Choosing Between Investing $100000 in a Bank Account or Common Stock at Costco Company – Research Paper Example
Investment Research Paper: Choosing Between Investing $100000 in a Bank Account or Common Stock at Costco Company Any investment decision is a function of the profitability of the investment option and the risk associated with it (Ross, Westerfield and Jaffe 221).
Evaluating Options A: Investing the $100000 in a Bank Account at 5% per annum interest
The level of risk and uncertainty involved in investing money in a bank account at a predetermined interest rate is minimal. Investing money in a bank account does not involve the interest rate risk since the rate remains constant throughout the investment period. An investor can make projections with the certainty of the expected returns and the total amount receivable in the five-year investment period. Using the compound interest formula, projections of the amount receivable by the investor are made as follows (Ross, Westerfield and Jaffe 104).
The principal amount P in the investment option is $100000. The annual nominal interest rate is 0.05(5%) per annum. The number of times the interest is compounded annually n is 1. The number of years (t) for which the interest is being accrued is 5. It, therefore, follows that the amount receivable by the investor under this option after five years is $127, 628. The interest accruable is $27,628 for the five years.
Option B: Buying $100000 Common Stock at Costco Company
An investment in the common stock of any company should take into account the prevailing and projected market conditions that affect the prices of the stock and the profitability of the business. According to the latest information about Costco Wholesale Corporation Stock Quote and Summary Data of 20th May 2015, the official stock closing price was $143.49. The closing official opening price for the same day was $145.06 marking a decline in the stock value of $1.25 (0.86%) (Shih, Yu and Yen, page 16). Using the official closing stock price, the investor would purchase $100000/$143.49 of the corporations stock. The calculation translates to 696 shares. The current yield of the companys stock stands at 1.11%. The stockowners received Earnings per Share of $5.12 on the last dividend payment date 15th May 2015. The P/E ratio was $27.67.
The implication of the Price-Earnings Ratio as an investment valuation indicator is that Costco’s stock (at 143.49) was trading at 27.67 times the corporations net underlying earnings of $5.12 Earnings per share. Therefore, investors in Costco Corporation would be paying $27.67 for every dollar of Costcos earnings. The indications of a high P/E ratio of a company’s stock are that investors expect a higher future growth of earnings compared with the overall market (Ross, Westerfield and Jaffe 306). Investors pay more for today’s earnings anticipating a growth in the future earnings. A low P/E ratio indicates that investors have more modest expectations for the stock’s future growth as compared to the overall market. However, the future growth of stock is affected by factors like competition and the market conditions for both the firm and the industry.
The Investment Decision (presentation)
The choice of one investment option between the two options is taken based on the earnings accruing from both and the risks associated with the future of each option. Considering the implication of the P/E ratio for the stock of Costco, the investor is advised to purchase the stock of the company rather than keep the money in the bank account to earn interest. Costco in the recent past has been an active performer maintaining a steady growth in the US despite the competition pressure and the weak economic environment (Shih, Yu and Yen 19). The companys revenues have grown at an average annual rate of 8% for the past six years. Combined with the relatively high P/E ratio, the companys stock is expected to grow much more giving rise to substantial earnings per share.
The greatest risk associated with Costcos growth is the stiff competition from Amazon and Sams Club and Walmart. Costcos ability to manage the competition pressure has been marked by its 4 million annual growth of its customer base and the growth in sales revenue and profitability. It is therefore assumed that Costco would continue to manage the risk of high competition in the future for its growth. The stock would, therefore, generate more returns given the high growth potential. Investing in the bank account involves a lesser risk and a lower return while purchasing the stock involves a higher risk and a higher return. The higher the risk, the higher the return.
Ross, Stephen A, Randolph Westerfield, and Jeffrey F Jaffe. Corporate Finance. 10th ed. Boston: McGraw-Hill/Irwin, 2013. Print.
Shih, Shiau Pei, Szuchiang Yu, and Feng Ju Yen. How Does Costco Win Customer Satisfaction: A Case Study Of The South Of Taiwan. JOEBM 3.3 (2015): 360-363. Web.