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Rate company performance
Dear Dollar Diva,
How can I compare a publicly traded company's performance with that
of its industry? I am interested in comparing ratios for profitability,
asset utilization and liquidity.
Comparing a company's ratios to industry averages
is a very smart thing to do. You'll want to look at the ratios measuring
valuation, growth and efficiency as well as the ones you've already
mentioned. Often, the investment sites on the Web tease you with
a limited amount of research on a company for free -- and charge
you for the good stuff.
Not so at Market Guide Inc.'s Web site, where you'll
get a menu of research that will help you decide whether a company
belongs in your portfolio. You'll get information on what the company
does; recent news articles; selected information from three years
of financial statements; earnings estimates; insider trader info,
and lots more. Select "comparison" from the menu, and you will get
ratio comparisons: company vs. industry vs. sector vs. S&P 500 --
very useful indeed!
Ratios
Ratios are used to measure various aspects of a business
-- including financial strength, profitability, efficiency and valuation.
One of the most common is the P/E ratio, or price earnings ratio,
in the valuation category. If a stock is selling at $80 a share
and each share earns $2 a year, the P/E ratio would be 80/2, or
40. By itself, the ratio doesn't mean much. But if you compare it
to an industry average of 30, it's quite high. The market is saying
the company is worth more than its peers. Perhaps it expects the
company to have a higher growth rate over the next couple of years.
If, however, the industry average is 50, the P/E of 40 tells you
that the market believes the company is worth less than its competition
. Perhaps the company is having legal problems, or it is expected
to grow more slowly than the industry average over the next couple
of years.
Here are sample ratios frequently used to evaluate
companies:
Profitability ratios
- Gross profit margin (calculated by subtracting
the amount of the cost of goods sold from the sales revenue and
dividing by the same sales revenue number) -- It measures what
percentage of sales the company has available to pay for operating
costs. If it costs the company 95 cents to make a widget and the
widget sells for $1, there's not much left over to pay for overhead
and selling expenses.
- Net profit margin (calculated by dividing
net profits by sales) -- It gives you the bottom line and measures
what percentage of sales the company has available to distribute
to shareholders, reinvest in the company and buy back shares.
Asset Utilization
- Return on total assets (calculated by dividing
net profit by total assets) -- It measures how well the company's
assets are working to produce income.
- Receivable turnover (calculated by dividing
sales by accounts receivable) -- It measures how successful the
company is in controlling credit and collections.
Liquidity
- Current ratio (calculated by dividing current
assets by current liabilities. "Current" means assets and liabilities
that are expected to be used or paid within a year such as cash,
inventory, accounts receivable, accounts payable.) -- It measures
the company's short-term ability to pay its bills. You'd like
the current ratio to be in the neighborhood of 1.5 just in case
the accounts receivables or inventories are overstated or would
be hard to liquidate.
- Quick ratio (calculated by dividing cash
by current liabilities) -- It is an acid test. If inventories
and account receivables turned out to have no value, could the
company pay its bills? A 1.0 is a very nice quick ratio.
 DOROTHY
ROSEN has a master's degree in finance, with a specialization in
accounting, from the Kellogg Graduate School at Northwestern University
in Evanston, Ill. Rosen has more than 15 years of experience in
the financial arena, serving in Illinois and Florida as a certified
public accountant, financial consultant, expert witness and educator.
She is owner of Dorothy Rosen, CPA, a public accounting firm that
serves individuals and small businesses.
-- Posted: Jan. 25, 2000 |
