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Investing lecture 2

Profitability ratios= return on sales and return on investment

1. return on sales 
  1. gross profit marigin
  2. operating profit margin
  3. pretax margin
  4. net profit margin
2. return on investment
  1. return on assets(ROA)
  2. operating ROA
  3. return on total capital
  4. return on equity(ROE)
  5. return on common equity(ROCE)
Income Statement= 

Revenue(sales)= 2cr. 
COGS=80L
gross profit= 1.2cr
mkt. sales= 20L
office and admin=10L
EBITDA=90L
depreciation=10L
amortization=0
EBIT=80L(operating profit)
int.= 20L
PBT=60L
Tax(30%)=18L
Net Profit=42L

Gross profit margin= Gross profit/Net sales

=120L/200L=0.6=60%

Operating proft margin= operating profit/ net sales= 80/200=40%

pretax margin=PBT/net= 60/200=0.3=30%

net profit margin= net profit/net =42/200=21%

high gross proft margin
higher pricing, lower product costs
higher pricing= competitive advantage
superior product, superior branding, exclusive technology

lower costs= economics of scale, operating efficiency
op margin growth> gp margin growth
greater control over operating costs eg= admin costs
op margin growth<gp margin growth
deteriorating control over operating costs. 
PBT is operating profit= interest
pretax margin reflects effect of debt(interest) on margins

all operating and non-operating expenses deducted in net profit
gives an overall picture of a company's profitability. 

Mark up vs profit margin

let's say, a shoe price is 600 and COGS= 400 
gross profit= 600-400=200
gross profit margin= 200/600=33.33%

markup= profit/cost=200/400=50%

 

Return On Investment(ROI), calculation, formula

ROI= cash you get per year/ cash you put in= profit per year/investment
It is normally used per year.

FD= 7%
mutual funds=12-15%

project-1 gym

investment=1cr
profit/year=15L
ROI=15L/100L=15%
loan=1cr=interest=18L=18% per year
ROI is less than a loan ( You will be in Loss)=3L LOSS= cost of capital

Project=2= vocational training
Investment=1cr
p/y=10
ROI=10L/100L=10%
Loan=7%=7L per year
ROI is greater than a loan( you will have profit)=3L profit
profit or loss after interest. 

Return on Equity(ROE)=

capital= equity share capital+reserves and surplue+preferred equity+debt 

4cr=100L+50L+50L(15% DIVIDENDS)+200L(10%)

income statement
EBIT=80L
interest=2oL
PBT=60L
TAX 30%=18L
PAT=42L(net profit)

ROE=PAT/total equity()= 42L/200L=21%

return on common equity= PAT-preferred dividends/common equity= 42-0.15*50/150L=23%

return on equity
capital structure 1=
total equity+debt
200L+200L
structure 1=
EBIT=80L
Interest=20L
PBT=60L
TAX 30%=18L
PAT=42L

Capital structure 2

total equity+debt=
100L+3O0L(75%)

EBIT=80L
interest=30L
PBT=50L
tax 30%=15L
PAT=35L

ROE=42/200=21%
2nd ROE=35L/100L=35% , scenario= good economy
scenerio= bad economy
EBIT=25L
interest=20L
PBT=5L
tax 30%=1.5L
PAT=3.5L
ROE=3.5/200L=positive

structure 2=

EBIT=25L
interest=30L
PBT=5L
tax 30%=0
PAT=5L
ROE=NEGATIVE
In this, your equity capital will be 95L(100-loss of 5L).

Excessive debt can kill companies in tough economic environments. 





Return on capital employed(ROCE)=

assets=equity share capital+reserves and surplus+preferred equity+current liabilities+non-current liabilities
100 equity, 50L reserves and surplus, preferred equity 50L, short term debt 50L, long term 150L
EBIT=80L
INT=20L
PBT=60L
TAX 30%=18L
PAT=42L
ROCE=PROFIT/CAPITAL EMPLOYED= EBIT/eqiuty+non current liablities=pbit/eq.+long term debt=pbit/eq.+long term+short term

ROCE=PBIT/EQ+LONG DEBT+SHORT DEBT=80/200+150+50L=20%(ideal)
ROCE==ONLY LONG TERM=80L/200L+150L=22.86%

important points=
ROE VS ROCE
ROE doesn't give overall picture of returns on capital. 
ROE can be manipulated, more debt to increase ROE
ROCE gives overall returns on the total capital employed in the business. 
ROCE  can be compared to returns from other investments e.g. FD, MFS, Bonds, etc. 
invest only if, ROCE> cost of capital
(interest- 12%), ROCE>12% 
ROCE>WACC

















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