finweek

Looking beyond the usual ratios

Simon Brown, founder and director of JustOneLap.com.
Simon Brown, founder and director of JustOneLap.com.

Financial results are rows and rows of numbers that often tell us little on the surface, beyond increases or decreases in revenue, inventories and the like. 

Hence the investment industry creates ratios to help understand the data better. 

These ratios also enable comparison between previous periods, as well as against peers within the sector.

Typically, we look at the popular price-to-earnings ratio (P/E), dividend yield (DY) and headline earnings per share (HEPS) before delving in deeper to others such as return on equity (RoE), debt-to-equity (DE) and the like.

These certainly serve their purposes, but there are a lot of other ratios that we could be considering that can help us understand a business and its future prospects. 

It is also true that often times these more bespoke ratios may be sector specific.

For example, in retail, what about sales per square metre of retail space, or per store? 

This would show the effectiveness of the space being used. 

Discount retailers may see a high rate of sales per metre, while high-end fashion retailers may have a lower number. 

This ratio would help us see sales trends by retail space, but could also give us a glimpse into cannibalisation that may be happening as a business opens new stores that will not only be attracting new customers but also customers from existing stores.

One ratio I very much like is revenue per staff member. 

This works not only in retail, but also in other sectors such as banking and gives a clear picture of the productivity of the business’ staff. 

Two businesses in the same sector may have vastly different sales per staff member. 

All else being equal, it would suggest that the one business is overstaffed and hence paying too large a salary bill.

Another indication of efficiency would be stock turnover. 

How many times a year does a business turn over its inventories? 

Now, if you add sales per square metre, sales per staff member and stock turnover, you will start getting a great picture of the overall efficiency of a business beyond just profit growth. 

It’s hugely helpful – not only to see the trends within the business you are looking at, but also to compare against its peers (and even international comparisons can be helpful).

An exercise such as this one was exactly what got me out of Pick n Pay and into Shoprite* in the early 2000s. 

For decades Pick n Pay had been the blue-chip mass food retailer in South Africa and I held it. 

But then, when other ratios such as HEPS growth and operating margins started to suggest Shoprite was the better option, digging into these more niche ratios confirmed that Shoprite was indeed streets ahead of Pick n Pay in terms of overall business efficiencies.

Now the hard part with all of this is that for the most part these numbers are not published by either the company or our usual source of fundamental data. 

So, you will have to crunch the data yourself and it is not always easy to get all the numbers. 

Annual reports are once again a useful source for much of what you would need, but some data, such as square metres of retail space, may simply not be available. 

So you’d have to hack it to use sales per store – a still very useful ratio.

Investing is about digging and about data. You need to keep an eye on the different data points that will help you understand a potential investment better.
 
*The writer owns shares in Shoprite.

This article originally appeared in the 6 December edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

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