Reference no: EM13967337

Market Value and Profitability

The paper and forest products industry is dominated by large integrated manufacturers. According to data from the Census of Manufacturers, roughly 50% of industry output comes from giant plants with more than 500 employees. This is despite the fact that specialized minimills with as few as 20 to 49 employees have recently emerged in the industry to take advantage of market niches. On an overall basis, this major industry group is one of the largest and most important in our economy in terms of sales, profits, and employment. Low prices combined with innovative new products, such as recycled newspaper products, have swept the industry and given innovative competitors the means to earn above-average rates of return. In this highly competitive environment, the way to survive and prosper is to reduce operating expenses, increase product quality, and improve customer service. As much as any other single industry, paper and forest products companies have taken advantage of advances in computer-based methods of data collection and analysis to improve their relation with suppliers, keep inventories lean, and boost sales by better serving customer demands.

To assess the effect of firm size on the business success of these companies, the table shows the rate of return on stockholders' equity (%), firm size as measured by the book value of stockholders' equity (in $ millions), rate of growth in book value (%), and leverage as captured by the ratio of long-term debt to total capital (%) for an n = 17 sample of paper and forest product companies. The profitability effects of firm size indicate how economies of scale translate into higher profits, or how diseconomies of large-scale production trans- late into lower profits. Growth can have positive effects on profit rates because rapid growth typically reflects companies with attractive product lines and/or cost-efficient operations. Finally, leverage has the potential to contribute to higher profits during periods of robust economic conditions, but can penalize profit rates during recessions or periods of tepid demand.

Return on Shareholders'      Shareholders'          Book Value

A. A multiple regression model with each paper and forest products company's rate of return on stockholders' equity (ROE) as the dependent Y variable and firm size (BV), growth (GR), and leverage (LTD) as independent Xvariables gives the following results (t statistics in parentheses):

ROE  =  2.689  -  9.09E-05 BV +  0.216 GR -  +  0.107 LTD

(0.40) (-0.22) (2.27) (0.76)

R2   =  27.2%, SEE  =  4.371

How would you interpret these findings?

B. What suggestions might you make for a more detailed study of the determinants of prof- itability for paper and forest products companies versus other types of companies?