Educational Programming Video
The Value Line Investment Survey
Program 16: The Statistical Array - Part 4
In this session, we're going to discuss more about the financial data contained in the portion of a Value Line company report that we call the Statistical Array. The array is the large block of data in the middle of the report.
In earlier sessions we discussed the top half of the Array. Now we will review the lower half, which includes some data taken directly from companies' annual reports, some data adjusted by Value Line, and some financial ratios calculated by Value Line. The material we will discuss is that published on a typical industrial company. Companies with more unusual accounting terminology and formats are somewhat different.
The first item in the lower half is sales (or revenue). Some companies call their gross income sales, others revenue; Value Line normally uses whichever term the company uses. Probably the most important thing to look at here is growth over time, since without growth in sales, the potential for earnings growth is limited.
For many, particularly larger, companies, internal growth (before acquisitions and divestitures) of 5% to 7% a year is considered reasonably good. For smaller "growth" companies, annual increases of 15% of more are the norm.
The next line in the report is Operating Margin, which shows the percentage of sales left after the cost of goods sold or services provided and also after selling, marketing, and general and administrative expenses. It is calculated before subtracting depreciation and amortization, interest, and taxes. The trend of the margin over time is important. A steady or rising trend is generally positive. Declining margins are often a cause for concern.
Depreciation is shown on the next line. This is an amount charged against operating profits to reflect the aging of plant and equipment. A building, but not the land under it, is often written off in equal instalments over a 30 or 40-year period. Computers, on the other hand, are likely to be written off over three to five years. These charges do not involve the annual outlay of any cash, and are thus referred to as "non-cash" charges.
Net profit is the total earnings of a company after all costs, including taxes.
The Income Tax Rate shows the total of all income taxes (Federal, state, local and foreign) as a percent of income before taxes. Most companies' tax rates stay relatively steady over time. Domestic tax rates tend to remain level unless there are changes in the rates established by the Federal, state or local governments. Foreign rates will vary depending on the countries a company does business in. Overseas rates can change as a company does more or less business in different countries.
The Net Profit Margin shows net profits as a percent of sales. As with the operating margins, investors should look at the trend over time. An increasing trend is normally considered positive.
Working Capital is the difference between a company's current assets (mostly cash, inventories, and receivables) and current liabilities (mostly accounts payable and short-term debt). It shows the liquid assets available for running a business in a day-to-day basis. Traditionally, it has been considered prudent for a company to have current assets that are double the size of current liabilities. That's still the case for many companies, but some larger companies, usually ones with strong balance sheets and generally predictable sales streams, operate very successfully with small or even negative amounts of working capital. Don't necessarily be surprised when you see a negative number.
Long-term Debt comes next. It is the total amount of debt that is due more than one year in the future.
The next line is Shareholder's Equity, also known as net worth. It shows what a company's common and preferred stockholders' interest in a company would be if all liabilities were deducted from a company's total assets. All intangible assets such as goodwill, patents, and, sometimes, deferred charges are included in shareholders' equity.
For comparative purposes, analysts often look at long-term debt in relation to shareholders' equity. For most companies, long-term debt is usually no more than 40% to 60% of shareholders' equity. If long-term debt is more than shareholders' equity, an investor may have reason for concern. A company may have borrowed too much.
Return on Total Capital measures the percentage a company earns on both its shareholders' equity and its long-term debt. When the return on capital goes up, there should also be an increase in the return on shareholders' equity. If not, it means that a company is borrowing more and paying interest, but not earning more for the stockholders on their equity in the company's assets. Unless a company can earn more than the interest cost of its debt over time, the risk of borrowing is not worthwhile.
Return on Shareholders' Equity reveals how much a company earns each year for stockholders. The higher the figure, usually the better.
Retained to Common Equity, also known as the "plowback" ratio, is net income minus all dividends, expressed as a percentage. It measures the extent to which a company has internally generated resources to invest for future growth. A high ratio is considered a positive investment characteristic.
All Dividends to Net Profits, or the "payout ratio," measures the proportion of a company's net income that is distributed as dividends. Young, fast-growing firms tend to reinvest most of their profits internally. Mature firms are better able, and more likely, to pay out more of their profits.
Please visit us again for the next lesson in our education series.
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