Meaning of ratios Flashcards
EBITDA margin
Measures the profitability from operations
Pro: focus on the essentials profitability and cash
Con: Should not be used for companies with high debt, since it draws attention away
EBITDA margin is usually higher than profit margin
DSCR
Ability to meet current debt (interest + principal) with the available cash flow
Pro: Slightly more comprehensive than the ICR
More solid indicator of financial health since principal payments are considered
Con: May not fully incorporate a company’s finances as some expenses like taxes may be excluded
ROE
How effectively a company uses its equity to generate profits
Con: extremely high ROE can also indicate risk when equity is small compared to income.
Extremely high ROE because of excessive debts
ROE < benchmark
Company is less profitable or less efficient than its competitors in generating returns for it shareholders
Makes a company less attractive to investors and may result in lower valuation of its shares
ROE > benchmark
Company is more efficient at using its equity to generate profits in comparison with other companies.
Competitive advantage over its peers, such as strong brand, efficient operations, superior management.
Company makes effective use of its assets and resources
ROTA
How effectively a company is using its assets to generate profits. Relationship between its income and resources.
Pro: sole focus on operating income by not including the influence of tax or financing differences.
Effective when comparing to different companies.
Con: use of book value instead of market value > overestimation of return.
May still look good even when debt was used to buy an asset
ROTA < benchmark
Less effective at generating profits from its total assets than others in the industry.
Company is not making optimal use of its assets.
ROTA > benchmark
Company is more efficient at using its assets to generate profits and is viewed more favourable by investors.
Positive indicator of its operational efficiency and management effectiveness.
Competitive advantage over its peers, such as a strong brand, efficient operations, or superior management
Profit margin
Reflects the profitability of a company’s core business operations
How much profit a company makes after paying for variable costs of production and before paying tax or interest
Pro: compare companies with similar business models, annual sales and companies which are in the same industry
Con: no comparison of companies within different industries
Profit margin < benchmark
Company less efficient at controlling its cost and generating profits from its core business operations.
May indicate that a company is struggling with meeting its financial obligations, is a concern risk for investors
Profit margin > benchmark
Company is generating strong profits from its core business operations and may be more efficient at controlling its costs than others
Company has an competitive advantage in the industry such as unique product or cost-structure, indicator of long-term growth potential end financial health
Net profit margin
How much % of the revenue a company keeps after paying taxes, interest and other costs.
How much net income is generated from every dollar in revenue
Pro:
Takes all costs of sales into account
Good for investors to see whether overhead and operating costs are under control and whether the management is generating enough profit from its sales
Con:
Can be influenced by non-recurring items.
No attention to revenue or sales growth
No insight wether management is managing their production costs
