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Chapter 2

REVIEW OF RELATED LITERATURE AND STUDIES


This part presents relevant literature and studies to show the need to
conduct this study.
The top five sector-based indices in PSE used in this study are listed
according to its main line of operations, namely: Financials, Industrial, Holding
Firms, Services and Property. These were chosen through the percentage
increase in each of the listed sectors' market index as presented in Table 1.
Historical data of sector-based indices in the PSE from December 2014 to
December 2015. And since this study is intended to determine the controlling
component in the ten-year trend of return on equity using DuPont analysis of
the top five (5) performing listed sectors on Philippines Stock Exchange for
the year 2015, the researchers identified and used the top five (5) companies
under each sector, through their most recent return on equity, to characterize
these sectors.
The Financials sector, to begin with, covers companies whose
operations are engaged in banking, investments, and finance. With the data
the researchers gathered, they were able to find out that the top five (5)
companies under this sector are: BDO Unibank, Inc. (BDO), Bank of the
Philippine Islands (BPI), Security Bank Corporation (SECB), Metropolitan
Bank and Trust Company (MBT), and Union Bank of the Philippines (UBP).
BDO is a public finance and insurance corporation founded in 1968
and is a member of the SM Group of Companies, one of the country's largest
and most successful conglomerates owned by tycoon Henry Sy, Sr. It
provides products and services to the retail and corporate markets including
lending, deposit-taking, foreign exchange, brokering, trust and investments,
credit cards, corporate cash management and remittances. With this, BDO
Unibank, Inc. is now the largest bank in the Philippines in terms of assets,
loans and deposits. Additionally, it has 28,217 employees, 1,028 branches
and 3,195 ATMs as of its 2015 Annual Report. It has a total assets of 2 trillion
Philippine pesos, which is up by 9% compared to the 2014 report. Its net
income is 25 billion Philippine pesos, which is up by 10% compared to the
2014 report. Its Generali Pilipinas Premiums grew by 27% equating to 6.9
billion Philippine pesos, insurance premiums grew by 19% and insurance
commissions by 22%, all data were derived on its 2015 operations.
BPI is a public finance corporation founded in 1851, owned by the
Ayala Corporation, and is the oldest bank in the Philippines still in operation. It
is the country's fourth largest bank in terms of asset, the country's largest
bank in terms of market capitalization, and the country's most profitable bank
to date. Currently, it has 12,355 employees and 831 branches that helped
generate a revenue of 52.498 billion Philippine pesos, which is up by 10.8%
compared to the 2013 report, net income of 18.017 billion Philippine pesos,
which is up by 25.5% compared to the 2014 report, and total assets of

1,450,197 million Philippine pesos, which is up by 21.3% compared to the


2014 report.
SECB is a universal banking and financial corporation founded in 1951
and was the first private and Filipino-controlled bank of the the post-World
War II period then it was publicly listed with the Philippine Stock Exchange in
1995. It is one of the Philippines' leading universal banks serving retail,
commercial, corporate and institutional clients. It offers a wide range of
services including financing and leasing, foreign exchange and stock
brokerage, investment banking and asset management through its
subsidiaries. It has approximately 253 branches as of July 2014, total assets
of 532 billion Philippine pesos, and net profit of 7.699 billion Philippine pesos
all as of the 2015 annual report.
MBT is a leading financial conglomerate founded in 1962 and has
since become the premier universal bank and among the foremost financial
institutions in the Philippines. It offers a full range of banking and other
financial products and services, including corporate, commercial and
consumer banking, as well as credit card, remittances, leasing, investment
banking and trust banking. Currently, it spans a consolidated network of
10,759 employees, over 1,950 ATMs nationwide, over 860 domestic
branches, and 31 foreign branches, subsidiaries, and representative offices.
Its total assets is 1.73 trillion Philippine pesos and net profit of 18.6 billion
Philippine pesos, all based on the companys 2015 annual report.
UBP is a public finance and insurance corporation founded in 1982 and
is now one of the largest banks in the Philippines, ranking seventh in terms of
assets after its successful merger with smaller competitor International
Exchange Bank. It is one of the most stable Philippine banks and is the host
bank of the E-Card accounts of the members of the Government Service
Insurance System. Currently, its revenues total to 20.2 billion Philippine
pesos, 6 billion Philippine pesos net income, and total resources of 441.7
billion Philippine pesos though, no information was provided as regards the
company's number of employees.
The Property sector covers companies whose operations are involved
in land and property development. The researchers then again, used the most
recent return on equity of the companies listed under this sector and were
able to identify the top five, namely: SM Prime Holdings, Inc. (SMPH), Ayala
Land, Inc. (ALI), 8990 Holdings, Inc. (HOUSE), Suntrust Home Developers,
Inc. (SUN), and Century Properties Group, Inc. (CPG).
SMPH is one of the largest integrated property developers in
Southeast Asia, founded in 1994, that offers innovative and sustainable
lifestyle cities with the development of malls, residences, offices, hotels and
convention centers. It is also the largest, in terms of asset and income base,
in the Philippines. Currently, it has 58 malls in and outside Metro Manila and 6
shopping malls in China, totaling 8.5 million square meters of Gross Floor
Area (GFA). In the Philippines, they have a total of 17,333 tenants and 1,478
tenants in China. As regards its total assets, SMPH generated total

investments properties of 190.4 billion Philippine pesos on its malls, 26.6


billion Philippine pesos on its offices, 9.5 billion Philippine pesos on its hotels
and convention centers and total assets of 108.8 billion Philippine pesos on its
residences, all from the companys 2015 annual report. With regard net
income, the company generated 15 billion Philippine pesos on its malls, up by
13.1% compared to the 2014 report, 1.3 billion Philippine pesos on its offices,
up by 67.3% compared to the 2014 report, 0.4 billion Philippine pesos on its
hotels and convention centers, up by 57.9% compared to the 2014 report, and
5.1 billion Philippine pesos on its residences, up by 7.9% compared to the
2014 report.
ALI is the largest property developer in the Philippines, founded in
1988, and is operating prime commercial spaces throughout the country. It is
a subsidiary of Ayala Corporation with core businesses focused on strategic
landbank management, residential development, shopping centers, corporate
businesses, and hotels. Currently, it has total assets of 442 billion Philippine
pesos and net income of 17.63 billion Philippine pesos to which residential
development business contributed 51% to consolidated revenues for 2015.
HOUSE, formerly IP Converge Data Centers, Inc., was incorporated as an
information technology and telecommunications services provider on July 08,
2005. On October 1, 2013, the Securities and Exchange Commission
approved the change in its corporate name to the present one and the change
in its primary purpose to that of a holding company. Currently, it has total
assets of 32 billion Philippine pesos, which is up by 32.9% compared to the
2014 report, total revenues of 9.28 billion Philippine pesos, which is up by
21.19% compared to the 2014 report, and net income of 3.7 billion Philippine
pesos, which is up by 12.5% compared to the 2014 report.
SUN was incorporated in 1956 to engage in the business of manufacture
and sale of all types of ramie products. In 2002, the Company changed its
name from Fairmont Holdings to the present one. The said change came
hand in hand with a corresponding shift in SUN's primary purpose from a
holding company to a real estate company authorized to engage in real estate
development, mass community housing, townhouses and rowhouses
development, residential subdivision and other massive horizontal land
development. As per the companys 2015 financial statement report, it has
total assets of 750.57 million Philippine pesos and total revenues of 361.03
million Philippine pesos, which is up by 19.20% compared to the 2014 report,
this led to a net income growth of 26.92% for the same year.
CPG is one of the leading real estate companies in the Philippines with a
proven track record of delivering projects with innovative real estate concepts.
The company is primarily engaged in the development, marketing, and sale of
mid- and high-rise condominiums, retail leasing and property management,
and is in the process of diversifying into two allied real estate segments, such
as leisure and tourism and horizontal economic housing, to further strengthen
our portfolio. As per the companys 2015 financial statements, it has a total
assets of 36.74 billion Philippine pesos and total revenues of 9.51 billion

Philippine pesos. Additionally, though the companys gross margin increased


by 45.24%, its free cash flow decreased by 2.05 billion Philippine pesos.
(Holding sector)
(Industrial sector)
(services sector)

2.1 Conceptual Literature

Financial Management
Financial Management focuses on decisions of an entity relating to how
much and what types of assets to acquire, how to raise the capital needed to
purchase assets, and how to run the firm so as to maximize its value
(Brigham 2014). This refers to how efficient and effective a financial entity
manages its funds to achieve its organizational objectives. The main goal of
financial management is to maximize shareholders wealth, not accounting
measures such as revenues or return on equity (ROE). However, accounting
data affect stock prices, and this data can be used to see why a company is
performing the way it is and where it is heading (Houston 2009). Financial
Management can also be viewed as the manner of how such entity make
economic decisions. Such decisions, if maintained in the long run, can have
an implication to the financial strategy of the entity including, but not limited to
operational efficiency, asset effectiveness and capital structure. However, for
this study, implications to financial management should be limited to
organizational decisions with regard to operational efficiency, asset
effectiveness and capital structure to match against the components of return
on equity using DuPont analysis.

Return on Equity
Return on equity (ROE) is a profitability ratio that provides investors insight
into how efficiently a company (or more specifically, its management team) is
managing the equity that shareholders have contributed to the company
(Fuhrmann 2015). Mathematically, it is computed by dividing the net income
(bottom-line profits reported on a firms income statement) over total
shareholders equity (assets minus liabilities on a firms balance sheet).
An example of applying return on equity as a profitability measure of a firm
is as follows:

Diligence Company generated a net income of $5,000,000 for the year


2015. Determine the profitability of the firm in terms of return on equity and its
implication if its shareholders equity totaled $12,500,000 at the end of the
year. Assume further that the average return on equity of the industry under
which Diligence Company belongs is 25%.
The solution to this problem is:
Return on Equity = Net IncomeTotal Shareholders' Equity
Return on Equity = $5,000,000$12,500,000
Return on Equity = 0.4 or 40%
This means that Diligence Company generated $0.40 of profit for every $1
of shareholders equity, giving the stock an ROE of 40% which is relatively
higher than that of the industry of 25%. This implies that Diligence Company
is relatively more profitable than its competitors.

DuPont Analysis
DuPont analysis is a method that can be used to further analyze return on
equity (ROE). According to DuPont analysis, ROE is influenced by three
factors: operational efficiency which is measured by profit margin, asset
effectiveness which is measured by total asset turnover, and capital structure
which is measured by equity multiplier (Pinsent 2014). Mathematically, ROE is
the product of three financial ratios: profit margin, total asset turnover and
equity multiplier. This implies that if ROE is relatively low, the firm could
experiencing a poor profit margin, a poor asset turnover, and/or has too little
equity multiplier.
Operational efficiency is the ability of a firm to deliver products or services
to its customers in the most cost-effective manner possible while still ensuring
the high quality of its products, service and support (Beal 2016). Operational
efficiency is often achieved by streamlining a company's core processes in
order to more effectively respond to continually changing market forces in a
cost-effective manner. Asset effectiveness describes how efficient a firm
deploys its assets to produce sales (Peavler 2016). If you have too much
invested in your company's assets, your operating capital will be too high. If
you don't have enough invested in assets, you will lose sales and that will hurt
your profitability, free cash flow, and stock price. Capital structure refers to
how a firm finances its overall operations and growth by using different
sources of funds: debt, equity and others (Kennon 2015). Debt comes in the
form of bond issues or long-term notes payable, while equity is classified as
common stock, preferred stock or retained earnings. Bonds are considered to
be less risky investments for at least two reasons. First, bond market (market
where debt instruments are traded) returns are less volatile than stock market
(market for trading equity instruments) returns. Second, should the company

run into trouble, bondholders are paid first, before other expenses are paid.
Shareholders are less likely to receive any compensation in this scenario
(Econ 2005). In addition, an example of other forms of capital is vendor
financing where a company can sell goods before they have to pay the bill to
the vendor without incurring any significant cost.
An example of applying DuPont analysis to determine the Return on Equity
(ROE) of a particular firm is as follows:
Elegance Company has the following account balances specially identified
from its 2015 Financial Statements:

Sales

$2,500,000

Total Assets

$5,000,000

Net Income

$450,000

Total Shareholders Equity

$4,000,000

The industry under which Elegance Company is classified has an average


profit margin of 20%, average total asset turnover of 30% and average
financial leverage of 1.5 times; thus having an average return on equity of 9%.
Using DuPont analysis, determine the three components of return on equity of
the company and their implications to the firms financial performance for the
year.
The solution to this problem is:
Return on Equity =Profit Margin Total Asset Turnover Equity Multiplier
Return on Equity = Net IncomeSales SalesTotal Assets Total
AssetsTotal Shareholders' Equity
Return on Equity = $450,000$2,500,000 $2,500,000$5,000,000
$5,000,000$4,000,000
Return on Equity =0.18 0.5 1.25
Return on Equity = 0.1125 or 11.25%
The firm has a lower profit margin and equity multiplier relative to the
industry average. This could imply that the company is not efficient in handling
its costs and has higher percentage of equity to asset than debt exposing it to
higher risks considering stock market returns are more volatile than bond
market return. However, the company has a higher total asset turnover of
50% than the average industry of 30% implying that the company has

efficiently deployed its assets to generate revenue. This is also the reason
why the company has a higher return on equity relative to its industry despite
having the other two lower components.

Listed Sectors under Philippine Stock Exchange


PSE Financials Index

2.2 Related Studies

Foreign Studies
A study (Radu et al. 2014) conducted in Alba Iulia, Romania, used the
DuPont model as a primary tool in conducting a performance analysis in the
construction industry of Romania. The main objective of the study is to
provide an analytical framework appropriate for observing factors that make
and influence financial profitability (indicated by return on equity); proposing
ways of growth for the construction industry in Romania. The DuPont analysis
was performed on a cluster of nineteen (19) companies from the construction
industry. The study also used Pearson correlation coefficient to measure the
strength of linear association between variables such as return on equity,
return on assets, return on sales, total asset turnover, equity multiplier, net
income and equity.
The study concluded that there is no significant correlation between net
income and total assets or net income and turnover. However, it was
determined that there is direct, reasonable correlation between net income
and equity. The study further recommended that for the construction industry
to improve its ROE, the companies should consider a growth in asset
utilization efficiency (indicated by return on asset) and operational efficiency
(indicated by return on sales or profit margin). Furthermore, The effect of
increasing the financial leverage (indicated by equity multiplier) would also
increase profitability, but has undesirable effects in the short run as excessive
indebtedness attracts risks of indebtedness that cannot be easily quantified by
the researchers because of a financial crisis in Romania caused by lack of
liquidity.
The study is similar to the researchers study in that both use DuPont
analysis to analyze factors that influence financial profitability of certain sector
and the companies under it. The differences between the study conducted in
Romania and the researchers study are the setting, time horizon and
objective of the study. The formers objective is to determine possible
correlations between variables used in DuPont analysis for one year to furnish

a recommendation into what factor should the construction industry in


Romania focus on increasing to affect return on equity; while the latters
objective is to characterize the financial strategy of the top five (5) listed
sectors in the Philippine Stock Exchange using DuPont analysis of the top five
(5) companies for each sector for ten years.

Local Studies

References:
Brigham, E. Fundamentals of Financial Management. Cengage Learning
Asia Pte Ltd. 2014
Houston, J. Financial Management. [cited 1 Nov 16]. Available from:
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http://www.investopedia.com/articles/fundamental-analysis/08/dupontanalysis.asp
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http://www.webopedia.com/TERM/O/operational_efficiency.html
Peavler, R. Use Asset Management Ratios in Financial Ratio Analysis.
[cited 01 Nov 16]. Available from: https://www.thebalance.com/useasset-management-ratios-in-financial-ratio-analysis-393187
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Nov
16].
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BDO Unibank, Inc. Annual Report (2015). [cited 01 Nov 16]. Available
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https://www.bdo.com.ph/sites/default/files/pdf/BDO
%202015%20Annual%20Report.pdf

No author. Metrobank. [cited 01 Nov


https://www.metrobank.com.ph/about.asp

16].

Available

from:

Metrobank Annual Report (2015). [cited 01 Nov 16]. Available from:


https://www.metrobank.com.ph/images/Annual
%20Reports/2015%20Annual%20Report%20(Financial
%20Statements).pdf
Financial Reports (Bank of the Philippine Islands). [cited 01 Nov 16].
Available
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cmpy_id=234
Ayala
180
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[cited
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Nov
16].
Available
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from:

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cmpy_id=32
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Available
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cmpy_id=32
UnionBank of the Philippines. [cited 01 Nov 16]. Available from:
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SM Prime Holdings, Inc.
http://www.smprime.com/

[cited

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Nov

16].

Available

from:

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http://www.pse.com.ph/stockMarket/companyInfo.html?
id=112&security=314&tab=0
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%20PrimeAR_2015%28Web%29_0.pdf
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8990
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http://www.8990holdings.com/about-us.html

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from:

8990 Holding, Inc. Annual Report (2015). [cited 02 Nov 16]. Available
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Suntrust Home Developers, Inc. [cited 02 Nov 16]. Available from:
http://quotes.wsj.com/PH/XPHS/SUN/financials#
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Available
from:
http://edge.pse.com.ph/companyInformation/form.do?cmpy_id=73
Century Properties Group, Inc. (About us). [cited 02 Nov 16]. Available
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Centuries Properties Group, Inc. [cited 02 Nov 16]. Available from:
http://quotes.wsj.com/PH/CPG/financials
CPGI 2015 Annual Report [cited 02 Nov 16]. Available from:
http://www.century-properties.com/wp-content/uploads/2016/07/CPGI17A-2015.pdf

Chapter 3
METHODOLOGY

(Short intro to inform readers about the different topics included in this
chapter)
Write in the past tense

3.1 Research Design


3.2 Data Gathering Procedure
3.3 Research Instruments
3.4 Statistical Treatment of Data

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