David Berman Harvard Case Solution & Analysis

Introduction

David Berman found a relationship between the retailers company and their probability as a result, there was a movement in share price. David Berman has done bachelors in finance, MBA and CPA. He is sure that by practicing as an accountant he will be able to take notices of relationship which most investors missed out. This inventory and profitability relationship is surprisingly used to predict stock price and potential return that can be earned.

 Overall Analysis

Berman has explained inventory and profitability relationship by depicting many examples of companies. In general if there is a buildup of inventories of Retailer Company then they are sold which leads to gross profit margin being higher than usual and there fore net profit will also be higher. The logic behind this could be possible in increasing inflation as inventories value increases by time In order to calculate cost of goods sold, the value of closing is deducted therefore higher value of closing inventory means less COGS and lower inventory value means higher COGS.

There is also another important relationship that is inventory to sales. There are several real life examples that prove this relationship matrix such as in year 2001 and 2002, as Depot was facing trouble with generating cash therefore it dramatically lowered inventory. Technically, retailers’ sales is dependent upon available inventory and huge amount is stuck up in inventory as inventory is sold cash is released. By reducing amount of inventory there is potential risk on sales.

If inventory is reduced then that would mean there is potential risk of loss revenue and hence loss of profitability Lost sales will result in decline in profitability there fore there will be directly impact on the share price.

In the given results and in the impact of inventory over sales, profitability and cash Berman was of view that his funds can value firms more accurately and fair value can be valued.

Wall Street ignores the importance of inventory and therefore, the prices of Retail Company’s shares are not priced accurately. One of most recent examples is Saucing, a shoe company. Berman identified it as a strong company on the basis of his analysis and started to accumulate stock at $14. Berman’s forecast was proved to be accurate and the stock doubled within a year, hence it was proved that the relationship of inventory and sales works in practical and can be used to earn potential gain.

There was another example of Bombay which deals in fashionable home accessories, wall décor and furniture. Berman identified that classic inventory to sales relationship work so fast and accurately that a decision based on this would be result in potential gain.

The relationship between inventory productivity in retail sector can be evaluated by using different ratios such as inventory turnover. Higher inventory turnover is good as it shows less time is required to convert inventory into cash.

Inventory turnover largely affects the valuation of the retail company such as between 1987 to 2000, the annual inventory turnover of Best Buy ranged from 2.85 to 8.53, while its close competitor’s inventory turnover was less than BB’s turnover there fore interpretation can be concluded that BB was able to convertits inventory more quickly than its counterparts.As a result there are different interpretations that could be used to interpret the variation in inventory levels.

There are also other ratios such as follows,

 These ratios can be further used for different retailers and different interpretations can be made to arrive at common decision of investment. By estimating similar ROE of different companies while if it is assumed all else are equal, then decision making would be enhanced.

There is also established link between gross margin and inventory turnovers, it is expected that inventory turnover and gross profit are negatively correlated. This relationship can be used to identify trends and will help to cherry pick shares which will result in potential profits.

John B. River is a potential target company for investment. John B. River is a leading men tailored and casual clothing and accessories store. John B. River is a retail chain store and it opened its 250th store recently and it is expected to expand up to 500 stores. Increasing number of stores means that John B. River is expanding its presence and hence sales, profitability and inventory level will increase.................

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