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Diving Deeper into Businesses

Mon, 01 Jan 0001 00:00:00 +0000

Diving Deeper into Businesses

In the previous chapter , we noted that as individual investors, our job is to find and exploit disparities between market and intrinsic values of businesses. Further, we explored a way to build a universe of companies to study and track based on sectoral categorization.

But, a mechanical study of sectors will only take you so far. Sure, we’ve gathered qualitative information and numbers associated with a sector based on a generic understanding, but that doesn’t cut it.

Efficiency

Mon, 01 Jan 0001 00:00:00 +0000

Efficiency

Asset Turnover Ratios

One of the most basic operational aspects of a business is generating sales using its assets. We can measure the efficiency of this operational aspect using the asset turnover ratio which can be defined as

Asset Turnover Ratio = Total Income / Average Assets

We’ll consider the average of the total assets during a financial year to account for potentially abrupt changes in total assets due to unusual events like sales of fixed assets, increase in goodwill etc.

Liquidity and Solvency

Mon, 01 Jan 0001 00:00:00 +0000

Liquidity and Solvency

Debt to Equity Ratio

The Debt to Equity ratio tells us how much a company’s debt weighs against its shareholders equity. It gives us an overview of a company’s capital structure by measuring the amount of employed debt against equity.

The Debt to Equity ratio can be defined as

Debt to Equity Ratio = Total Debt / Shareholders Equity

We’ll consider total debt as the sum of financial obligations which bear interest and lease liabilities. This includes current and non-current borrowings, lease liabilities, current maturities of long term debt and lease obligations, and any other liabilities that can bear interest. We will NOT consider trade payables, provisions, and deferred tax liabilities for calculating the total debt. Keeping this in mind, we can define total debt as,