Insurance Australia Group is the Australian based insurance firm operating across New Zealand, Asia and Australia. It provides several commercial and personal insurance services and products mainly home and motor vehicle insurance. Insurance Australia Group is mostly involved in underwriting of the general insurance as well as related services and investing operations. Its major division comprises of consumer division or segment that offers general insurance services and products to families and individuals across Australia, the business segment that offer some commercial insurance to different businesses both small and large across Australia, the WIFI and Swann that offer general insurance underwritten within New Zealand. It is considered as multinational insurance organization whose headquarter is in Sydney. The company was formed by demutualization of NRMA insurance in 2000 and return of shares to different members of the NRMA. As a result the NRMA interchanged it name to the Insurance Australia Group.
The company shareholders include Capital Research and Management, Black Rock Fund Advisors, Newton Investment Management Ltd, Vanguard Investment Australia, Norges Bank Investment Management, Colonial First Statement Australia Ltd, Fidelity Management and Research, Legg Manson Australia and Bershire Hathway Inc. Given that the company is a public limited company, there is not shareholder with more than 20% shareholding in this firm. Therefore, since the amount of shareholding ranges from 5% to 0.73%, the company can be considered a non-family organization or business.
IAG chairman is Elizabeth Bryan who the director of the company on December 2014. Elizabeth was also the chairman of Nomination Committee and is required to attend all the board meetings. In addition, Bryan is the chairman of the Insurance Manufacturers of the Australia Pty Limited.
The company board of the directors comprises of Elizabeth Bryan AM, Duncan Boyle, Doctor Helen Nugent, Hugh Fletcher, Jonathan Nicholson, Philip Twyman, Tom Pockett, Sheila McGregor, Michelle Tredenick and Peter Harmer. These members are usually accountable to the shareholder for operations, performance as well as affairs of the company. These members also serve and represent interest of the company’s shareholders and collectively appraise and oversee policies, performance and strategies of the firm.
In this case, there are no individuals with similar surname as substantial shareholders. Hence, there is no family member or owner in IAG governance. Furthermore, there is no similar surname for those shareholders with around 5% shareholdings meaning that there is no shareholder that is involved in governance of the company.
They are those ratios used in measuring an organization capability of settling it short-term debt commitments (Santosuosso 2014). In other words, it measures the capability of an organization in converting is current assets into liquid cash such that it could settle or repay it short-term or current debt commitments. The major liquidity ratios that can be computed for IAG include;
This ratio is used in measuring an entity’s capacity in settling or paying off all its current debt obligations (Babalola & Abiola 2013).. In this case, higher ratio is more preferred than lower one since it represents better organization’s liquidity condition. In this case, IAG current ratio for 2016 and 2017 was;
2017 = 25457/ 20,305 = 1.25
2016 = 25,785/ 20312 = 1.27
These are referred to financial ratio used in measuring the capability of an entity in meeting or settling its long- and short-term debt commitments on time (Babalola & Abiola 2013). The ratio assists in measuring whether an entity’s net income would be in a position to cover all its total debt commitments. The most important ratio examined in this case are debt ratio as well as debt to equity.
The ratio measures percentage of an organization’s total asset which is being financed by debts (Babalola & Abiola 2013).. Here, higher figure is less preferred since it signifies higher level of financial leverage and in turn financial risk for the firm. Therefore, for the past two financial years, IAG debt ratio was;
Debt ratio = total liabilities/total assets
2016 = 23,245/30,030 = 0.77
2017 = 22,805/29,597 = 0.77
This form of ratio is used in measuring level of the financial leverage or finance being employed by an entity (Babalola & Abiola 2013).. Here, increasing ratio means higher interest and might affect an organization’s credit rating of a firm. The IAG debt to equity for 2016 and 2017 was as follows;
Debt to equity = total liabilities/ total equity =
2016 = 23,245/6,563 = 3.54
2017 = 22,805/6,562= 3.48
Asset utilization (efficiency or turnover ratios)
These ratios are used in assessing how well an entity is utilizing all its assets or resources in generating profit or revenue (Santosuosso 2014). The most important ratio to be used in this case is the asset turnover ratio.
This is the form of financial ratio used in assessing management efficiency in utilizing its assets to generate revenue or sales (Filimon & Prior Jiménez 2005). The company 2016 and 2017 asset turnover was as follows;
Asset turnover ratio = sales/total assets
2016 = 9,074/30,030 = 0.302
2017 = 9,881/ 29,597 = 0.334
These are financial ratios used in examining capability of an organization in generating income in a given context. In other words, these ratios examine overall performance of an entity through profits generation (Lesakova 2007). Besides, they assist in measuring efficiency of an entity and amount of return the firm generates of a given period (Babalola & Abiola 2013). Some of the most important ratios used in assessing IAG profitability include net margin, ROE and ROA.
This ratio is one of the most common which is employed in examining income after expenses are deducted. It assesses how much an entity is making or generating on each dollar spent (Lesakova 2007). In this case, the 2016 and 2017 net income margin for IAG was;
Net profit margin = net income/sales
2016 = 625/9,074 *100% = 6.89%
2017 = 929/9,881 *100% = 9.4%
Return on Equity
The ratio measures amount of income earned on shareholder’s equity (Babalola & Abiola 2013). The ratio is computed using following formula;
ROE = net income/total equity
2016 = 625/6,563 *100 = 9.52%
2017 = 929/6,562 *100% = 14.16%
Return on Asset
Such ratio is used in examining dollar amount earned by an entity on its assets (Lesakova 2007). In this case, the 2016 and 2017 ROA for the company would be;
ROA = net income/total assets
2016 = 625/30,030 *100% = 2.08%
2017 = 929/29,597 * 100% = 3.14%
These are form of the financial ratios utilized in assessing or examining current share price of the firm’s stock (Santosuosso 2014). They assist the existing and future investors in determining whether an organization amount the shares of a given firm are under-price or over-priced (Lesakova 2007). In this case, earnings per share would be used in examining the market value of Insurance Australia.
This ratio is computed by dividing earnings by total number of the shares outstanding in an organization. In essence, it helps in estimating price investors are thinking the company shares are really worth (Lesakova 2007). In this case, EPS for Insurance Australia for the past two years would be;
2016 = 1.29
2017 = 1.95
Based on figure 1 below, it is evident that IAG share prices over the past two years experienced a significant increase. This is evidenced by an increasing trend in the curve over the period. Besides, it is evident that the company share price has been doing relatively good in comparison to the All Ords Index in the last two financial years. This means that the company offers a better investment opportunity for any potential investor willing to invest in the company.
As from the above chart, it is evident that Insurance Australia share price index movement was in line with the All Ords Index. This means that the share price for the company was closely related with the All Ords Index. The share price in the first months of the year 2017 was below the All Ords Index but by 2018, the share price was above most of the All Ords Index. Therefore, it can be stated that Insurance Australia Group share prices in the past two years were less volatile. Hence, the company offers better investment opportunity for any investor willing to invest in more promising and viable investment ventures.
Some of the key factors that are said to have influenced Insurance Australia Group’s share prices include the rising interest rate in the country which is said to have resulted in decrease in insurance sales to the company over the financial year 2017. Nonetheless, the management recent decision in raising its dividend payout is found to have contributed to the significant increase in the company share price over the period. Further, energy price increase is also another important factor that is said to have attributed to the current movement in the company’s share price movement (Osamwonyi & Igbinosa 2012). The strong equity market returns in the country is also another chief factors that is said to have influenced Insurance Australia Group share price movement for the past two years. The recent decrease in inflation rate within Australia is another important factor that is said to have contributed to the present share price movement for Insurance Australia Group. Gross domestic product increase is another aspect that could have attributed to the current increase in Insurance Australia share price. Gross domestic price is usually linked to the economic growth with higher GDP growth being associated with higher share prices in different firms (O’Hara, Lazdowski, Moldovean & Samuelson 2000). In essence, with increasing GDP growth in Australia for the past two years, Insurance Australia Group performed very well financially, which in turn led to increase in the number of investors interest to invest in the firm and as a result increase in its share price within the same period.
The computed beta for AIG for the period is 1.14.
R = rfr + b*(rm –rfr)
Where r stands for the required rate of the return’
Rfr stands for the risk free rate,
Rm represents the risk premium and
B represents beta value
Hence, r = 4% + 1.14(6%-4%) = 4% + 1.14*0.02 = 6.28%
iii) Whether Insurance Australia offer “conservative” investment
Given that Insurance Australia rate of return would be 6.28%, it means that the firm offer conservative investment opportunity for the potential investors. This is based on the notion that the company seems to have long-term growth probabilities which is expected to enable potential investors grow their retirement amount over long period. Besides, Insurance Australia is a low risk stock, hence, it preserved investment value for potential investors as it has low risk free rate. The company value of financials does not fluctuate over time, hence, making the company a conservative investment.
The WACC is usually computation of an entity’s cost of capital where every category of the capital is considered proportionately weighted. In computing WACC following equation is followed;
WACC = e/v * re + d/v * rd * (1-TC)
Where e is the equity
RE is the cost of equity
D is the debt
Rd is the cost of debt
V is the total market value (equity and total debt)
T is the tax
e/v is the percentage of the financing which is equity
d/v is the percentage of the finance which is debt
cost of equity or RE = 6.28%
cost of debt or re = 16%
market value or v = 22,805 + 6,792 = 29,597
Hence, d/v = 22,805/29,597 = 0.77
e/v = 6,792/29,597 = 0.23
Therefore, WACC = 0.23* 6.28% + 0.77*16%*(1-25%) =
= 1.44% + 9.24% = 10.68%
Hence, the WACC would be 10.68%
WACC is considered very important financial tool for the management and potential investors. This is because it assist organization management and investors in making appropriate investment decisions and in evaluating the investment project with dissimilar or similar risks. Therefore, a higher or lower WACC would have different implication on the management’s evaluation in a particular investment project. In this case, a high WACC is considered a sign of higher level of risks linked with the organization’s operations. This would force potential investors and management in requiring extra returns in assuming extra risks. Besides, given that WACC tries in balancing relative expenses of numerous sources of finance in producing single costs of the capital, high value of WACC would influence management evaluation negatively since it would imply that there is higher risk in the investment project. In other words, higher WACC would negatively influence management’s evaluation of a specific investment project since it implies that the investment is losing value forcing investors to look for investment project with more effective return which might be found elsewhere.
The debt ratio for Insurance Australia for the last two years was 0.77 in 2016 and 0.77 in 2017. These figures are a clear sign that the company is utilizing fewer amounts of assets in financing its liabilities or debt commitments. Besides, given that the debt ratio for the last two years was below 1, it is evident that Insurance Australia has been working towards maintenance of more preferred optimal capital structure. Basically, the figures are clear sign that the company is financially stable and therefore it is not at a risk of getting liquidated or going bankrupt in future.
The company has done so much in amending or adjusting its gearing ratio over the year. First, the company has increased or repaid its borrowing which is said to result in significant decrease in its total liabilities in comparison to its assets. Such in turn result in a significant decrease in the gearing ratio to below one. Further, the company is said to have purchased some share back. The director’s report clearly indicates some of these adjustments clearly. For instance, the report indicates some of the major activities that the group has been involving itself in order to reduce the gearing ratio some of which include underwriting of the general insurance as well as related services.
Dividend policy Implemented by Insurance Australia management
Once an organization generates some profits, they should decide on the best action to take with such profits. They might decide to continue retaining these profits in the firm or they might decide to distribute the profits to their shareholders in terms of dividends. This calls for some dividend policy which might impact on the investors and perspective of an organization in the market (DeAngelo, DeAngelo & Stulz, 2006). Insurance Australia Group employed residual dividend policy. This is based on the fact that the management depends on the internally generated shareholders’ equity in financing its operations. Therefore, dividend payments were basically from residual or the leftover equity after all the company operations are financed and met. In essence, the company management are said to employ residual dividend policy since based on the company debt to equity ratio, the company is said to rely on equity finance, hence, it has to first finance its operation where the leftover are then issued as dividends to its shareholders.
10 letter of recommendation
To: Client
From:
Date
Re: Inclusion of Insurance Australia in the investment portfolio
Insurance Australia Group is the Australian based insurance firm operating across New Zealand, Asia and Australia. The company provides several commercial and personal insurance services and products mainly home and motor vehicle insurance. Based on its ratio analysis and stock price analysis, there is need to include the company in the investment portfolio. In essence, the profitability ratios are clear sign that this company is performing relatively good in terms of profit generation and resource utilization. For instance, based on its ROE and ROA in the past two years, it is clear that the company is efficient enough in utilizing its assets and equity in generating income. Further, based on its liquidity and solvency ratios, it is evident that the company is financially stable. This is due to the fact that it liquidity ratio and in particular current ratio was higher than one in the last two years meaning that it was capable to settle its current debts on time. Its debt to equity and debt ratio is also a clear sign that this company is capable of settling its debt commitments on time once they come due. Besides, based on the company market value ratio and efficiency ratios, it is evident that IAG is effective enough in using its assets to generate revenue. Furthermore, the EPS ratio is a sign that the company performance is relatively promising. Therefore, there is need to take into account of these aspects and include Insurance Australia Group in your investment portfolio since it is probable to increase your overall expected return from the portfolio.
References
Babalola, YA & Abiola, FR (2013), ‘Financial ratio analysis of firms: A tool for decision making,’ International journal of management sciences, 1(4), 132-137.
DeAngelo, H, DeAngelo, L & Stulz, RM (2006), ‘Dividend policy and the earned/contributed capital mix: a test of the life-cycle theory,’ Journal of Financial economics, 81(2), 227-254.
Filimon, N & Prior Jiménez, D (2005), Efficiency and ratio analysis in assessing firms’ corporate performance. Universitat Autònoma de Barcelona,.
IAG (2016), Insurance Australia Group Limited annual report 2016; Viewed from; https://www.iag.com.au/sites/default/files/pods/Results/2016/FY/assets/pdf/IAGL-2016-Annual-Report.pdf
IAG (2017), Insurance Australia Group Limited annual report 2017; Viewed from; https://www.iag.com.au/sites/default/files/Documents/Results%20&%20reports/Appendix-4E-IAGL-annual-report.pdf
Lesakova, L (2007), ‘Uses and limitations of profitability ratio analysis in managerial practice,’ In International Conference on Management, Enterprise and Benchmarking (pp. 1-2).
O’Hara, T, Lazdowski, C, Moldovean, C & Samuelson, S (2000), Financial indicators of stock performance. West Haven: American Business Review.
Osamwonyi, IO & Igbinosa, SO (2012), ‘Economy fundamentals as long run explanation for stock price behaviour in Nigeria,’ European Journal of Economics, Finance and Administrative Sciences, 4(48), 21-38
Reuter (2018), Insurance Australia stock prices; Viewed from; https://www.reuters.com/finance/stocks/
Santosuosso, P (2014), ‘Do Efficiency Ratios Help Investors to Explore Firm Performances? Evidence from Italian Listed Firms,’ International Business Research, 7(12), 111.
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