help financial

analysts implement plans that improve profitability, liquidity, financial structure, reordering,

leverage, and interest coverage. Although ratios report mostly on past performances, they can

be predictive too, and provide lead indications of potential problem areas.

Ratio analysis is primarily used to compare a company's financial figures over a

period of time, a method sometimes called trend analysis. Through trend analysis, you can

identify trends, good and bad, and adjust your business practices accordingly. You can also

see how your ratios stack up against other businesses, both in and out of your industry.

There are several considerations one must be aware of when comparing ratios from

one financial period to another or when comparing the financial ratios of two or more

companies.

If one is making a comparative analysis of a company's financial statements over a

certain period of time, an appropriate allowance for any changes in accounting

policies that occurred during the same time span should be made

When comparing one business with another in the same industry, any material

differences in accounting policies between your company and industry norms should

be allowed.

When comparing ratios from various fiscal periods or companies, inquiry about the

types of accounting policies used should be done. Different accounting methods can

result in a wide variety of reported figures.

Determine whether ratios were calculated before or after adjustments were made to

the balance sheet or income statement, such as non-recurring items and inventory or

pro forma adjustments. In many cases, these adjustments can significantly affect the

ratios.

Any departures from industry norms should be carefully examined.

When we use ratio analysis we can work out how profitable a business is, we can tell

if it has enough money to pay its bills. Ratio analysis can also help us to check whether a

business is doing better this year than it was last year; and it can tell us if our business is

doing better or worse than other businesses doing and selling the same things. The key

question in ratio analysis isn't only to get the right answer: for example, to be able to say that

a business's profit is 10% of turnover.

We can use ratio analysis to try to tell us whether the business

1. is profitable

2. has enough money to pay its bills

3. could be paying its employees higher wages

4. is paying its share of tax

5. is using its assets efficiently

6. has a gearing problem

7. is a candidate for being bought by another company or investor

and more, once we have decided what we want to know then we can decide which ratios we

need to solve the problem facing us.

Any successful business owner is constantly evaluating the performance of his or her

company, comparing it with the company's historical figures, with its industry competitors,

and even with successful businesses from other industries. To complete a thorough

examination of your company's effectiveness, however, you need to look at more than just

easily attainable numbers like sales, profits, and total assets. You must be able to read

between the lines of your financial statements and make the seemingly inconsequential

numbers accessible and comprehensible.

This massive data overload could seem staggering. Luckily, there are many well-

tested ratios out there that make the task a bit less daunting. Comparative ratio analysis helps

you identify and quantify your company's strengths and weaknesses, evaluate its financial

position, and understand the risks you may be taking.

As with any other form of analysis, comparative ratio techniques aren't definitive and

their results shouldn't be viewed as gospel. Many off-the-balance-sheet factors can play a role

in the success or failure of a company. But, when used in concert with various other business

evaluation processes, comparative ratios are invaluable.

Not everyone needs to use all of the ratios we can put in these categories so the table

that we present at the start of each section is in two columns: basic and additional.

The basic ratios are those that everyone should use in these categories whenever we are

asked a question about them. We can use the additional ratios when we have to analyse a

business in more detail.

Use and Limitations of Financial Ratios

Attention should be given to the following issues when using financial ratios:

A reference point is needed. To be meaningful, most ratios must be compared to

historical values of the same firm, the firm's forecasts, or ratios of similar firms.

Most ratios by themselves are not highly meaningful. They should be viewed as

indicators, with several of them combined to paint a picture of the firm's situation.

Year-end values may not be representative. Certain account balances that are used to

calculate ratios may increase or decrease at the end of the accounting period because

of seasonal factors. Such changes may distort the value of the ratio. Average values

should be used when they are available.

Ratios are subject to the limitations of accounting methods. Different accounting

choices may result in significantly different ratio values.

USERS OF ACCOUNTING INFORMATION

The list of categories of readers and users of accounts includes the following people

and groups of people:

Investors

Lenders

Managers of the organisation

Employees

Suppliers and other trade creditors

Customers

Governments and their agencies

Public

Financial analysts

Environmental groups

Researchers: both academic and professional

WHAT DO THE USERS OF ACCOUNTS NEED TO KNOW?

Investors to help them determine whether they should buy shares in the

business, hold on to the shares they already own or sell the shares they

already own. They also want to assess the ability of the business to

pay dividends.

Lenders to determine whether their loans and interest will be paid when due

Managers might need segmental and total information to see how they fit into

the overall picture

Employees information about the stability and profitability of their employers to

assess the ability of the business to provide remuneration, retirement

benefits and employment opportunities

Suppliers and other

trade creditors

businesses supplying goods and materials to other businesses will read

their accounts to see that they don't have problems: after all, any

supplier wants to know if his customers are going to pay their bills!

Customers the continuance of a business, especially when they have a long term

involvement with, or are dependent on, the business

Governments and

their agencies

the allocation of resources and, therefore, the activities of business. To

regulate the activities of business, determine taxation policies and as

the basis for national income and similar statistics

Local community Financial statements may assist the public by providing information

about the trends and recent developments in the prosperity of the

business and the range of its activities as they affect their area

Financial analysts they need to know, for example, the accounting concepts employed

for inventories, depreciation, bad debts and so on

Environmental

groups

many organisations now publish reports specifically aimed at

informing us about how they are working to keep their environment

clean.

Researchers researchers' demands cover a very wide range of lines of enquiry

ranging from detailed statistical analysis of the income statement and

balance sheet data extending over many years to the qualitative

analysis of the wording of the statements

WHICH RATIOS WILL EACH OF THESE GROUPS BE INTERESTED IN?

Interest Group Ratios to watch

Investors Return on Capital Employed

Lenders Gearing ratios

Managers Profitability ratios

Employees Return on Capital Employed

Suppliers and other trade creditors Liquidity

Customers Profitability

Governments and their agencies Profitability

Local Community This could be a long and interesting list

Financial analysts Possibly all ratios

Environmental groups Expenditure on anti-pollution measures

Researchers Depends on the nature of their study

Therefore from the above table it is clear that profitability ratios are generally

required by owners, managers, customers, governments and their agencies. There can be still

more interest groups who will be interested in these ratios.

PROFITABILITY RATIOS

Profitability ratios are a class of financial metrics that are used to assess a business's

ability to generate earnings as compared to its expenses and other relevant costs incurred

during a specific period of time. For most of these ratios, having a higher value relative to a

competitor's ratio or the same ratio from a previous period is indicative that the company is

doing well. Profitability ratios focus on how well a firm is performing. Profit margins

measure performance with relation to sales. Rate of return ratios measure performance with

relation to the size of the investment.

The owners and management or the company itself are interested in the financial

soundness of the firm apart from its creditors. The management of the firm is naturally eager

to measure its operating efficiency. Similarly, the owners invest their funds in the expectation

of reasonable returns. The operating efficiency of a firm and its ability to ensure adequate

returns to its shareholders depends ultimately on the profits earned by it.

In other words, the profitability ratios are designed to provide answers to questions

such as

(i) Is the profit earned by the firm adequate?

(ii) What rate of return does it represent?

(iii) What is the rate of profit for various divisions and segments of the firm?

(iv) What are the earnings per share?

(v) What was the amount paid in dividends?

(vi) What is the rate of return to equity shareholders?

The profitability ratios can be sub-divided into two categories:

A. In relation to sales which include gross profit ratio, net profit ratio and operating

profit ratio

B. In relation to investments which include return on assets, return on return on

capital employed and return on shareholder’s equity

Profit is the difference between turnover, or sales, and costs: that is,

Profit = Sales – costs

A profit margin is one of the profit figures we just mentioned shown as a percentage

of turnovers or sales. They always tell us how much profit, on average, our business has

earned per Rupee of turnover or sales.

In the following pages, these ratios have been evaluated and analysed in detail.

A. Profitability Ratios Related to Sales

These ratios are based on the premise that a firm should earn sufficient profit on each rupee

of sales. If adequate profits are not earned on sales, there will be difficulty in meeting the

operating expenses and no returns will be available to the owners. These ratios are of three

types which are discussed below.

1. Gross profit Margin:

A company's cost of sales, or cost of goods sold, represents the expense related to

labor, raw materials and manufacturing overhead involved in its production process. This

expense is deducted from the company's net sales/revenue, which results in a company's first

level of profit, or gross profit. The gross profit margin is used to analyze how efficiently a

company is using its raw materials, labor and manufacturing-related fixed assets to generate

profits. A higher margin percentage is a favorable profit indicator.

It is also known as gross profit ratio. Profit margin measures the relationship

between profit and sales. Gross profit ratio is calculated by dividing gross profit by sales.

Thus,

Gross Profit Margin = Gross Profit x 100 Sales

Significance and uses of gross profit ratios

Gross profit ratio reveals profit earning capacity of the business with reference to its

sale. Increase in gross profit ratio will mean reduction in cost of production or direct expenses

or sale at reasonably good price and decrease in the ratio will mean increased cost of

production or sales at lesser price. The true efficiency or profitability of the business cannot

be understood by gross profit because profitability may be lesser, whereas gross profit is

more. So the gross profit ratio has to be calculated in order to have the correct view of the

business.

The gross profit ratio also acts as a guide to the management in determining its selling

and distribution expenses. There is no ideal standard for gross profit but it should be

sufficient to cover the selling expenses o the firm.

The effective stock control system can be adopted on the basis of gross profit ratio.

Higher gross profit ratio is always in the interest of the business.

Causes responsible for increase in gross profit ratio

Gross profit ratio may increase due to the following reasons:

1. Increase in the sale proceeds without corresponding increase in the cost of production

or purchase price of goods.

2. Under valuation of opening stock

3. Over valuation of closing stock

4. Decrease in the cost of production or purchase price without corresponding decrease

in sale price.

5. Decrease in direct expenses that is, expenses on acquiring or manufacturing goods

6. Omission of the invoices regarding purchases

Causes for decline in gross profit ratio

1. Purchasing of goods at relatively higher price. If the goods are purchased at

comparatively higher price the cost of goods will increase and reduce the margin of

profit.

2. Shortage of goods. Loss of goods due to theft, pilferage and spoilage will reduce the

quantity of goods to be sold and the sales will decrease. As the firm has paid for these

goods but is nor able to sell, the gross profits will fall.

3. Increase in the manufacturing expenses. An increase in the manufacturing expenses

such as carriage, freight, wages and power will increase the cost of production and

reduce the margin of profit.

4. Sales at comparatively low rates. Sales at lower rates will reduce margin of profit.

Efforts should be made to sell goods at competitive price.

The decline in the gross profit ratio must receive due attention of the management.

Possible reasons for its decline should be identified, thoroughly investigated and the remedial

measures applied.

HCL Infosystems ends its financial year in the month of June. Let us now look at the Gross

profit margin / Ratio of HCL Infosystems for the last three years:

June 2005 (Rs. in crores)

Gross Profit Margin = 7787-7141

x 100 7787

= 8.3 %

June 2006

(Rs. in crores)


x 100 11455

= 7.57 %

June 2007

(Rs. in crores)


x 100 11855

= 8.9 %

= 646

x 100 7787

= 867

x 100 11455

= 1055

x 100 11855

From the above chart it is clear that the gross profit ratio has dipped in the year 2006

before going to an all-time high of 8.9 % in 2007. The gross profit might have increased in

absolute terms but it has not done so in relation to sales. The total business revenue in terms

of sales has increased constantly over the years. But the gross profit ratio has not increased

constantly.

2. Operating Profit ratio

By subtracting selling, general and administrative (SG&A), or operating, expenses

from a company's gross profit number, we get operating income. Management has much

more control over operating expenses than its cost of sales outlays. Thus, investors need to

scrutinize the operating profit margin carefully. Positive and negative trends in this ratio are,

for the most part, directly attributable to management decisions.

A company's operating income figure is often the preferred metric (deemed to be

more reliable) of investment analysts, versus its net income figure, for making inter-company

comparisons and financial projections.

Operating profit = Profit before interest depreciation and taxes

= Profit before tax + Depreciation + Finance Charges

Gross profit Ratio

8.3

7.57

8.9

6.5

7

7.5

8

8.5

9

2005 2006 2007

Year

Gro

ss P

rofit

(in

%)

Gross Profit

June 05

(Rs. in crores)

= 3.96 %

June 06

(Rs. in crores)

= 3.46 %

June 07

(Rs. in crores)

= 3.83 %

Operating Profit Margin = Operating Profit

X 100 Sales

Operating Profit Margin = 308 X 100 7787



The operating profit ratio has seen a steep decline in the year 2006. The ratio has

recovered in the year 2007 but still it has not been able to reach the previous level of 3.96%.

3. Net Profit ratio

Often referred to simply as a company's profit margin, the so-called bottom line is the

most often mentioned when discussing a company's profitability. While undeniably an

important number, investors can easily see from a complete profit margin analysis that there

are several income and expense operating elements in an income statement that determine a

net profit margin. It behooves investors to take a comprehensive look at a company's profit

margins on a systematic basis.

The net profit ratio tells us the amount of net profit per Rupee of turnover a business

has earned. That is, after taking account of the cost of sales, the administration costs, the

selling and distributions costs and all other costs, the net profit is the profit that is left, out of

which they will pay interest, tax, dividends and so on.

Significance of net profit ratio

Net profit ratio shows the operational efficiency of the business. Decrease in the

ratio indicates managerial inefficiency and excessive selling and distribution expenses. In the

same way, increase shows better performance. Increase or decrease in the ratio is determined

in comparison to previous year’s performance. In case of increase, performance of the

management should be appreciated and plus points reinforced. In case of decline in the net

Operating Profit Ratio

3.96

3.46

3.83

3.2

3.3

3.4

3.5

3.6

3.7

3.8

3.9

4

2005 2006 2007

Year

Ope

ratin

g P

rofit

(in

%)

Operating Profit

profit ratio an investigation to find out causes for the decline in the net profit is made and

corrective action should be taken to remove the causes responsible for the fall in the net profit

ratio.

Net profit = earnings after depreciation, interest and taxes

June 05

(Rs. in crores)

= 2.93 %

June 06

(Rs. in crores)

= 2.44 %

June 07

(Rs. in crores)

= 2.67 %

Net Profit Ratio = Net Profit X 100 Sales

Net Profit Ratio = 228 X 100 7787



The net profit ratio has also declined in the year as it is not immune to the effects of

the other ratios. But a point to be noted here is that the net profit ratio has not declined as

steeply as the gross profit or operating profit ratios. This might be due to less dividend or

interest paid.

Users of the accounting information need to understand that the absolute numbers in

the income statement don't tell us very much, which is why we must look to margin analysis

to discern a company's true profitability. These ratios help us to keep score, as measured over

time, of management's ability to manage costs and expenses and generate profits. The

success, or lack thereof, of this important management function is what determines a

company's profitability. A large growth in sales will do little for a company's earnings if costs

and expenses grow disproportionately.

B. Profitability ratios related to Investments

RETURN ON INVESTMENTS 1. RETURN ON ASSETS

This ratio indicates how profitable a company is relative to its total assets. The return

on assets (ROA) ratio illustrates how well management is employing the company's total

assets to make a profit. The higher the return, the more efficient management is in utilizing its

asset base. The ROA ratio is calculated by comparing net income to average total assets, and

is expressed as a percentage.

Net Profit ratio

2.93

2.442.67

0

0.5

1

1.5

2

2.5

3

3.5

2005 2006 2007

Year

Net P

rofit

(in

%)

Net Profit

Variations:

Some investment analysts use the operating-income figure instead of the net-income

figure when calculating the ROA ratio.

The need for investment in current and non-current assets varies greatly among

companies. Capital-intensive businesses (with a large investment in fixed assets) are going to

be more asset heavy than technology or service businesses.

In the case of capital-intensive businesses, which have to carry a relatively large asset

base, will calculate their ROA based on a large number in the denominator of this ratio.

Conversely, non-capital-intensive businesses (with a small investment in fixed assets) will be

generally favored with a relatively high ROA because of a low denominator number.

It is precisely because businesses require different-sized asset bases that investors

need to think about how they use the ROA ratio. For the most part, the ROA measurement

should be used historically for the company being analyzed. If peer company comparisons are

made, it is imperative that the companies being reviewed are similar in product line and

business type. Simply being categorized in the same industry will not automatically make a

company comparable.

As a rule of thumb, investment professionals like to see a company's ROA come in at

no less than 5%. Of course, there are exceptions to this rule. An important one would apply to

banks, which strive to record an ROA of 1.5% or above.

Total Assets = Fixed Assets + Investments + Current Assets

Average total assets = (Opening Balance of Assets + Closing balance of Assets) / 2

June 05 (Rs. in Crores)

= 16.88 %

June 06

Return on Assets = Net Profit X 100 Average Total Assets

Return on Assets = 228 X 100 1351

(Rs. in Crores)

= 16.27 %

June 07 (Rs. in Crores)

= 13.98 %

Here, it can be seen that there has been a steeper decline in the ROA ratio in the year

2007 as compared to the previous year. This is because the total assets have increased at a

greater rate in the latter year rather than the previous year. This has resulted in a greater

increase in the denominator of the ROA ratio as compared to its numerator which is the net

profit.

2. Return on Capital employed

This is one of the most important ratios for the measure of profitability. It is also

known as Return on Investment ratio. It indicates the relationship of net profit with capital

employed in the business. Here, return for calculating the return on investment will mean the

net profit before interest, tax and preference dividend. Net profit means net profit of the year

Return on Assets

16.88 16.27

13.98

02468

1012141618

2005 2006 2007

Year

ROA

(in %

)

ROA



excluding undivided profit and reserves. Investment here means capital employed meaning

long term funds.

Significance

Return on investment ratio measures, the operational efficiency and borrowing policy

of the enterprise. It also shows how effectively the capital employed in the business is used. It

shows the earning capacity of the net assets of the business. The ratio judges the performance

of even dissimilar business or different departments of the same business.

Loan component in capital employed

Capital employed consists of shareholder’s funds and long term loans. Loans have

always been a blessing for an efficient company, because it earns income at rates higher than

the rate of interest paid by it on loans. Loans, if judiciously used in productive activities earn

income more than what the interest is paid on them, so in these cases shareholders gain from

loan being as part of capital employed.

Uses:

1. Return on investment is a very significant ratio for measuring operation efficiency of

the management.

2. It measures overall profitability of the business.

3. It is used for comparing the performance of the different departments and sections of

the organization.

4. It can also be used to compare the profitability of the firm with other firms of the

industry.

5. It helps in making investment decisions.

6. It also assists in planning capital structure of the company. It enables the enterprise in

deciding the ratio of various long term sources in the capital structure of the company.

7. It helps in determining the price of the product.

The return on capital employed (ROCE) ratio, expressed as a percentage,

complements the return on equity (ROE) ratio by adding a company's debt liabilities, or

funded debt, to equity to reflect a company's total "capital employed". This measure narrows

the focus to gain a better understanding of a company's ability to generate returns from its

available capital base.

By comparing net income to the sum of a company's debt and equity capital, investors

can get a clear picture of how the use of leverage impacts a company's profitability. Financial

analysts consider the ROCE measurement to be a more comprehensive profitability indicator

because it gauges management's ability to generate earnings from a company's total pool of

capital.

Variations:

Often, financial analysts will use operating income (earnings before interest and taxes

or EBIT) as the numerator. There are various takes on what should constitute the debt

element in the ROCE equation, which can be quite confusing. Our suggestion is to stick with

debt liabilities that represent interest-bearing, documented credit obligations (short-term

borrowings, current portion of long-term debt, and long-term debt) as the debt capital in the

formula.

Significance:

The return on capital employed is an important measure of a company's profitability.

Many investment analysts think that factoring debt into a company's total capital provides a

more comprehensive evaluation of how well management is using the debt and equity it has

at its disposal. Investors would be well served by focusing on ROCE as a key, if not the key,

factor to gauge a company's profitability. An ROCE ratio, as a very general rule of thumb,

should be at or above a company's average borrowing rate.

Unfortunately, there are a number of similar ratios to ROCE, as defined herein, that

are similar in nature but calculated differently, resulting in dissimilar results. First, the

acronym ROCE is sometimes used to identify return on common equity, which can be

confusing because that relationship is best known as the return on equity or ROE. Second, the

concept behind the terms return on invested capital (ROIC) and return on investment (ROI)

portends to represent "invested capital" as the source for supporting a company's assets.

However, there is no consistency to what components are included in the formula for

invested capital, and it is a measurement that is not commonly used in investment research

reporting.

Return on Capital Employed = Net Profit X 100 Average Total Capital Employed

Total Capital = Shareholder’s Funds + Loan Funds

Average total Capital Employed = (Opening Balance of Total Capital + Closing Balance

of Total Capital) / 2

June 05

(Rs. in Crores)

Average Capital Employed = (644 + 500) / 2 = 646

= 35.3 %

June 06

(Rs. in Crores)


= 38.94 %

June 07

(Rs. in Crores)


= 33.23 %

Return on Capital Employed = 228 X 100 646



There had been a phenomenal increase in the average total capital employed in the

year 2007 in comparison to the year 2006. On the other hand, the net profit has not been able

to keep pace with this increase in capital employed. This has resulted in a steep decline in the

ROCE ratio after a modest rise in the previous year.

2. Return on Shareholder’s Equity

This ratio indicates how profitable a company is by comparing its net income to its

average shareholders' equity. The return on equity ratio (ROE) measures how much the

shareholders earned for their investment in the company. The higher the ratio percentage, the

more efficient management is in utilizing its equity base and the better return is to investors.

Significance of Return on equity

This ratio reflects how effectively equity shareholders funds are utilized. It measures

the operational efficiency of the management. Higher ratio is always in the interest of the

enterprise, because it proves efficiency of the management. This ratio helps in the

comparison of performance and decision making regarding declaration of dividend and

creation of reserve.

Variations:

If the company has issued preferred stock, investors wishing to see the return on just

common equity may modify the formula by subtracting the preferred dividends, which are

not paid to common shareholders, from net income and reducing shareholders' equity by the

Return on Capital Employed

35.3

38.94

33.23

3031323334353637383940

2005 2006 2007

Year

ROCE

(in

%)

Return on Capital Employed

outstanding amount of preferred equity.

Significance:

Widely used by investors, the ROE ratio is an important measure of a company's

earnings performance. The ROE tells common shareholders how effectively their money is

being employed. Peer company, industry and overall market comparisons are appropriate;

however, it should be recognized that there are variations in ROEs among some types of

businesses. In general, financial analysts consider return on equity ratios in the 15-20% range

as representing attractive levels of investment quality.

While highly regarded as a profitability indicator, the ROE metric does have a

recognized weakness. Investors need to be aware that a disproportionate amount of debt in a

company's capital structure would translate into a smaller equity base. Thus, a small amount

of net income (the numerator) could still produce a high ROE off a modest equity base (the

denominator).

Return on Shareholder’s Equity = Net Profit X 100 Average Total Shareholder’s Equity

Total Shareholder’s Equity = Capital + Reserves and Surplus

June 05

(Rs. in Crores)

Average Total Shareholder’s Equity = (555 + 423) / 2 = 489

Return on Shareholder’s Equity = 228 X 100 489

= 46.63 %

June 06

(Rs. in Crores)



= 44.66 %

June 07

(Rs. in Crores)



= 40.56 %

The return on equity ratio has gone down over the period of three years which is a

natural consequence of the gradual increase in the net profit and a rapid increase in the

amount of loans and reserves and surplus without any increase in the equity capital. As a

result the numerator of the ratio has increased gradually and the denominator has increased

rapidly. This has brought down the ratio.

Return on Shareholder's Equity

46.63

44.66

40.56

373839404142434445464748

2005 2006 2007

Year

Retu

rn o

n Eq

uity

(in

%)

Return on Shareholder'sEquity

OTHER PROFITABILITY RATIOS: 1. EARNINGS PER SHARE

Earning per share

The ratio measures the market worth of the shares of the company. Higher earning per

share shows better future prospects of the company. It measures the return per share

receivable by equity shareholders.

Earnings per Share = Net Profit available to Equity holders No. of Equity shares Outstanding

June 05

(Rs. in Crores)

Earnings per Share = 2280000000 33,436,354

= Rs. 68.19

June 06

(Rs. in Crores)

Earnings per Share = 2800000000 168729255

= Rs. 16.59

June 07

(Rs. in Crores)

Earnings per Share = 3160000000 169152650

= Rs. 18.68

Earnings per Share

68.19

16.59 18.68

0

10

20

30

40

50

60

70

80

2005 2006 2007

Year

EPS

(in R

s.)

Earnings per Share

The earning per share had a steep decrease in the year 2006. This was a direct

consequence of the sudden rise in the number of shares in the year 2006. The company had

tried to come back by bringing up the EPS in 2007 to a modest 18.68 as the number of shares

had not increased much during that period.

2. DIVIDEND PER SHARE

It is the amount of the dividend that shareholders have (or will) receive, over an year,

for each share they own. It is similar to the EPS. Here the proposed dividend (the dividend

declared by the company) is divided by the total number of ordinary shares.

Dividend per Share = Dividend paid to Ordinary Shareholders No. of ordinary Shareholders outstanding

June 05

(Rs. in Crores)

Dividend per Share = 334694000 33,436,354

= Rs. 10

June 06

(Rs. in Crores)

Dividend per Share = 337500000 168729255

= Rs. 2

June 07

(Rs. in Crores)

Dividend per Share = 339100000 169152650

= Rs. 2

The dividend per share has also fallen drastically from Rs. 10 to Rs. 2 in the last two

years. This is because the proposed dividend of the company depends upon two factors,

namely, the profits available for appropriation and the number of shares. As there was a great

increase in the number of shares, the proposed dividend had to come down especially due to

the slow rise in profits.

3. PRICE EARNINGS RATIO

In general, a high P/E suggests that investors are expecting higher earnings growth in

the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the

whole story by itself. It's usually more useful to compare the P/E ratios of one company to

other companies in the same industry, to the market in general or against the company's own

historical P/E. It would not be useful for investors using the P/E ratio as a basis for their

investment to compare the P/E of a technology company (high P/E) to a utility company (low

P/E) as each industry has much different growth prospects.

The P/E is sometimes referred to as the "multiple", because it shows how much

investors are willing to pay per dollar of earnings. If a company were currently trading at a

multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1

of current earnings.

It is important that investors note an important problem that arises with the P/E

measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is

Dividend per Share

10

2 2

0

2

4

6

8

10

12

2005 2006 2007

Year

DPS

(in R

s.)

Dividend per Share

based on an accounting measure of earnings that is susceptible to forms of manipulation,

making the quality of the P/E only as good as the quality of the underlying earnings number.

Price Earnings ratio = Market price of shares Earning per share

June 05

(Rs. in Crores)

Price Earnings ratio = 756 68.19

= 11.09

June 06

(Rs. in Crores)

Price Earnings ratio = 140 16.59

= 8.44

June 07

(Rs. in Crores)

Price Earnings ratio = 185.3 18.68

= 9.92

The market value of the shares of HCL Infosystems has fallen in the year 2006 due to

reduced EPS. This ratio reflects the price currently being paid by the market for each rupee of

currently reported EPS. Since the EPS had fallen steeply in 2006, the Price earnings ratio has

also come down. Then with an increase in the EPS the market had also reposed some trust in

the company due to which the P/E ratio has risen in 2007.

Price Earnings Ratio

11.09

8.449.92

0

2

4

6

8

10

12

2005 2006 2007

Year

P/E

Ratio

Price Earnings Ratio

SWOT ANALYSIS

Strengths:

It has a large customer base in South India that can be utilized for introducing new

products.

Infosystems, network integration is a logical high that it had to take in a network-centric

IT world.

In the process, it gave its IT services customers benefit of a one-window source for not

only IT hardware/software solutions, but also their networking needs. This IT

powerhouse strongly believes that at the end of the day, applications is what matters to

customers.

HCL Infosystems has built a service model that utilizes all its intrinsic advantages. It has

a layer of IT/networks support available in 151 locations as its foundation.

For this integrator, the emphasis has been on the traditional manufacturing, and banking

and finance sectors. It won two huge orders for networking—Bank of Rajasthan and

Indian Overseas Bank.

Weaknesses:

Networking is a relatively new field for HCL

It is not known for its networking solutions

The initial research costs have run high which is reflected in its profitability ratios

Large companies may opt for relatively experienced network service providers

Opportunities:

However, it is aggressively looking to tap emergsing markets like the ISP and telecom

sector.

It has already done a few projects in this area with the implementation of its own sister

company HCL Infinet.

Likewise, this year HCL Infosystems is confident to do well in CTI, unified messaging

and e-business solutions area, with the recent tie-up with Intel.

Threats:

There are more established and focused players in the software market in India like

Infosys.

Besides, software piracy has a direct effect on the revenue of these firms. To prevent this,

a lot of money has to be spent.

RECOMMENDATIONS

On the basis of the above profitability analysis, the following recommendations are

made:

1. Profitability ratios related to sales:

Special attention has to be paid to the profitability ratios related to sales. The gross

profit ratio has to be paid special attention to ensure that it grows at the same pace in

which it has started growing from the last year. For this the cost of sales has to be

brought down on the one hand and on the other hand, the revenue from sales has to be

increased. For increasing sales, aggressive advertising and marketing strategies have

to be taken. This might result in increase of selling expenses initially thereby affecting

the operating profit. But it would reap benefits for the company ion the long term.

Funds could also be diverted towards research and development of new software and

improved hardware as these markets are very dynamic and there is strong competition

in these markets. If the profit margins go down again like what happened in 2006,

investor confidence on the ability of the company’s capacity to give steady returns

will diminish.

Special attention should also be paid to the operating and net profit ratios which have

not been able to come up to the levels achieved during 2005. For this, the

administrative and selling expenses have to be brought down by way of efficient

management. Also, a proper and effective dividend policy has to be adopted. If very

low dividends are proposed then the net profit may be high but the market prices of

shares may go down. So an optimum level of dividend has to be proposed.

2. Return on Assets:

Coming to the profitability ratios related to investments, the ROA ratio has shown a

trend of going down which is not good. The gross block has gone up but the

investments have come down which is not a very healthy sign. The company should

concentrate more on investments so that it can get return on its investment. The

present investment policies do not seem to be very fruitful. The company should

invest in places where the rate of return is higher.

3. Return on Capital Employed:

The return on investment or capital employed is in a serious situation indeed. The

number of shares has increased rapidly in the last year.the sudden increase in capital

in the last year has been due to two main reasons, namely, increase in reserves and

surplus and increase in unsecured loans. On the other hand, there has been no increase

in the capital at all. So this shows that the funds of the company by way of reserved

profits are not utilized properly. The held up reserves and surpluses are not even

invested fruitfully. Besides, the quantum of unsecured loans has also increased which

is another ominous sign for the business. So the company should try to pay off its

debts and raise more equity capital from the market. All these can happen only if the

company makes proper policies in order to enhance sales, make fruitful investments,

increase its goodwill in the market, etc.

4. Return on shareholder’s equity:

The return on shareholder’s equity has also gone down simply because there had been

a phenomenal rise in capital employed in the form of unsecured loans and reserves

and surplus with little increase in the net profit on the other hand. This situation

should be tackled as soon as possible or else the shareholder’s will lose confidence in

the company’s performance capacity and withdraw their money.

5. Earnings per Share, Dividend per Share & Price Earnings ratio:

The EPS had taken a nosedive in the year 2006 due to the sudden rise in the number

of shares. The EPS had now become stable because there had not been much rise in

the number of shares in the last year. But the point of concern for the company should

be that the EPS is very low, a mere Rs. 18.68. The EPS can be increased by only one

way presently that is by increasing the amount of profit available for appropriation.

The company should distribute a part of is reserves and surplus as it cannot invest that

money efficiently now. The benefit of doing this would be that the DPS and the P/E

ratio would go up and thus repose investor’s confidence in the company for the time

being. The DPS and the P/E ratio are directly affected by the EPS. So they have also

gone down along with the EPS though the P/E ratio has shown some signs of

improving.

LIMITATIONS

1. Difficulty in comparison

Firstly, HCL Infosystems closes its books on June 30 every year which is not the

usual date of year ending for most of the companies. This creates difficulty in

comparing the financial figures of HCL Infosystems with other companies in the same

industry.

2. Conceptual diversity

The companies operating in the same industry might follow different accounting

policies. The choices of accounting policies may distort inter company comparisons.

3. Creative accounting or Window Dressing

The businesses apply creative accounting in trying to show the better financial

performance or position which can be misleading to the users of financial accounting.

In order to improve on its profitability level the company may select in its revaluation

programme to revalue only those assets which will result in revaluation surplus

leaving those with revaluation deficits still at depreciated historical cost.

4. Ratios are not definitive measures

Ratios need to be interpreted carefully. They can provide clues to the company’s

performance or financial situation. But on their own, they cannot show whether

performance is good or bad. Ratios require some quantitative information for an

informed analysis to be made.

5. Outdated information in financial statement

The figures in a set of accounts are likely to be at least several months out of date, and

so might not give a proper indication of the company’s current financial position.

6. Seasoned factors

As stated above, the financial statements are based on year end results which may not

be true reflection of results year round. Businesses which are affected by seasons can

choose the best time to produce financial statements so as to show better results.

CONCLUSIONS

On the basis of the above analysis and discussion, it can be said that HCL Infosystems

are in the recovery stage now after going through a recessionary phase in 2006. But if the top

management does not frame suitable, efficient and affective policies at this stage, the overall

profitability of the company may go down again.

The recommendations made could be effective if they are implemented after doing a

thorough cost analysis of the various departments. The company has to make a favorable

impression in the minds of the investors. Only then it can aim for the success of its products

and services. If the investors’ faith goes away, they may withdraw their money from the

company which would result in a financial crunch for the company.

The profitability ratios present a true picture of the company’s performance. The

actual figures may mislead the management if they are not compared with other ratios by way

of various ratios.

ANNEXURE

2005

Download - Hcl- Profitabilty Ratios

Top Related