Today we turn to the Ratio Analyzer's Profitability Ratios and Asset & Inventory Ratios.
Under the heading of Profitability Ratios we find these items:
- Sales or Revenues (annualized change)
- Cost of Sales (annualized change)
- Price to Sales Ratio
- Shares Outstanding (annualized change)
- Gross Profit Margin (annualized change)
- Gross Profit Margin (current)
- Gross Profit Margin (yr. ago)
- Earnings Confidence Rating
Sales or Revenues (annual change) ought to be familiar to anyone who has completed a Stock Selection Guide, or to anyone who is interested in growth companies. Growth of Sales is the source of growth in profitablity. So, we look at the annualize growth in sales as a key ingredient. We want sales to increase, and we want them to increase at a healthy rate. Nominally, a sales growth rate of 15% or more can drive an equal rate of change in the company's Earnings Per Share.
We expect the Cost of Sales to grow at the same rate (or less) than the growth in sales. As a company grows in size, we would hope that there are efficiencies that result in the cost of sales growing more slowly than sales. Certainly, if the cost of sales grows faster than sales, that is a concern.
The Price to Sales Ratio is another way of looking at how sales flow into individual shares.
Price to Sales Ratio = ( Current Price ) / (Revenues Per Share )
In keeping with our quarterly focus, the "Current Price" in this calculation is the price at the end of the quarter.
The Price to Sales Ratio tells us what we (as shareholders) have to pay to own each dollar of Sales. Lower numbers are better than large ones, and the result is likely to depend on the industry. This ratio is also larger for higher growth companies, as these attract investors. A number greater than 3 is considered to be high, while a number less than 1 is quite favorable.
We are interested in the growth in the number of Shares Outstanding because that will diminish all of the "per share" numbers. In particular, we will often look at Earnings Per Share as the true cost of a company. If the company is continuing to issue shares, and do so at a rate that outpaces other statistics, this is unfavorable.
We would like the shares outstanding to decrease or remain steady, but will accept a growth rate of a few percent per year.
We also look at the Gross Profit Margin to assess the company's ability to convert sales into profits. The Gross Profit is the money left over from revenues after accounting for the cost of goods sold. The Gross Profit Margin expresses this as a percentage of the Sales or Revenue.
Gross Profit Margin = 100 * ( 1 - (Cost of Goods Sold)/(Revenues) )
We display the Gross Profit Margin for this year and for last year, and we compute the annualized change as a percentage. We would expect to see the Gross Profit Margin remain steady or rise. Increases indicate that the company is using economies of scale or improved processes.
The Earnings Confidence Rating quantifies the quality of a company's earnings. This ratio identifies how efficient the company is in turning net income into net cash.
Earnings Confidence Rating = [Net Cash from Continuing Operations] / [Net Income from Continuing Operations]
Values greater than 1.5 are considered to be good. Values less than 1 are considered to be bad.
The Asset & Inventory Ratios are:
The Plant & Equipment (annualized change) indicates how a company is investing for future growth.
When a company invests in a new plant or equipment, there is an expectation that sales will increase once the plant/equipment is on line. A decrease in Plant & Equipment spending may not speak well for future growth of the company. But we should also look at the long term trend. If the company has been spending heavily in the past few years, perhaps additional expenditures are no longer necessary to provide for future growth. Investing in a weak economy may indicate management is taking the long-term view, preparing to take market share when the economy improves.
The Inventory Turnover Ratio indicates how often a company "turns over" its inventory in the given year.
Inventory Turnover Ratio = [ Cost of Sales ] / [ Inventory ]
Here, the Cost of Sales is the total cost to create inventory in the past year, whereas Inventory is the value of the goods still in inventory. The ratio tells us how many times the inventory has been used up or "turned over."
Plant Turnover Ratio
Plant Turnover Ratio = [ Sales ] / [ Property Plant & Equipment]
The Plant Turnover Ratio gives us an idea of how efficient each dollar invested in Property, Plant and Equipment might be in generating sales. But, remember that we are comparing current spending on PP&E with current sales. Current investments in plant or equipment will lead to future sales, but it does take time for a new plants to come on line and benefit sales.
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Now let us look at Microsoft and Airgas through these lenses.
Microsoft's Cost of Sales is increasing, but not as fast as sales are increasing. The Price to Sales ratio is high, but this probably more of an inticator ofinvestor interest in Microsoft's stock rather than a negative about the company. Microsoft's Gross Profit margin is steady (and around 82%!).
Microsoft continues to increase its investment in Plant, Property and Equipment, and it does so at a rate faster than sales are growing. Otherwise, the inventory turnover is in a normal range, and the plant turnover ratio is ok.
For Airgas, sales are also increasing and increasing faster than the cost of sales. The price to sales ratio is low, but other factors look good. Notice that Airgas Gross Profit Margin is in the 50% range, quite a bit less than Microsoft. This undoubtedly is due to the difference in the industries.
Airgas' is investment in Plant, Property and Equipment is growing faster than sales, while the Plant Turnover Ratio is low. Perhaps this is why they need to make those investments. Inventory is turning over at a reasonable rate, but should be compared to other companies in the same industry.
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This concludes the line-by-line examination of the Ratio Analyzer. On Monday and Tuesday I will take a look at several companies, and I'll also give some tips for printing reports.
Questions? I'm still willing to answer questions ... |