Taking a close, hard look into a business isn’t always easy, and for investors who like to do deep due diligence, they may enjoy the long but rather tedious process of digging into companies’ financials. However, for those who may not be inclined to browse through a whole stack of documents and numbers, there are simpler ways to gain a quick understanding of how well a business is doing.
Even for seasoned investors, making use of simple ratios and metrics helps to shorten the process and acts as a quick way to figure out whether further analysis is warranted. I’ll introduce three simple ratios investors can use to quickly understand a company and to alert investors on any red flags. The company I’ll focus on is Valuetronics Holdings Ltd (SGX: BN2), or Valuetronics for short, which is an electronics contract manufacturer serving the consumer goods and automotive industries.
Ratio 1 – Gross profit margin
The gross profit margin measures the pricing power of the business and also how well costs can be controlled at the production or service provision level. Valuetronics’ gross profit margins are as follows:-
From the table, we can see that the company’s gross margin has improved year-on-year, from 14.4% to 15.9%. Reasons for this could range from the cheaper cost of materials to lower overheads used in producing electronic parts for its customers.
Ratio 2 – Operating profit margin
Operating profit margin assesses how well the company controls expenses and investors can use this ratio to tell if a company may be spending much more than its revenue growth. If spending increases at a faster rate than revenue is able to grow, the operating margin would decline and send out a red flag to investors.
Valuetronics has managed to increase its operating profit margin from 8.6% a year ago to 9.1% currently. However, the increase in operating profit margin was smaller than that of the increase in gross profit margin. Upon closer analysis, this was due to higher administrative expenses, partially offset by lower selling and distribution expenses.
Ratio 3 – Net profit margin
The net profit margin will include financing costs and tax expenses which operating profit did not account for. For companies with high levels of borrowing, their finance costs will be high and thus drag down net profits. Tax expenses generally do not differ significantly as the corporate tax rate in Singapore is a flat 16.5% but, occasionally, companies may have non-deductible expenses that raise their effective tax rate.
For Valuetronics, net margin is slightly higher year-on-year due to greatly reduced tax expenses (24% lower year-on-year).
With just these three ratios, investors can obtain valuable insights into how well a company is performing and whether it has disciplined expense control, pricing power or is paying too much in financing costs. Investors can use these same ratios on other companies within the same industry (i.e. electronic components manufacturing) in order to size them up against Valuetronics.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Royston Yang does not own shares in Valuetronics Holdings Ltd.