Key Financial Metrics and Ratios: ROA, ROE, and ROIC

• published: 20 Jan 2015
• views: 182

http://breakingintowallstreet.com/biws/ http://youtube-breakingintowallstreet-com.s3.amazonaws.com/105-14-Key-Financial-Metrics-Ratios.xlsx http://youtube-breakingintowallstreet-com.s3.amazonaws.com/105-14-Key-Financial-Metrics-Ratios.pdf http://youtube-breakingintowallstreet-com.s3.amazonaws.com/105-14-Amazon-Financial-Statements.pdf http://youtube-breakingintowallstreet-com.s3.amazonaws.com/105-14-Salesforce-Financial-Statements.pdf http://youtube-breakingintowallstreet-com.s3.amazonaws.com/105-14-Walmart-Financial-Statements.pdf In this tutorial, you’ll learn about some of the key metrics and ratios used to analyze companies’ financial statements, including Return on Equity (ROE), Return on Assets (ROA), and Return on Invested Capital (ROIC), as well as Inventory Turnover, Receivables Turnover, Payables Turnover, the Current Ratio, and the Asset Turnover Ratio. Table of Contents: 1:15 Why Metrics and Ratios Matter 4:58 Return on Equity (ROE), Return on Assets (ROA), and Return on Invested Capital (ROIC) 10:50 Asset-Based and Turnover-Based Ratios 14:40 Interpretation of Key Metrics and Ratios for Wal-Mart, Amazon, and Salesforce 19:32 Why the Key Metrics and Ratios Are Sometimes Not That Useful Why Metrics and Ratios? They let you evaluate and compare different companies, and see why one company might be worth more (higher valuation multiple) than others. They let you answer questions such as: How much equity is required to generate a certain amount of after-tax profit (Net Income)? How much in assets is required to generate a certain amount of after-tax profit (Net Income)? How much total capital is required to do this? How dependent is a company on its assets? How liquid is the company? Can it meet its obligations? How quickly does it sell all its Inventory, pay its outstanding invoices, and collect its receivables? ROA, ROA, and ROIC Return on Equity (ROE) = Net Income / Average Shareholders’ Equity Return on Assets (ROA) = Net Income / Average Assets Return on Invested Capital (ROIC) = NOPAT / (Total Debt + Equity + Other Long-Term Funding Sources) Return on Equity (ROE): How efficiently is a company using its equity to generate after-tax profits? Return on Assets (ROA): How well is a company using its assets / how dependent is it on them? Return on Invested Capital (ROIC): How well is a company using ALL its capital, or how much capital is required to grow its business? Here, Wal-Mart easily ranks #1 in all these metrics because it has a very high ROE of 20-25%, an ROA of close to 10%, and an ROIC of 13-14%; for Amazon and Salesforce, these numbers are negative or close to 0%. Asset-Based Ratios and Turnover-Based Ratios Asset Turnover Ratio = Revenue / Average Assets How dependent is a company on its asset base to generate revenue? Current Ratio = Current Assets / Current Liabilities How liquid is a company? Can it use its short-term assets to repay its short-term obligations, if required? Inventory Turnover = COGS / Average Inventory How many times per year does a company sell off all its Inventory? Receivables Turnover = Revenue / Average AR How quickly does a company collect its receivables from customers that haven’t paid in cash yet? Payables Turnover = COGS / Average AP (*) How quickly does a company submit cash payment for outstanding invoices? Interpretation of Figures for Wal-Mart, Amazon, and Salesforce On the surface, many of these metrics make Wal-Mart seem like a "better" company - much higher ROE, ROA, and ROIC, and Amazon is negative on some of those! Wal-Mart tends to have higher margins as well, and shows more consistency with those margins. Similar inventory management, but Wal-Mart collects from customers and pays invoices much more quickly than Amazon. Wal-Mart is levered a bit more heavily, though. And yet… Amazon is a much more expensive stock, or at least it was at this point in time, and the market values it much more highly based on metrics such as the P / E ratio. At the time of this analysis, Wal-Mart P / E Ratio = 16x, and Amazon P / E Ratio = 456x! How could that be possible? Is Amazon really nearly 30x as valuable as Wal-Mart with WORSE metrics? Answer: The "Revenue Growth" line tells the whole story here. You're comparing 2 very different companies – one is a mature, predictable, mostly slow-growing firm, and one is growing revenue at 20-30% per year, despite revenue in the tens of billions already. Admittedly, Amazon's valuation still seems ridiculous, but it's not that surprising it's valued more highly than Wal-Mart, given that it's growing 20-30x more quickly. The Bottom-Line: These metrics are MOST useful when comparing companies of similar sizes, growth rates, and margins – not as useful when you're comparing a high-growth company to a stable, mature firm.