Online Investing Hacks (2024)

The first ratio to consider is the asset turnoverratio, which assesses the sales that a company cangenerate for each dollar of assets it owns—the higher the assetturnover ratio, the better. Companies with high asset turnover ratioscan thrive even with low profit margins.

The asset turnover ratio is calculated using the formula in Example 4-36.

Asset Turnover Ratio = Total Revenue for Period / Average Assets for Period

Companies report the value of their assets on their balance sheetsincluded in the financial statement section of their SEC 10-Q and10-K filings. However, they report the value of those assets as theystood at the end of the year. You can calculate the average assetsfor the period by averaging the year-end values for total assets forthe current and previous years.

The financial data spreadsheets available at EdgarScan (http://edgarscan.pwcglobal.com) provide aquick way to obtain the necessary values.

Let’s look at Home Depot’s assetturnover ratio. Table 4-4 shows pertinent HomeDepot financials.

Using the assets from each period, the average assets are $28,202.5million. Plug these values into the formula to determine HomeDepot’s asset turnover for the year, as shown inExample 4-37.

Home Depot's Asset Turnover Ratio = 58,247.0 / 28,202.5 = 2.1

You can use the AVERAGE function to calculate theaverage assets, as shown in Example 4-38.

Average Assets = AVERAGE(B2:C2)

MSN Money (http://money.msn.com)provides asset turnover and other turnover ratios for companies,industry turnover averages, and average turnover values for theS&P 500 index. As you can see in Figure 4-14,Home Depot’s asset turnover ratio of 1.9 comparesfavorably to other companies in its industry, which has an averageasset turnover ratio of 1.8.

The inventory turnover ratio is an indicator of how quickly acompany moves its inventory out of warehouses, factories, or stores,and into the hands of customers. The formula to calculate the ratiolooks like Example 4-39.

Inventory Turnover Ratio = Total Revenue / Average Inventory

Total revenue appears on the income statement and inventory appearson the balance sheet. You must calculate the average value ofinventory from the most recently reported inventory value and thevalue from the same period a year earlier. Using a spreadsheet ofextracted financial data downloaded from EdgarScan (http://edgarscan.pwcglobal.com), you canquickly calculate the inventory turnover ratio for a company.

Continuing the evaluation of Home Depot’s efficiencyratios, Table 4-5 shows pertinent Home Depotfinancials for calculating the inventory turnover ratio.

Using the assets from each period, the average inventory is $6,913.5million. Using these values, Example 4-40 shows HomeDepot’s inventory turnover ratio for the year.

Home Depot's Inventory Turnover Ratio = 58,247.0 / $6,913.5 = 8.4

When it comes to evaluating the inventory turnover ratio, higher isbetter. As is standard practice, you should compare acompany’s inventory turnover to its competitors.Retail stores and grocery chains usually have higher rates ofinventory turnover, because they sell a lot of low-cost products.Heavy equipment makers generally have lower turnover ratios, becausebulldozers and cranes each sell for hundreds of thousands (or evenmillions) of dollars. You can see average inventory turnover ratiosin the sidebar earlier in this hack.

You can quickly check a company’s inventory turnoverratio at MSN Money (http://money.msn.com) and compare it to theindustry average inventory turnover ratio and the average for theS&P 500 index. As shown in Figure 4-14, HomeDepot’s inventory turnover ratio of 4.9 comparesfavorably to other companies in its industry, which average 4.7.

Product inventories are the least liquid assets that a company owns,and unsold inventory quickly becomes a money-losing proposition. Lastyear’s fashions become this year’sbargain basem*nt buys, outdated technology lands in the junk pile,and spoiled food goes into the garbage. This is whyit’s important for companies to manage theirinventories closely. In the last decade, industries ranging from automanufacturers to computer hardware makers have increasingly turned tomethods that keep their inventory levels at a minimum, such asjust in time delivery of parts and materialsfrom suppliers, or building goods to order that are immediatelyshipped to customers, as Dell does with computers.

A low inventory turnover ratio is sometimes a signal that a companyis out of step with customer demand for its products—itsproducts are not succeeding in the marketplace, because ofobsolescence or poor quality. However, companies sometimes stock uptheir warehouses to prepare for a new product rollout or for theholiday sale season, so you should dig deeper into the reasons.

The third ratio to consider is the receivables turnoverratio. Accounts receivable (also known as receivables) area company’s uncollected income from customers, suchas unpaid invoices. Higher receivables turnover ratios are preferableto lower ones, because companies run the risk of never collecting onopen invoices if they delay too long. In addition, those receivablesrepresent income, which most companies need to pay their own bills.Example 4-41 shows the formula for receivablesturnover ratio.

Receivables Turnover Ratio = Total Revenue / Average Receivables

The receivables turnover ratio reveals how many times a company hascollected its receivables during a period. Unlike assets andinventories, receivables have a more immediate element of timeliness,and you use more recent values to calculate the receivables turnoverratio. Instead of averaging the receivables from the current andprior years, you calculate the average from the most recent twoquarters.

Continuing the evaluation of Home Depot’s efficiencyratios, Table 4-6 shows pertinent Home Depotfinancials for calculating the receivables turnover ratio.

Using these values, you can calculate Home Depot’sreceivables turnover ratio for the year, as shown in Example 4-42.

Home Depot's Receivables Turnover Ratio = 58,247.0 / 1,225.5 = 47.5

Is a receivables turnover ratio of 47.5 good? As with most retailstores, the bulk of Home Depot’s customers pay withcash or credit cards that the company almost immediately turns intocash at the bank, so the company’s ratio is quitegood. You can see average inventory turnover ratios in the earliersidebar “Industry Average Efficiency Turnover Ratios(2002).” As with the inventory turnover ratio,financial stocks don’t report receivables, so thereceivables turnover ratio isn’t applicable forthese companies.

You can also quickly compare the company to its industry at MSNMoney, as shown in Figure 4-14. A low receivablesturnover ratio compared to the competition is cause for concern. HomeDepot doesn’t compare as favorably with this ratioas it does with other efficiency ratios. Its receivables turnoverratio of 46.8 is slightly lower than the industry average of 51.4,but it is still high enough to safeguard the company from obsoleteinventory.

—Douglas Gerlach