How to use ratios for different sectors on the bourse | Fin24
 
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How to use ratios for different sectors on the bourse

Jan 24 2020 10:42
Simon Brown

When investing there are several ratios you can use as part of analysing a company’s current performance or to compare it with another company. 

These ratios would include return on equity (RoE), price-to- earnings (P/E), debt-to-equity (D/E), cash conversion and many others. 

They’re all useful, but you can also get more niche with industry-specific ratios, and I want to look at some of those.

In mining the indicators used are head grade and reserves. 

Head grade is the amount of mineral that is extracted and measured as grams per tonne. 

The issue here is that the lower the head grade is, the higher the cost of extraction becomes as one has to mine more tonnes to get an ounce of the mineral. 

I have written about reserves before and here you would use the Samrec codes, or the South African code for the reporting of exploration results, mineral resources and mineral reserves. 

The codes are extremely detailed and very important for those investing in mining stocks. 

They help you understand the real value of any minerals still underground. For example: How certain are the engineers that they’re there? 

Is extraction economically viable? 

Banking has two key ratios, namely cost-to-income and impairments. 

Impairments is a polite way of saying bad debts and is expressed as a percentage of debts that have been written off. 

Locally, for the large banks, this number has been below 1% and, in some cases, even below 0.5%, which is a great number and indicates that banks are being cautious in their lending. 

Cost-to-income is a percentage that tells us how much of every 100c a bank receives as income goes into the cost of running the bank. 

This number used to be in the very low 50s but since increased regulation was introduced after the 2008 and 2009 global financial crisis, it has got stuck in the mid- to high 50s. 

It will likely never get back to the low 50s for the traditional banks due to their higher cost structures.

Construction companies have order books, which indicate the value of contracts confirmed, but not yet started. 

However, I find this a fairly useless number as I see very little correlation between the order book and future revenue.

Nevermind profit. 

Contracts can be cancelled or changed, and margins are never certain, as has been evidenced by several loss-making contracts that local construction companies have been engaged in.

Retail companies don’t have industry-specific ratios, but I do focus on the operating margin. 

This indicates profit at group level before head office costs, such as debt servicing, are subtracted. 

I also like to look at the revenue per employee. Often, you’ll have to work this number out for yourself but that is easy enough – you may find the number of employees in the financial results presentation or in the annual report. 

This gives you an idea of the efficiency of the retailer. 

However, remember that a clothing retailer will have a very different number compared with a grocer.

Life insurance companies use embedded value instead of a straight net asset value (NAV) as a measure of value. 

Embedded value is the present value of future profits from existing policies added to the NAV of the capital and any surplus. 

This gives you an idea of the “fair value” of a stock and, in theory, a life insurance company will trade around this embedded value.

With hotel stocks the focus is on occupancy levels, which makes sense as that is their core business. 

Investors want to know how many beds are filled every night. Another important metric is the revenue generated per room. 

Property companies focus on vacancies, which indicate how much space is not tenanted and thus not earning revenue for them.

None of these ratios are perfect or a stand-alone solution, but they all help us understand a company’s profitability and enable us to compare one company with its peers. 

This article originally appeared in the 16 January edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

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