Principals of Financial Market Economic Level Emphasises

Question: Describe about the Principals of Financial Market for Economic Level Emphasises. Answer: Introduction Before making any investment in a market or any industry, it is important to understand various types of brokers and traders in the market. Before making any investment decision it is important to have the basic knowledge regarding the stock market (Kinsky, 2012). When selecting a stock, an investor might use different analysis methods and the most important method that is used is fundamental analysis. All the investors are concerned with the share price which also involves the direction of share price. Fundamental analysis is the method that helps the investors in examining the basic drivers that affects the well being of the company. When the dealers or brokers use fundamental analysis, they use macro and micro fundamental analysis that include three major analyses such as industry, economy and company analysis (Singh, 2011). These three different levels of fundamental analysis provide different information that can be helpful for the investors. Fundamental analysis at economic level emphasises on different economic indicators that helps in assessing the information about the economy and its present and future conditions. The economic indicators include retail sales, GDP, unemployment figure, interest rate and inflation rate (McIntos, 2012). At company level, income statement, companys cash flow, debt statement, balance sheet and management is examined which helps in understanding the stock market prices. At industry level, factors such as market size and growth rate are considered and it helps in understanding the supply and demand forces of industry. Top-Down Approach There are two approaches of Fundamental analysis macro approach also known as top down approach and micro approach known as bottom up approach. The top down approach is an investment strategy that analyses the economy in general, after which the industry and companies are analysed (Baresa, Bogdan and Ivanovic, 2012). The figure below depicts that the top down approach moves from top to bottom in economic analysis and starts from studying the economic scenario and ends at understanding the expectations of the company (Satyanarayana and Sidhu, 2015). Economy of Australia In the views of Greenwood and Holt (2010), economic growth is increase in the productive capacity of an economy or any country in terms of goods and services over time. In the opinion of Heath (2015), the economy of Australia has expanded at much faster pace than it was forecasted by the economists in the third quarter (Q3). It is investigated that the GDP of Australia increased by 0.9% in Q3 which exceeds the economists forecasts. Year 2015-2016 is considered as the second longest and continuous period of economic growth for Australian economy in the world. Employment scope is growing and it is estimated that more than 250,000 job opportunities has been created in past 18 months (Budget, 2015). Although, the Australian Dollar is low but it will help in supporting the domestic businesses to exploit strong world outlook by making them more competitive. It is identified that in the year 2014, Gross Domestic Product (GDP) rate recorded was 0.5 in for the first quarter which decreased to 0.4. The GDP for first quarter in 2015 was forecasted to be 0.5 which showed a significant growth and increased to 1% by the end of 2015 (Trading Economics, 2016). The data collected from Knoema (2016) shows that International Monetary Fund estimated that GDP of Australia will increase to 2.6% in 2015, 2.5 in 2015 and with stable position in 2016. The Inflation rate in 2014 was as forecasted by OECD 2.49% which is expected to decrease to 1.57% in 2016. It is also expected that inflation rate in Australia will increase to 2.11% in the year 2016 (Koema1, 2016). The unemployment rate forecasted by International Monetary Fund in 2014 was 6.1% which is expected to remain same in 2015 but will decrease to 5.9% in 2016 (Koema2, 2016). The interest rate in the year 2015 was cut down from 2.25% to 2% which is considered the lowest in the history of Australia ( Elsworth and Sun, 2015). Moreover, the value of Australian Dollar declined in 2015 due to free fall of commodity prices and risk of Chinese hard-landing remains. The data collected shows that the exchange rate of Australian Dollar to US Dollar is at 0.7776 and to New Zealand Dollar is 1.0354 (Peters, 2015). In the similar manner, euro to Australian Dollar exchange rate is 1.4675 whereas, exchange rate of pound to Australian Dollar is 1.9775 (Peters, 2015). Major Industry to Invest in Australia: Mining and Energy Industry The mining industry is considered as one of the major and oldest industries that has played a significant part in the development of Australia. Australia according to IBIS World (2016) has a large supply of hydrocarbon; non-mineral and mineral reserves which are extracted processed and sold by mining industries. The mining industry products include extraction of oil and gas, iron ore, minerals, metals and non-metals. It is identified that these mineral and non-mineral reserves are very close to the surface of the earth and are often high quality that enables the mining divisions of Australia to be price competitive in international grounds. The mining division of Australia is export oriented and the export is projected to account for approximately two-third of total revenue in 2015 and 2016. In the economy of Australia, mining has been the constant driver that has boosted the economy of the country (Lovells, 2015). Mining industry in Australia were expected to contribute approximately 3.6% to the GDP growth but due to the global fall in the commodity prices and declining prices of iron ore, the government and industries are revision their approach to business (Yeomans, 2016). However, the mining industry in Australia is transforming and seeing a down fall at present, but the industry is still considered as the massive contributor in the economic growth. As per Jericho (2015), there is massive investment collapse but the mining exports in Australia are still able to make up the highest contribution to the GDP growth. In addition to this, the Mineral Council of Australia (2015) explored that there is strong growth in the activities of mining industry in Australia over the first quarter by approximately 5.2%. In the year 2015, the gross valued added by the mining industry i n Australia was recorded to be 4.1% which was led by the growth of iron ore mining by 8.2%. Furthermore, it is also identified that total out from mining industry in Australia increased by 7.6% between 2014 and 2015 and mining industry was the largest contributor in the growth of GDP (Mineral Council of Australia, 2015). Major Mining Companies in Australia According to Reid (2016), the mining industry will see a significant improvement in 2016; therefore, investment in large mining companies of Australia will be beneficial. The two major mining companies of Australia includes BHP Billiton and Rio Tinto that covers major portion of energy and mining sector in Australia. BHP Billiton is a multinational company in Australia that is considered as one of the largest mining companies across the world. The company was founded in the year 2001 after the merger of two companies namely Anglo Dutch Billiton and Australian Hill Proprietary Company with its headquarter in Melbourne (BHP Billiton, 2016). It is explored that in 2015, the total market capitalisation of the company was recorded as US$108 billion and it also obtained revenue of US$44.6 million from continuing operations (BHP Billiton, 2015). BHP Billiton deals in diverse range of business including energy, minerals, and petroleum. The Total dividend per share of BHP Billiton increased t o 124 US cents by 2% and reached to a total of US$ 6.6 billion. The operating cash flow US$ 19.3 billion and the total investment of the company on community is US$ 225 million (BHP Billiton, 2015). On the contrary, Rio Tinto is another leading mining company that has international operations and focuses on searching, mining and processing the mining resources in the earths crust. The company operates in more than 40 countries and has a strong workforce of 55,000 employees (Rio Tinto, 2016). Rio Tinto is headquartered in London (UK) and comprises of Rio Tinto Limited which is listed on Australian Securities Exchange and Rio Tinto plc listed on London and New York Stock Exchange (Rio Tinto, 2016). In the year 2015, the underlying earnings of Rio Tinto were US$4.5 billion and the net cash generated from operating activities was recorded as US$ 9.4 billion (Rio Tinto, 2015). The total sales revenue achieved by the company was US$ 34.8 billion and the capital expenditure was US$ 4.7 billion (Rio Tinto, 2015). Bottom up Approach In this section, financial performance of Rio Tinto and BHP Billiton has been evaluated in context of year 2014 and 2015 in order to throw light on the health of companies in mining and energy sector. This micro analysis of above companies helps to understand more about the mining and energy sector in Australia and also acts as a guide to the investors. Analysis of financial performance of BHP Billiton and Rio Tinto in year 2014 and 2015 Liquidity Performance: Liquidity performance tells short term solvency position of the company as it shows how much working capital company carry to pay their liabilities arising during course of action (Moynihan and Titley, 2001). Current ratio: This ratio tells about the term liquidity position of the company in the year and it is calculated as current assets divided by current liabilities. While estimating the current assets all the assets that can be converted into cash and cash equivalents in one year span are taken for the calculation purpose. Same is the case with current liabilities and all liabilities that are due in the year are taken as current liabilities. Current ratio of BHP Billiton was 1.09 in year 2014 and it got reduced to 0.91 in year 2015 (Annual Report, 2015: BHP Billiton and Rio Tinto). This means that in year 2014 BHP Billiton has 1.09 times cash assets to pay off their liabilities while in year 2015 company has only 0.91 times the assets against the current liabilities. It reflects poor liquidity position of the company in year 2015. In case of Rio Tinto Company, management was able to mange enough current assets to pay off their obligations of current liabilities. Current ratio of Rio T into in year 2014 was 1.73 and in year 2015 it was 1.55. It reflects better liquidity of position of the company of Rio Tinto in comparison to BHP Billiton. It can be said that in year 2015, current ratio of both the companies has shifted downwards shoeing lack of cash and equivalents with the companies. Quick Assets: This ratio is more certain and shows clear picture of liquidity performance of the company. This ratio does take inventory and prepaid expenses while making the calculation for quick assets. The main reason for not including the inventory and prepaid expenses in the quick assets is because it is not easy to convert inventory and prepaid expenses to cash and cash equivalents in one year span of time. The quick ratio of BHP Billiton was 0.80 times in year 2014 and it got further reduced to 0.68 in year 2015. It clearly reflects that BHP Billiton fails to maintain enough quick assets to pay their obligation (Annual Report, 2015: BHP Billiton and Rio Tinto). On the other hand Rio Tinto has quick ratio of 1.35 times in year 2014 and 1.21 times in year 2015. It reflects better liquidity position of Rio Tinto as compare to BHP Billiton. Capital Ratios: This ratio shows the structure of capital in the organisation. It shows the position of debt and equity in the firm (Moynihan and Titley, 2001). Equity Ratio: This ratio is Equity divided by total assets. This ratio tells proportion of equity in the total assets of the organisation (Moynihan and Titley, 2001)... The equity ratio of BHP Billiton was 0.52 in year 2014 and it remains the same in year 2015. It shows that BHP has financed more than 50 % of total assets through issuing the equity shares. In case of Rio Tinto the equity ratio was 0.43 in year 2014 and it got slightly reduce to 0.41 in year 2015 (Annual Report, 2015: BHP Billiton and Rio Tinto). It means more than 40% of a total asset was financed through owners capital while rest is financed through debt capital. It reflects poor formation of capital in case of Rio Tinto. Debt Equity Ratio: It shows proportion of debt and equity in the firm. The debt equity ratio of BHP Billiton was 0.50 in year 2014 and it increased to 0.56 in year 2015. It shows BHP Billiton uses 50% of equity as debt capital, reflecting the balanced capital formation. In case of Rio Tinto debt equity ratio was 0.80/1 in year 2014 and it was further increased to 0.91/1 in year 2015. It clearly shows capital position in Rio Tinto was more of leveraged capital (Annual Report, 2015: BHP Billiton and Rio Tinto). Profitability ratio: Ratios calculated in this segment shows the profitability performance of the company in the particular time period (Moynihan and Titley, 2001)... Net profit ratio: This ratio is net profit divided by the net sales. It provides the information about the profit that firm has earned on the net sales. Better the ratio will the better will be profitability of the company. In case of BHP Billiton the net profit ratio was 20.58 % in year 2014 and it got highly reduced in year 2015. It means BHP Billiton performance was not as per standards defined for year 2015 because there was decrease in net profit and increase in expenses in year 2015. The profitability position of Rio Tinto was similar to BHP Billiton as there was negative net profit ratio of Rio Tinto in year 2015. It can be said that year 2015 was not good for mining and energy industry due to decrease in export prices internationally (Annual Report, 2015: BHP Billiton and Rio Tinto). Conclusion and Recommendations The overall analysis depicts that the economy of Australia is growing more than expectations which provides a good scope for investors in different sectors. In addition to this, it is found that the GDP is expected to rise in 2016 along with inflation rate which shows growth in economic condition of Australia. Moreover, the mining and energy sector has a good scope for investors to invest as it is the major contributor in the economy of Australia. Two major companies that are not only the leading mining and energy companies in Australia but also across the globe are analysed. The two companies include BHP Billiton and Rio Tinto that has contributed in the economy of Australia to a large extent. Other than this, it is identified that the mining industry in Australia is seeing a down fall at present; however, it is expected to emerge in future again. Thus, mining companies needs to implement some changes in its operations to stay competitive. The companies mining companies are considered to pollute the air to a large extent which needs to be reduced. For this purpose, companies should take necessary actions that help in saving the environment and keep it clean (Brew, Junwu and Addae-Boateng, 2015). This can be done by using advanced technology that helps in making zero emission tools which further helps in reducing the emission of pollutants. In addition to this, the companies need to evaluate its operations in advance so that any emergencies and mishaps can be eliminated on time. Moreover, it is evident that mining companies are exploiting its labour which should be avoided so as to be a socially responsible company. By being a socially responsible company, the major environ mental and society related issues can be minimised which will not only help the organisation but will be beneficial for environment as well as society (Chang, Chen, Hsu and Hu, 2015). It is highly to the companies in mining and energy sector in Australia especially BHP Billiton and Rio Tinto to reduce the cost to goods sold and other operating expense through adopting cost reduction strategies at all the level of production, supply and administrative level (Nevitt and Fabozzi, 2000). It is also suggested to both the companies to expand the production so that overall expenses can be settled with an increase of net sales. References Annual Report 2015. BHP Billiton. [Online]. Available at: https://www.bhpbilliton.com/investors/reports [Accessed on: 20 September, 2016]. Annual Report 2015. Rio Tinto. [Online]. Available at: https://www.riotinto.com/documents/RT_Annual_Report_2015.pdf [Accessed on: 20 September, 2016]. 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