Montgomery Howell, Vice President for investment analysis

Montgomery Howell, Vice President for investment analysis at First National Bank of Utah, is looking for a company to recommend to the bank’s portfolio committee for inclusion in its “buy list” for the various trust funds managed by First National’s trust department. Howell’s criteria for recommending a company are that it be a good, fundamentally sound, long term prospect and not a hot stock. Since the stock market crash, portfolio returns had been unpredictable. Howell hopes to convince the portfolio committee to take a long term view of the market rather than focus on short term price changes.

Howell recently read an article in the Wall Street Journal concerning Stevens & Johnson, Inc., a toy manufacturer. Stevens & Johnson had posted a six month pretax profit margin of 10 percent. While this was far below the 15% profit margins enjoyed before the market decline, it was far ahead of other companies in the industry. Perhaps Stevens & Johnson was a good long term investment.

The toy industry depended on three main factors for growth: the economy, demographics, and new product innovations on a regular basis. The average life for new products in the toy industry was only one or two Christmas seasons. Companies had two choices to maintain their sales strengths. Either they came up with regular product innovations or they relied on strong standby toys.

Stevens & Johnson had changed its marketing strategy during the past two years. Management was concentrating on its solid performing toys and moving away from the highly risky (yet potentially very profitable) promotional, faddish toys that had dominated the toy market over the most of the past decade. However, for the past two years, shipments of the blockbuster toys had steadily declined, leaving the manufacturers with obsolete inventory and machinery. Two of Stevens & Johnson’s three primary competitors had put too much emphasis on blockbuster toys. One was in Chapter 11 bankruptcy and the other had been forced to borrow to stay afloat. Its debt was now 88% of its total capital.

In contrast Stevens & Johnson and the other major competitor had bitten the bullet. They had trimmed overhead, written down inventories, and closed plants with excess capacity. Stevens & Johnson was focusing on its traditional toy line of stable toys, board games, and preschool games.

Today Stevens & Johnson has three new hot prospects for the future. First, the company recently announced the purchase of two operations that produced ride-on toys and outdoor furniture for children. These were expected to compliment Stevens & Johnson’s solid array of preschool items. Second, Stevens & Johnson had just signed the toy license on what was expected to be this summers hottest children’s movie. Third Stevens & Johnson was rumored to be planning to enter the video game segment of the industry.

In preparation for the necessary analysis, Howell had collected his financial statements and industry data for the past five years. Exhibit 1 contains company income statements for the five years 2013 through 2017. Exhibit 2 provides comparable balance sheets. Exhibit 3 contains industry average percentage income statements, balance sheets, and ratios as reported by RMA Associates.

Prepare a detailed memo for Mr. Howell, with attached schedules that addresses the following questions:

2. Using the financial ratios identify the relevant financial strengths, weaknesses, and trends of the company.

3. Compare the financial results of Stevens & Johnson with the industry and identify and discuss the areas where Stevens & Johnson is stronger or weaker than the industry.

4. Using the DuPont model analyze the return on equity for the past five years. Comment on the strengths and weaknesses uncovered by this analysis.

5. Given this analysis would you recommend Stevens & Johnson be included in First National Bank’s “buy list”? Explain why?