Factors to Consider in Stock Market Investment Case study AAR Corporation
There are risks involved in buying or investing in the stock market and there are no guarantees of success, just like in any other business especially when it comes to individual shares. Taking more considerable risks, though, brings higher returns on the investment made. The study was conducted concerning AAR Corporation.
Company history
AAR was founded in 1952, structured in 1955 and reincorporated in Delaware in 1966. AAR is a corporation that provides a wide range of products as well as value-added services for the aviation or the aerospace industry. It uses a close to the customer business model, AAR serves airline and defense customers through four main operating segments, namely i) Aviation Supply Chain, which consists mainly of the business activities conducted through AAR Parts Trading, Inc, AAR Allen Services, Inc and AAR International, Inc. ii) Maintenance, Repair and Overhaul, which includes the business activities conducted through AAR Services, Inc, iii) Structure and Systems, which serves the customers through AAR Manufacturing, Inc and iv) Aircraft Sales and Leasing which conduct their business activities through AAR Aircraft Engine Sales Leasing, Inc.
AAR recently formed an international defense and government joint venture to serve domestic and foreign customers in three key areas, namely technical services, aircraft services, providing comprehensive aviation support, relief and security functions as well as construction services.
AAR has more than half a century of experience in helping commercial as well as governmental customers to achieve their goals as they control their costs. Their commitment according to the board of directors is quality, safety, customer satisfaction in addition to airworthiness serves as the cornerstone of their business. AAR Corporation faces tough competition in the current market just like any other company in the world. The competition is based on the quality as well as the variety of products and services, the speed of delivery and the price. The corporation has competitors who have much more considerable financial and other resources, but they maintain their position. As of May 31, 2008, the backlog of AAR Corporation was about 466,700 as compared to 319,700 at May 31, 2007. At the same period of time, it had provided the employment for around 5,400 people worldwide.
The competition in each of the worldwide markets is based on the superiority, the ability to provide an extensive assortment of products and services, the speed of delivery and the price. Competitors in the Aviation Supply Chain and the Maintenance, Repair and Overhaul segments include the original apparatus manufacturers, the service divisions of big commercial airlines as well as other autonomous suppliers of parts and renovate and repair services. The AAR Corporations engineering, manufacturing, machining in addition to integration activities in their Structures and Systems segment struggle with a number of divisions of large corporations and other large as well as small companies. In the Aircraft Sales and Leasing segment, the corporation has faced the competition from hedge funds, syndicators, financial institutions, profitable and specialized leasing companies as well as other entities that provide financing.
Every business undergoes certain risks and the principal risks AAR Corporation has to face are those affecting the aviation industry. The general economic conditions of the aviation industry affect the business of AAR Corporation, which is a provider of services as well as providers to that industry. The aviation industry is said to be historically cyclical and with time has been adversely affected in the previous years by attacks by terrorists in 2001, September 11. This caused a decline in air traveling, and there were cases of high oil prices which affected the industry. The outbreak of Severe Acute Respiratory Syndrome and the war on terrorism have also affected the aviation industry and consequently the AAR Corporation. As a result of all these and other events, certain customers filed for insolvency protection over the past several years. Most recently, in 2008, a good number of the U.S air carriers have announced a new wave of cost reduction initiatives, route consolidations, including staffing reduction as well as the capacity reductions. It is believed that the announced capacity reductions have a 10 to 15 percent impact on the U.S fleet. The announced fleet reductions are due to the recorded high oil prices and the economic conditions. There have been reports on the credit market which have been tightening and this consequently affects the ability of the customers to raise equity capital and debt capital.
Problem statement
The stock market is a public market used for the trading of company stocks as well as derivatives at an agreed price. These are securities that are listed at the stock exchange in addition to those that are traded privately. The size of the world stock market has been estimated at around 36.6 trillion at the start of the month of October 2008. The estimation of the total world derivatives market is around 791 trillion nominal value and this is eleven times the size of the entire worlds economy. The stocks are usually listed and traded at the stock exchanges which are entities of a corporation or mutual organization which is specialized in the business of bringing forth buyers as well as sellers of the organizations to the listing of stocks and securities together.
There is a direct relationship between the stock market and the modern financial system and this is the reason why investing in the stock market has become very popular. The general public ha heightened its interest in investing in the stock market and this is either directly or through the mutual funds. Statistics show that in the recent years, shares have made up a gradually larger proportion of the households financial assets.
There are companies issuing there shares but the question would be what is the criteria used to determine which company is viable for investment and presents less risks than other companies. What are the reasons to invest in the company and how to make comparison and come to a conclusion that a particular company is the best option and should be able to analyze critically whether or not this particular company is one that is worthwhile to invest in.
General objectives
The objective of this study is to establish how one can determine the best company to invest in using the performance and the history of the company. The comparison of the performance of the company with other companies and at the same time, the progressive performance over a certain period of time should be done. Another objective would be to make forecasts of the performance of the company in a few years to come.
Research hypothesis
The research or project should have a hypothesis to argue for or against it. AAR Corporation being the object of the case study, the hypothesis should state that the Corporation is viable and is a good company to invest in. the second hypothesis is that there is a relationship between the profits made by the AAR Corporation and the stock rates of the company.
Scope of the study
The study will analyze the performance of the AAR Corporation over a certain period of time. This means monitoring the company in terms of the companys history, the structure of the board of directors, the stock prices over a period of time in comparison to the profits made. Due to time and budget constraints, the study will concentrate on the information provided by the AAR Corporation. The accuracy of the data collected will depend heavily on that.
Significance of the study
Over, the years, the stock market has become a matter of much interest and it has a certain effect on the economy of the world. Many people have joined or are on the verge of joining the investment stock market but there are certain issues to be considered. This study should enlighten investors and the same time highlights the measures that should be taken to ensure the stock market grows stronger. The study will also validate whether AAR Corporation is viable for investments.
Literature review
Business trends and highlights
According to Preda Alex (2009), in the year 2008, the majority of the U.S air carriers announced a series of cost reduction initiatives, route consolidations, capacity reductions and staffing reductions. There have been more recent capacity reductions and they are claimed to be the response to the deteriorating U.S economic environment as well as the considerable declines in the fourth quarter 2008 as well as the first quarter 2009. There was also a high rate of unemployment, greater than that in 1983. In the first quarter of 2009, in the North America the capacity was down by approximately 8 percent and the passenger traffic decreased by 10 percent. Some of the foreign carriers abroad and in the U.S had already filed for bankruptcy protection and some had already ceased operating.
During the fiscal year of 2009, sales to the global security customers improved by 16.8. May 31, 2009 represented 42.5 of general sales. AAR Corporations continued to create opportunities to make available performance-based logistics services in addition to manufactured products supporting their own defense customers requirements. Although it remained difficult for the corporation to forecast long-term claims for these types of products as well as services, they had to believe they were well positioned with the current portfolio of growth plans and products and services to profit from the longer-term U.S. martial employment and program administration strategies.
The AAR Corporations disclosure to the market risks included the unpredictable interest rates under their credit agreements as well as changes in foreign exchange rates along with credit losses on accounts receivable. During fiscal 2009, 2008 and 2007, AAR Corporation did not exploit derivative financial instruments to make up for these risks. At May 31, 2009, 187,090 was obtainable under their Credit contract. As of May 31, 2009, the exceptional balance under this contract was 50,000. A theoretical 10 percent raise to the average interest charge under the credit facilities applied to the average exceptional balance during fiscal 2009 would have reduced the pre-tax income by just about 108 during fiscal 2009. Revenues as well as expenses of AAR Corporations foreign operations were translated at standard exchange rates during the year, and balance sheet financial records were translated at year-end exchange rates.
Balance sheet translation adjustments were debarred from the results of operations and were as well put down in the stockholders equity as a constituent of accumulated income or loss. A theoretical 10 percent depreciation of the foreign currencies against the U.S. dollar would not have had a material impact on the AAR Corporation financial position as well as the results of operations.
Fiscal 2009 in comparison to fiscal 2008
According Richard J. Poulton, the consolidated sales for the fiscal year 2009 increased by 39, 057 or in other words by 2.8 percent over the previous year period. The sales to the profitable customers decreased by 5.5 percent as compared to the previous year and this reflected a reduction in the demand for the parts supports as well as the maintenance activities. All this was a result of the declining airline capacity. There was a decline in the sales to the commercial customers due to the lower sales in the Aircraft Sales and Leasing segment. This reflected lower aircraft sales as a result of the tight credit markets as well as the reduced orders for big ticket items. There was an increase in the sales to global defense customers by 16.8 percent. There was a favorable force of acquisitions as well as a strong demand for particular mobility products in addition to performance-based logistics programs.
Flint (1998) says that sales in the Aviation Supply Chain segment decreased by 22, 525 or in other words by 3.7 percent as compared to the previous year. The decrease of the sales was accredited to the drop in the demand for parts support from the profitable customers. This was as a result of the airline capacity reductions, the adverse impact of foreign currency translation as well as poorer sales to a regional airline customer. The gross profit in the Aviation Supply Chain segment decreased by 14, 680 or by 10.1 percent. The gross profit in that sector has also declined to 22.3 percent from 23.9 percent in the previous year. This was attributed to the impairment charges of 10,000 which was recorded in the fourth quarter of the fiscal 2009.
The operating income decreased 31, 626 or equivalently by 23.5 percent as compared by the previous years which was also due to the impairment charges, administrative charges and increases in sales. The factor that affected the operating income increased 11,717 as a result of the impact of acquisitions.
According to Keefe Lisa M (1990), during fiscal 2009, the AAR Corporation retired 110,510 of its convertible notes. The notes were retired for 72,916 cash as well as the gain after deliberation of unamortized debt issuance costs which was 35,316. It was reported in gain (loss) on extinguishment of debit on the consolidated testimonial of operations for fiscal 2009. During the second quarter of fiscal 2009, AAR Corporation sold their non-core developed turbine business, which was then after classified as a discontinued operation. Losses on the sale of business, net of tax, were estimated at 1,403. Net income was approximately 78,651 as compared to 75,144 in the previous year.
The financial year 2008 compared to the financial year 2007
The sales for the year 2008 increased by 30.5 percent or by 323,750 as compared to the financial year 2007. This is because all the four sectors of the AAR Corporation had all experienced an increase in the sales rates. The market share gains drove the overall sales growth through solid execution across the corporation business. Sales to the defense customers increased by 36.7 percent while the sales to commercial customers also went up by 27.8 percent as compared to the previous year.
The increase in sales to the commercial customers usually reflects gains in the market share. According to Murphy H Lee, (1994), this also reflects an increase in the demand for the aircraft maintenance as well as landing gear overhaul. The company is also deemed to have success in the international markets as well as impacts from acquisitions. The increased sales to the defense customers also reflect some characteristics. It shows that there is favorable impact of acquisitions. There is also a strong demand for the specialized mobility products and for the performance-based logistics program.
In the Aviation Supply Chain segment, the sales had increased by 62,816 or by 11.6 percent over the previous year. Murphy (1994) says that the sales increase was attributed to the strong demand for the parts support from defense-related performance-based logistics programs as well as aftermarket parts sales to commercial customers. In the aviation supply chain segment the gross profit increased by 30,708 or by 26.8 percent over the previous year. This was due to increased sales volume. The gross profit margin percentage increased to 23.9 percent from 21.0 percent in the prior year. This was due to the constructive mix of products the corporation sold as well as the 4,750 impairment charge which was recorded for the duration of the first quarter of fiscal 2007.
The sales rates for the Maintenance, Repair and Overhaul department of the AAR Corporation increased by 42.2 percent or by 89,355 over the previous year. The increase in sales was principally attributable to improved revenue at the Indianapolis heavy maintenance facility. It was also attributed to greater volume of landing gear overhauls as well as the addition of revenue from Avborne which was acquired in March 2008 .this contributed approximately 16,000 of revenues during financial 2008. Gross profit in the Maintenance, Repair and Overhaul department were reported to have increased by 47 percent or 14,052. The gross profit percentage improved to 14.6 from 14.1 in the previous year. This was due to increased volume in addition to operational improvement initiatives.
Factors that affect AAR Corporation
According to Lefer Henry (1991), making investment is the risk and one should be conversant with the factors that affect the company that one wants to invest in. This gives a clearer picture of what to expect. The financial condition as well as the results of the operation of the AAR Corporation may be affected adversely by the following factors. The first would be weakening in the financial condition of the existing as well as potential customers. The second factor that would affect the performance as well as the stock market would be reduction in the need for aircraft maintenance, spare part support and the deferral of those materials. The retirement of the older generation aircraft would automatically affect the operations at the AAR Corporation. This is because it would consequentially lower the prices of the services and the spare parts of those aircrafts. High oil prices would also adversely affect the operation of the Corporations and in return the stock prices of the company. Terrorists attacks or wars on terrorism have adverse effects on the operation of the airline industry which is the main factor of the AAR Corporation. Lastly, outbreak of infectious diseases would bring down the profits of the corporation and adversely affect the stock prices.
Factors that affect the stock market
According to the experts, when one is investing in the stock market, the investor should conduct a good survey of the entire market. As it is well known, it is not possible to make predictions on the stock market hence the need to know the functioning of the market. The first factor that affects the stock market would be the demand and supply. The trend of the stock market has a direct impact on the prices. When investors are buying more and more stock, then the prices of that particular stock usually increase. The reverse is also true if the majority of the shareholders are selling their stock then the prices consequentially go down.
Mandelbrot and Hudson (2006) say the second factor to consider would be the market cap. It is not advisable, according to the experts, to guess the worth of a corporation or company by comparing the stock prices. The stock prices do not determine the worth of the company but the market capitalization. The overall performance of the company matters and it should be the determining factor. The other factor that should help an investor would be the news. Positive news about a company usually increases the buying interest in the current stock market. The reverse is also true, negative press results in fewer buyers of that stock. So the type of news that reaches the clientele affects the stock prices. The last most important factor would be the earning or the price ratio. This usually gives the shareholders or the clientele an idea of a companys share price when compared to its earning. According to Preda, Alex (2009), the explanation is that stock usually becomes undervalued if the prices of the shares are much lower than the earnings of the corporation or company. The reverse is true the stock becomes overvalued when the prices are much higher than the actual earnings.
Methodology
Data collection, management and analysis
Data collection will involve the collection of secondary data. The study has already benefited during the proposal phase from many secondary sources such as the website and textbooks at a minimal cost. The research will be done using descriptive analysis methods time series analysis and regression analysis method as well as correlation. Some of the secondary data will be organized using tables and graphs.
Time series analysis
A time series is an ordered sequence of observations made at regular intervals over a given period of time, for example, hourly, weekly or annually. The time series analysis involves the way to fit a linear curve. Also future values of a series can be estimated from the past values but as discussed before forecasts of the stock prices can not be given. The time series analysis involves the analyst to identify the behavior of a series which could be trend, seasonal, cyclical or irregular variations. A trend variation is considered in this case and it is the tendency of time series data to either increase or decrease. The stock prices of the AAR Corporation would either increase or decrease. The time series give the description of the data using graphs and explains the variations.
Correlation analysis
The measure of correlation in this study will be done to show the relationship between the performance of the AAR Corporation and the stock prices. The null hypothesis would be that the performance has no relation to the stock prices and the alternative hypothesis is that the performance of the company has a relation to the stock prices. This should help the investors determine whether it would be wise to use the profits of the AAR Corporation in making decisions about investment.
Data analysis, findings and interpretations
YearMarket stock pricesProfit rate 200023.3014.9200128.1312.0200229.5616.3200321.7116.6200426.3817.8200529.5117.0200640.0618.2200745.1714.4200831.2713.4200925.443.0
The graph below shows the trend of the market stock prices from the year 2000 to 2009.
SHAPE MERGEFORMAT
The analysis shows there is a sharp decline in the market stock prices in 2003. There are peaks in 2002 and 2007. After which there is a steady decline to the fiscal 2009.
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The profit rates have declined in 2002 and have gradually decreased since 2008.
The correlation test between the profit rates of the AAR Corporation and the stock market stock prices from the year 2000 to 2009 is done below.
Profit rateStock pricesProfit rate Pearson correlation
Sig. ( 2-tailed)
N1.000
100.196
0.588
10Stock prices Pearson correlation
Sig. (2- tailed)
N0.196
0.588
101.000
10
In this section, using the above table, one can test whether there is a significant correlation between the market stock prices and the profit rates of a company using the AAR Corporation as the case study. Spearmans rank correlation shows that there is a positive correlation between the two variables. This implies that the increase in the stock prices while consequentially imply a rise in the profit rates of the company. The reverse is also true, the increase in the profit rates of the AAR Corporation signifies an increase in the stock prices.
Summary, Conclusion and Recommendation
The table below sets forth for each quarter of the past two fiscal years the reported high and low
closing market prices of the Common Stock on the New York Stock Exchange.
Fiscal 2008 Fiscal 2007
Per Common Share Market Prices Market Prices
quarterhighlowhighLowfirst34.8628.5025.1719.50second33.2528.8827.6922.24third38.5425.8931.5226.32fourth28.1018.9433.5527.40
According to Donoghue J.A. (1995), the fiscal year 2007, the highest market price 33.55 and the lowest was 19.50 which gives a margin of 14.05. According to the stock market analysis that is a reasonable margin of a period of one year. Fiscal 2008, the highest market price is 38.54 which was in the third quarter and the lowest market price was 18.94 which was in the fourth quarter. The margin for this year was 19.60.
According to the results of a press release given in Wood Dale, Illinois in December 2009, the financial year 2010 second quarter sales of 328.7 million in addition to the net income attributable to AAR Corporation of 13.3 million or 0.34 per diluted share. Year over year, the sales to the defense as well as government customers increased by 4 percent and it also represented 48 percent of total sales while the sales to commercial customers declined by 15 percent. The company reported sales of 353.6 million as well net income attributable to AAR of 10.4 million or equivalently 0.27 per share and this was in the second quarter of the previous fiscal year.
According to Sergey Perminov (2008), in opposition to a realistically tough trade and industry environment, AAR Corporation has delivered solid second quarter results. AAR Corporation has achieved well-built sequential earnings development, had solid margin expansion, in addition to generated cash the corporation has gained the benefits of the process development initiatives, cost reductions, as well as improved mix. Due to this several new businesses have benefitted. The company has won a significant contract pertaining to providing supply chain services as well as logistics support for the USAFs KC-10 fleet. Moreover, in the face of a soft profitable market, the corporation has increased their market share by winning more than a few previously unannounced awards providing MRO as well as supply chain services.
According to Dr. Steve Sjuggerud, (2002) when an investor is selecting a mutual fund, the standard annual return is a supportive guide for measuring a funds long-term performance. However, Homan Timothy (2009) says investors should also look at a funds yearly performance to fully appreciate the consistency of its annual total returns. For instance, a five-year average yearly return of 10 looks eye-catching however, if the yearly returns ,those that produced the average annual return, were 40, 30, -10, 5 and -15 (50 5 10), the funds current performance (past three years) is absolutely unpleasant.
With such a high-quality performance, the investors should be able to buy the AAR Corporate shares and have confidence in their investment. The stock market prices though fluctuate, are deemed favorable for investors. The fact that AAR Corporation has been in business for several years, is a good sign of consistency.
According to Silverblatt Howard (2010), an investor looks at the diversification of a company and as for the AAR Corporation it has several sectors such that if one sector is not so successful, the others would still uphold the company. This gives the investor a piece of mind and confidence to invest more by buying more shares. This increases the companys earning as proven by the correlation test done.
An investor should also be ensured that they achieve consistency as well as sustainable return. According to Guan Ong (2007), the main aim of an investor should not be to achieve the highest returns but to achieve and maintain consistent as well as sustainable returns. He says there have been many examples of investors who have invested in the most popular stocks believing that the performance will re-occur the next financial year. According to the AAR Corporation stock prices there is consistency. This helps the investor to make wealth creation instead of making quick profit. Wealth creation involves developing a diversified portfolio which in return helps the investor achieve realistic returns. There should be careful analysis as well as preparation when it comes to investing in the stock market to avoid losses.
According to Guan Ong (2007), the analysis and preparation include the investors understanding of the available asset classes, evaluation of the risks, the investment environment and also the associated return levels. The level of risks that an investor should prescribe to their portfolio should depend on the type of institution or the companies to be invested in. The companies are all different and the risks involved are of different capacities. Asset allocation is the discipline used to determine the level of risk for each asset class within the portfolio.
According to Guan Ong (2007), the review reallocation and frequency of the portfolio depends strongly on the availability of the investors resources in addition to the differential growth rates of the market.
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