Statement of the problem
The financial performance of National Electric Corporation had fallen short of prediction for all the quarters of 1992 as well as for the whole of the year. This was despite the fact that revenues had increased when compared to the previous year. The problem was even more puzzling to analysts because the company was headed by D.C. Burke who within a period of ten years had the earnings of the company double and its profits increase four times.
The problem here is for Janet Blair who is a portfolio manager in an investment company. Her company, through a mutual fund holds a significant amount of stock in National. She is in a dilemma as whether to reduce or increase her company’s share in National. The principal duty of Janet Blair is to see that her company’s funds are invested well and hence she analyses the company financial statements for the years 1992 and 1991. She has to make her decision soon.
Assumptions: National Electrical Company is a very professionally managed company with high growth prospects. Since it had shown a steady growth over the past ten years, the trend is expected to be reflected in future also. It would be worthwhile for investors to invest in the company and be assured of reasonable to good returns in the future. Another advantage is that the company’s interests are in widely diversified industries and hence risk is spread out to a great extent. But all the markets in which the company operates in highly competitive and dominated by much larger companies.
Key facts
National Electric Corporation is perceived to be a company that is worth investing in by financial experts. The company has business interests in the USA and 10 other countries. The company is mainly engaged in manufacture and supply of electrical equipment for transmission, generation and control of electricity. Its main customers are power companies, railroads, industries including marine industries and city transmission systems. It also has interests among other things, television and broadcasting, education, consumer durables and soft drinks.
The company also sells electronic equipment and instrumentation systems for the aerospace industry. It has also interests in the construction industry. The company is headed by D C Burke who is credited with having doubled the company sales and increasing its profit by 400% within a period of ten years he served the company in that capacity. Revenues of the company increased from $2 billion in 1983 to $1.8 billion by 1992. Earnings per share rose steadily from $1.02 to $2.24 in 1991. It fell to $1.82 and this was the primary reason for investors like Blair to rethink strategy about investing in the company. Profits (net income) also fell from 198 million in 1991 to 161 million in 1992. But total revenue actually increased from $5.086 billion in 1991 to $5.702 billion in 1992. The main reason for the fall in revenue was losses incurred by the company’s four subsidiaries, joint venture losses and other logistic reasons.
Alternative Solutions
- Janet Blair can hold on the current shares without either increasing or decreasing her company’s investment in National
- She can divest the entire portfolio held in National.
Option A would be a safe option because even though profits and consequently earnings per share has decreased when compared to the previous year, the company still has declared a dividend of $1.82 per share which is not significantly lower than the $2.24 per share declared last year. She can still earn a sizeable income for her company. Even though profits have fallen, the reasons attribute were not because of the parent company’s poor performance. Option B is to sell off the entire portfolio in the company. This would mean that even though the company can use the money so earned to invest in other profitable ventures, they can only reinvest in National Electrical Company by possibly buying shares at a much higher price in the future.
Decision: Janet Blair will hold on to the current portfolio and to indulge in a wait and watch situation. The current negative reversal of fortunes of National Electric Corporation is no indication that the company could be in trouble. As per the statement given by Mr Burke, the cause of the current performance is due to the poor performance of four of its subsidiaries. The company also made the mistake of expanding too rapidly in handling too many projects at a time. The CEO had promised that all efforts were made to things profitable and the company revenue is expected to touch $ 6 billion by the end of 1993. There is a high possibility that this would be the case with National Electric Corporation. The best option for Janet Blair would be to wait and see for some more time in 1993 and to take a decision after analysing the performance of the company during first and second quarter of that year. Hence the investment in National Electric Corporation will remain until the first or second quarter of the coming financial year.