Key Ratios For Fundamental Research – Part – 1

Operating Profit

It is the profit earned from the core operations of the business. It excludes interest expenses, non-recurring items (such as accounting adjustments, legal judgments, or one-time transactions), effect of taxes or profit earned from the firm’s investments such as associate companies.

Operating Profit Margin (OPM)

Operating Profit Margin is used to measure company’s pricing power and operating efficiency. It also shows whether fixed costs are too high for production.

Operating Profit Margin = Operating Profit/Net Sales × 100

 

• Look For– High, Consistent & Increasing OPM
• Compare– With its past performance and peers within same industry

Net Profit

Net income is often referred to as “the bottom line” since it is listed at the bottom of the P&L statement. Net profit represents the amount of money remaining after all operating expenses, interest, taxes and preferred stock dividends (but not ordinary stock dividends) have been deducted from a company’s total revenue. Net profit is one of the most closely followed numbers in finance, and plays a large role in ratio and financial statement analysis.

Net Profit Margin (NPM)

It is an indicator of overall profitability of the business i.e. how efficiently it is converting its sales into profits based on its pricing power and controlling costs.

Net Profit Margin = Profit After Tax/Net Sales × 100

• Look For– High, Consistent & Increasing OPM
• Compare– With its past performance and peers within same industry

Let’s learn to choose a better company in the same business by comparing their financials:

Both the companies mentioned above are pharmaceuticals company. But Sun Pharma has better net profit margin which shows its efficiency in controlling costs and converting its top-line into bottom-line.

Return On Assets (ROA)

Return On Assets = Net Income/Average Total Assets*100

Return On Assets indicates how efficient management is at using its assets to generate profit.

• Look For– High, Consistent & Increasing OPM
• Compare– With its past performance and peers within same industry
• Industry– Asset based industries such as banking & finance

 

Let’s learn to choose better company in the same business by comparing their financials:

Both the companies mentioned above are engaged in banking business. But HDFC Bank is better in generating profit on its assets and also enjoys highest ROA in banking industry.

Return On Capital Employed (ROCE)

Return On Capital Employed = Earning Before Interest & Tax/(Debt + Equity)*100

Return On Capital Employed indicates company’s ability to generate profits from its total capital base. It also gives a clear picture of how the use of leverage impacts company’s profitability.

Look For– High, Consistent & Increasing ROCE Comparable– With its past performance and within same industry Industry– Capital intensive industries such as infrastructure, capital goods, power, oil & gas, metals & mining

Let’s learn to choose better company in the same business by comparing their financials:

Both the companies mentioned above, are engaged in the business of exploration and production of oil & gas. But Cairn India is better in utilizing its capital to generate profits.

Return On Equity (ROE)

Return On Equity = (Income – Preference Dividend)/ Average Shareholder’s Equity*100

Return On Equity is more than just a measure of profit, it is also a measure of efficiency. It shows that how much a company is earning on its shareholder’s equity. Look For– High, Consistent & Increasing ROE Comparable– With its past performance and within same industry Industry– All industries

Lets learn to choose better company in the same business by comparing their financials:

Both the companies mentioned above offers a range of IT services, outsourcing and business solutions. But TCS enjoys higher ROE than its peer which shows its efficiency in using shareholder’s fund.