Free «American Electric Power Company» Essay Paper

Making an investment decision is a critical task. It should engage all potential investors and be accompanied by substantial research and seeking proper advice from a financial analyst. It is important for people who want to make their fist investments to know profiles of different companies which they might like to choose to invest in. The major aspects to consider are company’s operations, location, market and lines of business, etc. In addition, it is important to analyze company’s financial statements for the last three years to ascertain its vulnerability to financial threats like recession, high interest rates, and global competition. Considering these factors will help in predicting the future performance of a company. There are two categories of companies: private companies and public companies. Private companies are individually owned and do not trade their shares openly to the general public, while public companies are owned by the general public as their shares are openly traded in the stock market. These companies are also called publicly traded or public limited companies. Therefore, it is advisable for a potential investor to choose a publicly traded company to make his or her investments. A good example of such a company that can be preferred by investors is the American Electric Power company which is a publicly traded company.  

 

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Description of American Electric Power Company

History

American Electric Power company (AEP) developed from a small company called American Gas and Electric company (AG & E) which was founded in 1906 as a small company that was dealing with the provision of electric services, steam, and water. AG & E had its headquarters based in New York and was serving few states such as Ohio, New York, Pennsylvania, and New Jersey. AEP came into existence in the year 1958 as an electricity generating company with the completion of three major power stations, construction of which began in the year 1923 in three states: Ohio, Pennsylvania, and Northern Indiana. Today AEP is a multibillion company, which also grew due to its merger with the Central and South West Corporation of Dallas in 1997. The latter had a capital of $12.billion, which by today has risen tremendously to $50.5 billion. AEP had total earnings of $ 1.45 billion with $3.03 earning per share (AEP, 2012).

Location, Markets and Operations

American Electric Power company has its headquarters based in Riverside Plaza, Columbus in Ohio state. AEP serves about 5.3 million customers in larger geographical market in the United States of approximately 200,000 square miles. Its main branches are located in Texas, Indiana, Michigan, Arkansas, Virginia, Tennessee, West Virginia, and Kentucky. AEP covers the largest transmission network in the whole territory of the United States, which is about 39,000 miles. It is one of the largest suppliers of electricity producing about 38,000 megawatts. AEP is a publically traded company owned by shareholders and managed by a board of directors headed by a democratically elected chairman Michael Morris. Morris was elected in the year 2004. The company is also headed by a chief executive officer Nick Akins and has over 18,700 employees (AEP, 2011).

Financial Analysis

According to the extract from consolidated financial data for the last five years including 2007, 2008, 2009, 2010, and 2011, AEP has had a steady increase in total net profits during all years, except a slight fall in the year 2009 and 2010.

It is evident from the above appendix of a consolidated financial data report of the AEP, that recession had a negative impact on the total revenue of the company. This can be seen from the decline in total revenue in the year 2009 and 2010, which is a deviation from the consistent increase in revenues during previous financial years. Despite the decline, there was an increase in total revenue in the year 2011 after the economy had recovered from the recession. Even though profits of most companies went down during the economic downturn, AEP still managed to make profit from its operations. Every potential investor should understand that investment is a speculative business, which might be impacted by hard economic conditions. These conditions result in a short-term decline in dividends paid for the shares. However, the most important factor to consider is company’s past records and recovery trends after the economic turmoil. For example, AEP had been enjoying consistent growth in total revenues every financial year in the period where the economy was stable. Furthermore, it is showing a recovery trend after the recession (Martin, 2011).

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Subsequently, it is predicted that financial performance of AEP will continue to improve and continue to follow an upward trend as in the past financial years before the recession. Consequently, earnings per share are also expected to continue rising after economic recovery from the recession. This is indicated in the appendix bellow (AEP appendix, 2011).

It is clear from the appendix above that returns per share of AEP have been growing every financial year. For example, earning per share in financial year 2007, 2008 and 2011 were growing, despite the slight decrease in the year 2009 and 2010, which was caused by the recession. In this view, Frank Martin, an investment consultant, advices investors to consider long-term returns and not short-term returns. He also holds the opinion that investment is a speculative business, which faces short-term challenges like recession, but, however, will recover in the long run. Therefore, the most suitable person for this kind of investment is a long-term investor. This is because the speculative trade of shares is only profitable in the long run. For example, a person who bought shares in 2007 at $2.73 per share, could sell it at $4.02 in the year 2011 making a profit of $1.29 per every share sold (Martin, 2011). In addition, AEP has maintained a positive current ratio even during recession periods because its assets were consistently higher than its debts. This means that the company enjoys stable growth and is not vulnerable to hard economic times, since it can pay off its debts and still have enough assets to continue its operations. The assets and liabilities of AEP are indicated in the balance sheet as shown below (AEP appendix, 2011).

High interest rates reduce investments in all sectors of economy. This is because individuals and businesses tend to cut down on their spending, which results from reduced borrowing that they would otherwise have to pay for. A reduction of the number of investors resulting from increased interest rates will force company managers to reduce prices of unit share to cope with the low demand (Blinder & Baumol, 2011). Slow economic activity during the period from 2008 to 2010 resulted in a decrease of real wages in majority of sectors. This happened because firms laid off their workers to cut on operation costs. This in turn led to a decrease in demand for investment goods and lowered the supply of money in the economy. This situation, therefore, led to an increase in nominal interest rates, which was caused by an increase of the demand for money, thus leading to an increase in interest rates. Constant low demand for investments may force managers of a company to reduce prices per unit share traded in the stock market (Sardoni, 2011). It is, therefore, clear that AEP managers had to reduce unit share prices in 2009 and 2010 due to low demand for investment caused by recession, which led to higher interest rates on borrowing. Changes in the unit share prices for the past five years are indicated in the appendix below.

Analysis of the above appendix presenting the unit share prices range shows that high interest rates had a negative impact on share prices in the stock market. At a given period the unit share price was trading as low as $24 and as high as $36.51 in the year 2009. However, the company had a potential to increase its share prices, when the economy started to recover in the year 2010 selling at a lower price of $ 28.17, which was higher than the price during the previous year - $24 (AEP appendix, 2011).

Despite the short term fall in unit share prices, it is still viable for an investor to continue with the investment plan with AEP Company. According to Frank Martin, an investment advisor needs patience and courage to focus on long-term returns rather than on short-terms returns. This is because positive returns on an investment occur in the long term. He further argues that short-term challenges will come and go because the company will recover and perform well in the long-term. Therefore, this kind of investment is beneficial for long-term investors (Martin, 2011).

Lastly, AEP being one of the largest generators and transmitters of electricity in the US is an established company, which does not face any threats from competitors. The restructuring of electricity market into generators and transmitters as well as controlled territory of distribution has decreased competition. This enabled AEP to enjoy economies of scale by generating large volumes of electricity and to use the small emerging companies in the retail transmission, thereby increasing its aggregate sales volume. This is also an advantage to potential investors because it ensures prosperity and continuous growth (Greer, 2012).

Conclusively, as a savvy financial analyst, I would advice any potential investor to choose America Electricity Power company as a publically traded company to invest in. The rationale for selecting this company is based on the analysis of the last five years of financial statements, which included the balance sheet and the income statements. From this financial analysis AEP has shown a consistent growth during the last financial years with a slight short-term decline in performance during the economic crisis. It was, however, able to resume growth trend as the economy stabilized, which is a normal case for most companies.