Glad I could help, mate. But don't get too stressed out about accounting & finances...I didn't save your life :-D . But still, thanks for the positive feedback, it means a lot. Cheers, Axel
Thanks for the positive feedback, mate! As for your question: ROE is (in it's simplest terms) Net Income / Stockholder Equity. Return on Capital Employed [ROCE] (a ratio I personally haven't used that much yet) is EBIT / Capital Employed, where EBIT is Net Income + Interest + Tax and Capital Employed is Stockholder Equity + NonCurrent Liabilities. So ROCE removes Interest (a debt financing decision outcome) and Tax (a government(s) decision outcome) on the numerator and then adds Non-Current Liabilities (the other source of long-term capital outside of equity) to the denominator. As mentioned, I'm not yet too experienced in applying ROCE so I wouldn't want to misguide you by asserting any advantages or disadvantages between the two ratios. I hope this is okay and this reply will suffice. Best wishes, Axel November 2018 EDIT: While I'm still less familiar with ROCE, if I were to make an assumption about differences in interpreting the two... ROE would be a performance measure based for shareholders ...it's the return on what shareholders have put into the company. ROCE would be more likely used by management ...this is because it's a performance measure based on both forms of financing (debt and equity), while also stripping out some of the factors that management doesn't have control over (i.e. management doesn't want to be judged on interest expense or tax when they don't control interest rates or tax rates). Hope this helps a liitle more. Cheers, Axel
Many people said that average P/E ratio in the market has been around 15-25. Why has the average P/E ratio in the market been around 15-25? How do we define the average P/E ratio? Who define the average P/E ratio in the market around 15-25? If the average P/E Ratio is 15-25, it means that we need to wait for 15-25 years to cover our principle capital, which is not short period. Why is it a fair value and stable industry if P/E ratio is 15-25?
Gigi Gi Hi Gigi, 1) Average P/E of 15-25 is based on what shareholders are prepared for earnings, on average in the market. It is based on historical valuation concepts and has changed dramatically over the full history of the stock market. 2) Average market P/E ratio is based on the individual P/E ratios of every stock on the market, and then averaged. 3) I don't understand this question exactly, if you mean what I think you mean, then it's normally market commentators and analysts who discuss average P/E's 4) While I wouldn't put it that way myself, yes! If the P/E ratio is 25 then it will take 25 years for accumulated EPS to be equivalent to the stock price we paid. However, this is based on the assumption that EPS is constant over that 25 years...it is often the case that companies with high P/E's are considered 'growth' companies and thus their EPS may grow quite fast and make it quicker than 25 years. 5) I don't necessarily agree with this proposition. Finding a 100% accurate 'fair value' is based on many aspects of financial statement and market analysis and not only on a P/E ratio. Secondly, using a P/E ratio to determine a 'stable' industry is also not always a suitable method. While extreme market P/E levels may describe bubbles or troughs, throughout history and across geographies and industries there have been a very wide variety of average P/E's. I hope this helps, Axel
Hi Kamlesh. My channel doesn't yet have any other Profitability Analysis videos, specifically. But I'll make a note that this type of video is in demand, and this will influence future video production. I'm sorry I can't offer more now, you might have to try another Channel at this stage. Kind regards, Axel
+aadithya sethunath Hi mate, In theory, yes it can be negative but it is not very common. For example, would an electronics retailer purchase TVs from a supplier for $300 each and then sell them to the customer for $250...and do this often enough that in the income statement the COGS figure is higher than revenue, in aggregate over the full period? This would be quite rare. There are a couple of exceptions: 1) Perhaps it is a marketing strategy to attract market share 2) Perhaps the business sells commodity based products and is a price-taker. Maybe their input costs (the COGS) as a manufacturer or primary producer are fixed, but the final sales price of the commodity product are falling globally. Think about the oil companies that are struggling at the moment with the falling crude price. They may have drilled for oil when it was $90/barrel and could extract the oil for $70/barrel. Now oil is about $50 and it still costs them $70/barrel to get it out of the ground. Whatever the case, it is rare. What should we interpret from it? a) We would need to investigate why COGS is so high or revenue is so low. b) We would hope that this phenomenon is temporary, because very few businesses can survive long-term in this situation. After all, they still need to pay all the operating expenses beyond the COGS....plus, ideally, a return to shareholders. c) The business will need to reduce it's COGS asap, or it may be forced to increase prices and thus lose market share (Does the business have this level of control in their operations & industry? You would need to consider this too). Overall, Yes it can happen, but it's a very bad sign for the business unless the situation is very short-term. I hope this helps. Cheers, Axel
Hi again, in response to your assignment I must say, Shell is no ordinary business like a small electronics retailer or junior oil company. Shell's immense asset base and financial credibility means that it can possibly have negative profitability ratios for much longer than a standard business. I said that negative gross profit margins must only be short term, and while one would always want them to be better, a business only fails when it runs out of cash. Shell has a huge asset base (which could be sold) to raise cash and their immense history, size and financial credibility means that they could raise both debt or equity capital for more cash. Thus, Shell can last much longer with a negative gross profit margin than most businesses. I hope this helps further. Cheers, Axel
EPS =( Net income - preferred dividend) / number of share outstanding I don’t understand that why preferred dividend must be deducted for calculating EPS. Why isn’t the formula be just net income / number of share outstanding?
Gigi Gi Hi Gigi, You remove the preferred dividend because: 1) You divide the numerator by the number of common (or ordinary) shares outstanding, and this does not include preferred shares or stock. Thus you wouldn't want to include the part of net income that is bound to go to a separate class of stockholders (the preferred stockholders). 2) Preferred stock is often regarded as an odd mix between equity and debt, so when EPS is a pure equity performance measure then you need to remove the debt-like aspect. After all, most people buy common stock based on the EPS figure and, once again, you have to remove the debt-like, bound payment to another class of stockholders that you would not be buying. I hope this helps. Get in contact again if you still find it confusing, I have written this response off the top of my head, so I'm happy to do a bit more research and offer a more comprehensive response. Cheers, Axel
Is profitability ratio analysis only done for profit making company? If the company is loss company, does it mean that we do not need to do that profitability ratio analysis?
Joan Joan Hi again Joan! Yes, profitability ratio analysis should be done on all companies, even those that make a loss. The ratios outlined in this video still work for loss making companies, they will just be negative/minus results. As an example as to why profitability ratio analysis is still useful in loss making companies: Take Company A... it has a Return on Equity for three years of -30% then -35% then finally -45%. Now take Company B... it has a Return on Equity of -30% then -20% and then finally -5%. You see both have all negative ROE results due to losses, but doesn't Company B look more appealing? It has an improving ROE (although still negative) and if the trend continues will soon have a positive ROE. So from using profitability ratio analysis on loss making Company A and B we can see (through one ratio alone) that Company B is a more attractive business. I hope this helps. Kind regards, Axel
Joan Joan Hi Joan, thanks for the question. You will find that bankers (when deciding on whether to lend money) are more interested in the income statement (for loan serviceability) and the balance sheet (for security) rather than the share price. It is investors and management who would be more interested in the share price. This is just a quick & general answer but I hope it helps. If you need anything more specific, just add a bit more detail to the question. Kind regards, Axel @ accofina
First comment with new video! Get in contact or comment with any feedback. Also get in touch if you need any further support or clarification in regards to this video. And if you did enjoy the video please Share or Thumbs Up, or better yet: Please Subscribe at ua-cam.com/users/accofina or Visit accofina.com direct. Best wishes, Axel
Oh god I've been dying in my finances class. I wished I had seen this video earlier. So easy to understand!
Thanks for the great comment, Lorena. I'm very happy you got value from the tut. That makes my day! Cheers, Axel
this saved my life, thank you so much
Glad I could help, mate. But don't get too stressed out about accounting & finances...I didn't save your life :-D . But still, thanks for the positive feedback, it means a lot. Cheers, Axel
Awesome lecture, thank you! Very clear and easy to follow.
Thanks, Alice, much appreciated! I'm very happy you enjoyed the video and your comment has brought a big smile to my face. Best of success!
This is awesome! Best explanation I have ever received.
Wow, thanks! I'm glad it helped, mate :-)
Great content! Keep it up.
Thanks mate, glad I could help.
that is good one
Thanks mate!
Really good, and easy to follow, thank you!
1 question, how does Return on Capital employed differ from Return on Equity?
Thanks for the positive feedback, mate! As for your question: ROE is (in it's simplest terms) Net Income / Stockholder Equity. Return on Capital Employed [ROCE] (a ratio I personally haven't used that much yet) is EBIT / Capital Employed, where EBIT is Net Income + Interest + Tax and Capital Employed is Stockholder Equity + NonCurrent Liabilities. So ROCE removes Interest (a debt financing decision outcome) and Tax (a government(s) decision outcome) on the numerator and then adds Non-Current Liabilities (the other source of long-term capital outside of equity) to the denominator. As mentioned, I'm not yet too experienced in applying ROCE so I wouldn't want to misguide you by asserting any advantages or disadvantages between the two ratios.
I hope this is okay and this reply will suffice.
Best wishes, Axel
November 2018 EDIT:
While I'm still less familiar with ROCE, if I were to make an assumption about differences in interpreting the two...
ROE would be a performance measure based for shareholders ...it's the return on what shareholders have put into the company.
ROCE would be more likely used by management ...this is because it's a performance measure based on both forms of financing (debt and equity), while also stripping out some of the factors that management doesn't have control over (i.e. management doesn't want to be judged on interest expense or tax when they don't control interest rates or tax rates).
Hope this helps a liitle more.
Cheers,
Axel
yeah, i understand, thanks for your reply :)
No problems :-)
Many people said that average P/E ratio in the market has been around 15-25.
Why has the average P/E ratio in the market been around 15-25?
How do we define the average P/E ratio?
Who define the average P/E ratio in the market around 15-25?
If the average P/E Ratio is 15-25, it means that we need to wait for 15-25 years to cover our principle capital, which is not short period.
Why is it a fair value and stable industry if P/E ratio is 15-25?
Gigi Gi Hi Gigi,
1) Average P/E of 15-25 is based on what shareholders are prepared for earnings, on average in the market. It is based on historical valuation concepts and has changed dramatically over the full history of the stock market.
2) Average market P/E ratio is based on the individual P/E ratios of every stock on the market, and then averaged.
3) I don't understand this question exactly, if you mean what I think you mean, then it's normally market commentators and analysts who discuss average P/E's
4) While I wouldn't put it that way myself, yes! If the P/E ratio is 25 then it will take 25 years for accumulated EPS to be equivalent to the stock price we paid. However, this is based on the assumption that EPS is constant over that 25 years...it is often the case that companies with high P/E's are considered 'growth' companies and thus their EPS may grow quite fast and make it quicker than 25 years.
5) I don't necessarily agree with this proposition. Finding a 100% accurate 'fair value' is based on many aspects of financial statement and market analysis and not only on a P/E ratio. Secondly, using a P/E ratio to determine a 'stable' industry is also not always a suitable method. While extreme market P/E levels may describe bubbles or troughs, throughout history and across geographies and industries there have been a very wide variety of average P/E's.
I hope this helps,
Axel
Any other video is available for profitability analysis
Hi Kamlesh. My channel doesn't yet have any other Profitability Analysis videos, specifically. But I'll make a note that this type of video is in demand, and this will influence future video production. I'm sorry I can't offer more now, you might have to try another Channel at this stage. Kind regards, Axel
Just a quick question. Can the GPM be a negative figure and how do we interpret this
+aadithya sethunath Hi mate,
In theory, yes it can be negative but it is not very common.
For example, would an electronics retailer purchase TVs from a supplier for $300 each and then sell them to the customer for $250...and do this often enough that in the income statement the COGS figure is higher than revenue, in aggregate over the full period? This would be quite rare.
There are a couple of exceptions:
1) Perhaps it is a marketing strategy to attract market share
2) Perhaps the business sells commodity based products and is a price-taker. Maybe their input costs (the COGS) as a manufacturer or primary producer are fixed, but the final sales price of the commodity product are falling globally. Think about the oil companies that are struggling at the moment with the falling crude price. They may have drilled for oil when it was $90/barrel and could extract the oil for $70/barrel. Now oil is about $50 and it still costs them $70/barrel to get it out of the ground.
Whatever the case, it is rare.
What should we interpret from it?
a) We would need to investigate why COGS is so high or revenue is so low.
b) We would hope that this phenomenon is temporary, because very few businesses can survive long-term in this situation. After all, they still need to pay all the operating expenses beyond the COGS....plus, ideally, a return to shareholders.
c) The business will need to reduce it's COGS asap, or it may be forced to increase prices and thus lose market share (Does the business have this level of control in their operations & industry? You would need to consider this too).
Overall,
Yes it can happen, but it's a very bad sign for the business unless the situation is very short-term.
I hope this helps.
Cheers,
Axel
+accofina.com
Im doing an assignment on shell and all their profit ratios are negative and this really helps me interpret it better.
Thanks mate
Hi again, in response to your assignment I must say, Shell is no ordinary business like a small electronics retailer or junior oil company. Shell's immense asset base and financial credibility means that it can possibly have negative profitability ratios for much longer than a standard business.
I said that negative gross profit margins must only be short term, and while one would always want them to be better, a business only fails when it runs out of cash. Shell has a huge asset base (which could be sold) to raise cash and their immense history, size and financial credibility means that they could raise both debt or equity capital for more cash.
Thus, Shell can last much longer with a negative gross profit margin than most businesses.
I hope this helps further.
Cheers,
Axel
EPS =( Net income - preferred dividend) / number of share outstanding
I don’t understand that why preferred dividend must be deducted for calculating EPS.
Why isn’t the formula be just net income / number of share outstanding?
Gigi Gi Hi Gigi,
You remove the preferred dividend because:
1) You divide the numerator by the number of common (or ordinary) shares outstanding, and this does not include preferred shares or stock. Thus you wouldn't want to include the part of net income that is bound to go to a separate class of stockholders (the preferred stockholders).
2) Preferred stock is often regarded as an odd mix between equity and debt, so when EPS is a pure equity performance measure then you need to remove the debt-like aspect. After all, most people buy common stock based on the EPS figure and, once again, you have to remove the debt-like, bound payment to another class of stockholders that you would not be buying.
I hope this helps. Get in contact again if you still find it confusing, I have written this response off the top of my head, so I'm happy to do a bit more research and offer a more comprehensive response.
Cheers,
Axel
Is profitability ratio analysis only done for profit making company? If the company is loss company, does it mean that we do not need to do that profitability ratio analysis?
Joan Joan Hi again Joan! Yes, profitability ratio analysis should be done on all companies, even those that make a loss. The ratios outlined in this video still work for loss making companies, they will just be negative/minus results.
As an example as to why profitability ratio analysis is still useful in loss making companies:
Take Company A... it has a Return on Equity for three years of -30% then -35% then finally -45%.
Now take Company B... it has a Return on Equity of -30% then -20% and then finally -5%.
You see both have all negative ROE results due to losses, but doesn't Company B look more appealing? It has an improving ROE (although still negative) and if the trend continues will soon have a positive ROE.
So from using profitability ratio analysis on loss making Company A and B we can see (through one ratio alone) that Company B is a more attractive business.
I hope this helps.
Kind regards,
Axel
awesome
Thanks :-)
Why do bankers need to look at the share price of the company?
Joan Joan Hi Joan, thanks for the question.
You will find that bankers (when deciding on whether to lend money) are more interested in the income statement (for loan serviceability) and the balance sheet (for security) rather than the share price.
It is investors and management who would be more interested in the share price.
This is just a quick & general answer but I hope it helps.
If you need anything more specific, just add a bit more detail to the question.
Kind regards,
Axel @ accofina
First comment with new video! Get in contact or comment with any feedback. Also get in touch if you need any further support or clarification in regards to this video.
And if you did enjoy the video please Share or Thumbs Up, or better yet: Please Subscribe at ua-cam.com/users/accofina or Visit accofina.com direct.
Best wishes,
Axel