Growth Rates
Although the reports list a number of growth rates the basic formula and
idea is the same across each one.
To calculate the % growth rate there are two options: 1.
(year2/year1-1)*100 or (year2-year1/year1)*100 they both give you the
percentage change between year 1 and year 2 (or period 1 and 2).
Why is this useful? if you compare the dollar value of change you don't
get an accurate comparison, for example two companies increase their NPAT
by 100,000 company A had previous NPAT of 90,000 company B had previous
NPAT of 70,000 in percentage terms company A has increased about 11%
and company B by about 43. The percentage change then allows relative
comparisons so that the proportional change can be compared - it also
allows you to ignore scale, so you can compare the growth rates of
different sized companies. In an ideal world you would prefer companies
that had positive or consistently positive growth rates.
Problems? negatives. Negative figures distort growth rates, it is vital to
understand this when you are looking at growth rates because a company
going from a loss to a profit has increased its profit but the percentage
change will be a negative figure i.e. 1/-1=-1 and similarly a company
going from a loss to a greater loss will show a positive growth rate i.e.
-1/-1=1. So be wary of this and check the dollar figures as well. One
point that will resonate is the importance of not focusing on one figure
alone, this is especially the case for ROE.
Average growth rate: a basic average = the growth rates of all periods
summed and divided by the number of periods
Compounding growth rate = [(Final year/first year)^(1/number of
periods)-1]*100
Per share figures
This measure simply gives the amount of net assets/dividends/earnings per
share, it is a product of the figure e.g. net assets, divided by the
number of shares on issue. It therefore adjusts figures for changes in the
number of shares and allows a comparison between companies. However these
figures are more useful when used in conjunction with market data i.e.
price. Earnings per share and price can give you the PE ratio i.e. price
divided by EPS, and dividend yield as dividend per share divided by price.
Return on Assets (ROA)
This figure shows how much profit per dollar
of assets the company was able to generate, for example with an ROA of 5%
a company would get 5 cents for each dollar
of assets. It is a rough measure of profitability, and is useful when used
alongside ROE.
Problems? ROA differs drastically based on industry and business model,
banks and finance companies have low ROAs but because of the proportion of
debt they use their underlying profitability is comparable. Also there is
debate on which inputs should be used, i.e. do you use the asset figure at
year end, or the average assets over the period?
Equity multiplier (EM)
This is a measure of debt/leverage, it is calculated by total assets
divided by total debt. This gives a relative measure of how much debt a
company is using and will have a direct affect on it's return on equity.
Return on Equity (ROE)
Return on equity is measured as NPAT divided
by net assets. It gives the underlying profitability of the company, and
in general the higher the figure the better, as a corollary the more
consistently high the better. ROE combines ROA and EM: ROE=ROA*EM, thus
when analysing ROE you must look at ROA and EM also, ROA gives you the top line
profitability, while ROE adjusts it for leverage. Net assets or equity is
listed on the balance sheet as shareholders equity - so this figure
measures the return on your funds.
Net profit margin
Net profit divided by revenue, this measures how much revenue gets
turned into profits.
Dividend payout ratio
What percentage of profits are paid out as dividends, the opposite figure,
retention ratio measures how much profit the company retains- this is
important when the company is growing and has a lot of positive NPV
projects i.e. when it can put the money to good use. Ideally you want a
high retention ratio when the company can earn a higher return on equity
than you can.
Net working capital
Current assets less
current liabilities, this is a gross measure of liquidity, the higher the
figure, the more liquid the company. However there is a trade off, more
liquidity often means lower profitability e.g. the most liquid asset is
cash, but obviously it is not the most profitable use of funds to hold
cash.
Current and acid test ratios
These ratios measure liquidity on a relative basis, so this figure can be
compared across companies easily ignoring scale. The higher this figure is
the more liquid the company is, or more appropriately the more funds are
allocated to current assets, it could also be a sign that the company has
a sloppy receivables management policy, or that it has too much inventory.
Calculated: current = current assets/current liabilities . Acid test =
(current assets-inventory)/current liabilities.
Times interest earned:
Measures how well the company is covering its interest expense,
calculated = EBIT/interest expense.
Efficiency ratio (operating
expense/operating revenue)
This is a common figure in analysis of bank performance, it attempts
to measure how efficient the company is in generating revenue, for example
a company with a low efficiency ratio uses less expense than one with a
high expense ratio to generate profits. However of course this figure can
differ due to structural and industry differences, so it should be viewed
as one pixel in the picture.
Summary Financials
This was included so that a brief summary of the key totals could be
quickly assessed, it should be intuitively obvious what is displayed. This
segment is useful when viewed in conjunction with the ratios; indeed these
figures should be used to check the validity of the growth rates. The
graph included in the report allows the user to assess the bottom line
figures of this section in a visual format.
Parting comments in general:
The ratios deal only with the numbers, this means you are relying on the
numbers being true and accurate, and that your calculations are correct.
You can learn a lot about a company by it's numbers, and you can lower
your risk by setting standards in terms of minimums or guidelines of ratio
measures. However numbers can not tell you the qualitative aspects, they
can't tell you what distortions have been influencing them, the numbers
-do- contain this information indirectly, however for a fuller picture you
should be prepared to look beyond the numbers, and question them also -
"is there a reason for this figure?"
The numbers are an easy way to distinguish between financially healthy and
well performing companies and those which are not, however they are
backwards looking, and there is a need to forecast, e.g. will this growth
rate continue? At the end of the day though, the numbers can serve as a
good filter, and as long as you integrate them into a sound investment
strategy you should be able to use them to your advantage.
Look at the numbers and use them wisely, but remember to look past them
into what story they tell.
By Callum Thomas
See the new
tutorial for the v2 reports for more extensive and advanced analytics
and insights.
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