Restaurant industry average return on equity

Overview

In this assignment, you will be performing DuPont Analysis (discussed below), which focuses on return on equity, for a chosen firm from the restaurant industry. In the accompanying dataset to this assignment, you will find financial statement information for more than 50 restaurant firms over the years 2014-2017. You will analyze this data using the DuPont Method to draw inferences regarding firm performance. Afterwards, you will write a short memo regarding your findings.

The DuPont Analysis

The DuPont analysis is a method of evaluating the performance of a company and was named after the DuPont corporation, who first utilized the method in the 1920s. The analysis starts with the ratio, return on equity (ROE):

ROE =

where average shareholders’ equity is the average of a firm’s beginning and ending shareholders’ equity in any given year. Return on equity (ROE) tells us how much return a company generates on its shareholders’ behalf. Said another way, it tells us how much net income a company generates for each dollar invested by its shareholders. While ROE is obviously an important metric for shareholders, it would be naïve to make judgments and decisions based on this metric alone, as it provides little detail as to what factors are causing changes in a company’s ROE. To provide additional insight, we can decompose ROE into smaller components using the DuPont Method. In turn, we can gain a better understanding of what is driving ROE. We can first decompose ROE into two major drivers, return on assets (ROA) and financial leverage, where:

ROA = and Financial Leverage =

Notice that if we multiply ROA by Financial Leverage, the product is mathematically equivalent to ROE. ROA indicates how much net income is generated for each dollar of total assets that the company acquires. That is, it measures how effectively and efficiently a company uses its resources to generate profit and provides an indication of operating performance. The second component of ROE in this decomposition is financial leverage, which captures the degree to which a company’s assets are financed with equity, as opposed to debt. Thus, by decomposing ROE into ROA and financial leverage, we can determine to what extent a company’s financing and/or operating activities are driving the change in ROE.

Similar to the decomposition of ROE into 2 smaller components, we can gain further insight into a company’s operating performance when we break down ROA into 2 smaller components, return on sales (ROS) and asset turnover, where:

ROS = Asset Turnover =

Again, notice that if we multiply ROS by Asset Turnover, it is mathematically equivalent to ROA. ROS is a measure of probability and represents the amount of profit a company earns on each dollar of sales. Asset turnover is a measure of efficiency. It represents the magnitude of sales that a company generates for each dollar of assets. Thus, we can see to what extent a company’s change in profitability is driven by its ability to generate sales, as opposed to the profitability of its sales. Bringing everything together, we can now see that:

ROE = Return on Sales × Asset Turnover × Financial Leverage

or

ROE = Profitability × Efficiency × Leverage

This decomposition of ROE allows us to better determine which aspects of the company’s operations are driving ROE, and thus determine the advantages and disadvantages of the company. Generally, it is not desirable for the change in ROE to be largely driven by leverage, since a firm’s operating activities are, by nature, the most important aspect of a company’s ability to generate profits. In other words, if a company cannot operate its business well over a long-term period, they will eventually go bankrupt; it does not matter how they finance their activities. [While we could further perform financial ratio analysis to further investigate factors driving the 3 above components of ROE, this assignment is only intended to introduce financial analysis].

Last, but not least, any lesson in financial statement analysis stresses the importance of comparing financial numbers to draw insights. To provide a meaningful analysis, we need to be able to benchmark a company’s performance. For example, while a company may report a ROE of 15%, it may be the case that its competitors, on average, performed very well in a particular year. Therefore, a 15% ROE may be sub-par relative to the performance of a company’s competitors. There are several approaches to determining the competitors of a company to draw comparisons. The method we will use in this assignment is to compare your chosen firm to other firms in the same industry. To make these comparisons, you will calculate the mean of each financial ratio (discussed above) for each year.

Instructions

1. In the accompanying dataset to this assignment, you will find financial data for more than 50 firms from the restaurant industry. You will need to perform a DuPont analysis on all the firms to calculate the industry average for ROE and its 3 components, with respect to the Dupont Analysis, for each year from 2015 to 2017. In other words, you may first calculate industry averages to benchmark your chosen firm’s performance against.

a. Note that you have annual data for many restaurant industry firms from 2014 to 2017. You only have data for the year of 2014 so that you may calculate average shareholders’ equity and average total assets in 2015.

2. Pick one firm from the dataset.

3. Compare your chosen firm’s performance relative to the industry.

a. Using data visualizations (e.g. charts and graphs) will help you to analyze the data and identify patterns.

4. Write a memorandum describing your analysis and findings.

a. In a tabular format, present ROE in each year and the decomposition of ROE for your chosen firm. Do the same for the industry average.

b. Discuss your findings from the DuPont analysis in a memo. Your memo should, at a minimum, discuss the following points:

· How your chosen company’s ROE (as well its components) compares to the industry average?

· What factors are driving your chosen company’s ROE? To what extent are these factors driving ROE desirable or undesirable?

· Brainstorm regarding other factors that may drive the 3 components of ROE. In other words, we could further investigate the 3 components of ROE to gain even more detailed insight on the company’s performance. No calculations are necessary for this portion of the assignment; simply discuss some general factors that may be driving the 3 components of ROE (i.e., Return on sales, Asset Turnover, Leverage).

· For example, if return on sales increases, what factors could lead to an increase in return on sales?

5. Turn in the table and memo from steps 4a and 4b, respectively, to me via e-mail. Late submissions will not be accepted.

a. Peer evaluation forms [Optional, found on Canvas]:

i. If a single member of your group wishes to fill out a peer evaluation form, each member of the group will be required to fill one out.

ii. If you wish to turn in a peer evaluation form, you may do so discretely by e-mailing it to me, along with the contact information for the members of your group. I will then contact all members in the group to fill out a peer evaluation form.

iii. If I do not receive any peer evaluation forms from your group, every member will receive the same grade. If I do receive a peer evaluation form, each student’s grade will be commensurate to the evaluation from their peers. For example, if your group receives a grade of a 100%, but a member receives an average overall peer rating of ¾, then that member will receive a grade of ¾ of 100% = 75%.

Dataset variables

· Most variables in the accompanying dataset to this assignment are self-explanatory. Some variables are not, and are explained below:

· Global Company Key (GVKEY): unique identifier given to each firm; not necessary for the analysis

· Data Date: the end of the company’s fiscal year

· Feel free to ask me about any other variables you are unsure of.

Guidelines for the memorandum

· It is important to be able to write concisely, yet effectively to convey your points. The memorandum should be:

· No more than 3-typed pages (double spaced)

· Exhibits do not count towards the page limit.

· 12-point font

· Minimum of 1” margins from all sides.

· Failure to follow these guidelines may result in point deductions. The formatting requirements above are to make sure everyone has the same amount of space with which to convey their analysis.

· It is possible to write very concisely and complete the assignment in less than a page. DO NOT unnecessarily write to fill up 3 pages.

· The use of data visualizations (e.g. charts, graphs, or tables) is highly recommended. You can attach as exhibits any computations or other analyses used in your analysis. However, simply referring to data visualizations without any discussion is unacceptable.

Additional Resources to Help Advance Your Written Assignment:

· You are strongly encouraged to utilize the writing assistance resources on campus. The Department of English offers a writing center that is available to all CSUF students. More information is available online at http://english.fullerton.edu/writing_center/ and you can schedule appointments for writing assistance at https://fullerton.mywconline.com/.

· Visit the “Tutoring Center” at the Mihaylo College of Business and Economics for writing suggestions on your work.

Location: SGMH 2404 West Pavilion

Hours: Mon - Thurs: 10:00am - 7:00pm

Phone: (657) 278-2704 Email: mcbetutoring@fullerton.edu

Webpage: http://business.fullerton.edu/StudentServices/Tutoring/default.htm

· “Effective Writing: A Handbook for Accountants”, Claire B. May and Gordon S. May, 10th ed., Publisher: Pearson (ISBN: 0-13-357949-2).