Introduction
Tootsie Roll and Hershey are two similar companies with a similar product offering, but they operate on entirely different scales. In an effort to determine the better investment of the two companies we will utilize multiple financial analysis ratios to gauge the health of the respective companies in terms of liquidity (the ability to pay short-term liabilities and respond to opportunities), solvency (the long-term viability of the company) and profitability (the efficiency at which the can turn it’s resources into profits).
However, the snapshot picture of health that a single years worth of financial statements provide is not enough. Below we have offered a horizontal analysis of the respective companies to show the change in their health from 2012 to 2013 and analyzed the two companies against each other to show why we recommend Hershey as the better investment.
Liquidity and Solvency
Current Ratio
The current ratio is defined as the current assets divided by the current liabilities for a given period. This ratio is important because it helps measure a company’s ability to pay their current liabilities with their current assets. This shows helps determine the liquidity of the companies and their ability to respond to market opportunities. Tootsie Roll has a current ratio of 3.25 in 2012 and 3.99 in 2013(an 18.5 percent increase).
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Hershey, on the other hand, has a current ratio of 1.44 and 1.77 (also an 18.5 percent increase) respectively. Both companies have increased year over year. As the current ratio shows, the Tootsie maintains a healthier ratio, but both have improved at the same rate.
Debt to Asset Ratio
This is a comparison of the debt-to-total asset ratio; also known as the leverage ratio, of both companies. This ratio is a good measure of solvency as it shows the percentage of assets that are financed with debt. Tootsie Roll has a ratio of 23 percent for both years while Hershey has a ratio of 78 percent and 70 percent respective to 2012 and 2013. Generally, this number should not be too high. While Hershey’s numbers are higher than Tootsie Roll’s, Hershey’s numbers have improved over the year. Furthermore, we believe Tootsie Roll may actually be under-leveraged since, “Having a healthy amount of debt can actually enhance a company’s profitability, in terms of the shareholders’ investment” (Harrison, Horngren, Thomas, 2013).
As will be seen from the following ratios on profitability, Hershey is more efficiently turning their assets into profits, suggesting a better use of the healthy leverage shown in the debt to asset ratio.
Profitability
Gross Profit Rate
A major factor for investors will always be the profitability of a company. One of the fundamental ratios to utilize when measuring the ability of a company to create a profit is the gross profit ratio, which is important for internal use as well as external use. For example: “Gross profit percentage is markup stated as a percentage of sales”. (Harrison Jr., Horngen, Tomas, 2013) This ratio will identify how much gross profit is being generated by every dollar the company generates though sales. Investors will always want to carefully keep track of the gross profit ratio in order to identify a downturn or an upturn in profits. Furthermore, The Hershey Company had a higher increase in gross profit ratio than Tootsie Roll Industries. The Hershey Company managed to increase the profit ratio from 43 percent in the year 2012 to 48 percent in the year 2013.
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This shows that The Hershey Company managed to increase their profit ratio by 11.5 percent from previous year. Tootsie Roll, on the other hand, also improved year over year, but only by 5.5 percent to reach a gross profit rate of 35 percent in 2013. It is important to note that the minimum increase in gross profit for every dollar of sales can make a huge difference in profits. For example: “an upturn by a small percentage can mean millions of dollars in additional profits”. (Harrison Jr., Horngen, Tomas, 2013) Even though the cost of goods sold consumes $0.52 of each sale, The Hershey Company managed to generate a profit of $0.48 for each dollar of sales.
Profit Margin Ratio
The profit margin ratio demonstrates the ability of a company to increase the percentage of net income earned for every dollar of sales. For example: “this ratio shows the percentage of each sales dollar earned as net income”. (Harrison Jr., Horngen, Tomas, 2013) The Hershey Company was able to increase the profit margin ratio from 10 percent in 2012 to 11 percent in 2013. The increase in profit margin from the previous year 2012 shows that the performance of the company is increasing which means that revenue is increasing or expenses are decreasing. Furthermore, The Hershey Company is managing their performance efficiently and this is directly reflected in profit margin ratio.
Return on Assets
The return on assets (ROA) ratio helps measure how profitable a company is in relation to its total assets. In the case of Tootsie Roll, the company had an ROA of .06 in 2012 and an ROA of .07 in 2013. This is an increase of close to 16.7 percent year over year. Hershey, on the other hand had an ROA of .14 in 2012 and .16 in 2013. Hershey’s rising ROA is comparable at 14.3 percent. With change 16.7 percent and 14.3 percent being so similar, we favor Hershey’s ROA at the higher rate of .16 in 2013 as opposed to Tootsie Roll’s relatively meager .07 ROA.
Payout Ratio
The payout ratio will help make the final case of Hershey as the better investment of the comparable companies. The payout ratio measures the proportion of earnings that are paid to investors and shareholders. Because dividends are so important to the investment opportunity, this is an important ratio when looking at a company for investment income. In 2012 Tootsie Roll had a high payout ratio of 1.01 percent where Hershey’s was 52 percent in comparison. However, in 2013 Tootsie Roll’s payout ratio dropped a huge, 77 percent to 23 a percent ratio. Hershey’s payout ratio also dropped, but only 7.6 percent to 48 a percent ratio. Not only is 48 percent a better current number than Tootsie Roll’s .23, but as a long-term investment Hershey shows much more stability. Therefore Hershey continues to stand out as the stronger investment opportunity.
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Conclusion
Determining the better of two companies to invest in is risky business and involves many factors outside of the numbers provided on financial statements. However, we have seen that by looking at the liquidity, solvency and profitability of the companies against each other an over time, we can gain valuable insights as to how well the respective companies are performing in the current environment and how well they are positioned to take advantage of rising opportunities and threats. Our analysis of Tootsie Roll and Hershey show that while Tootsie Roll has safer numbers in respect to liquidity and solvency, Hershey is clearly more efficiently using both it’s assets and liabilities to turn higher profits and pass that money on to it’s investors. Therefore, The Hershey Company is the clear choice to invest with.
Bibliography
Harrison, W. T. (2013).
Financial Accounting, VitalSource for DeVry University, (9th ed.).
Pearson Learning Solutions. Hershey. (2013).
SEC Annual Report. SEC. Hershey: The Hershey Company. Tootsie Roll Industries. (2013).
SEC Filing 10-K 2013. Chicago: Tootsie Roll.
