A better way to track changes in company performance
It doesn't take too much time to get a feel for how well a company is doing. Most people do this by looking at percentage changes in key numbers - such as turnover and profit - from one period to the next. They may also look at key ratios such as profit margins or return on capital employed (ROCE).
This is a useful thing to do and you can learn a lot from it. But it is possible learn a lot more for just a little bit more effort.
If you really want to get a feel for how a company might perform in the future then it's rarely a bad idea to know where it has come from. Yet it is not just the overall performance of the business that is key here but also the incremental changes from year to year or over a few years.
This way it is possible to get more of an insight into whether a company is on the right track or not. It is possible to spot trends in its financial performance with some very simple and quick calculations.
How to do this
I am going to show you how I use SharePad and a quick bit of spreadsheet work to get a better idea of what's going on in a business. All of this can be done in a matter of minutes and is something that I find immensely valuable when I am looking at a company.
I'll take you through four worked examples of companies whose shares I currently own in my portfolio (this is not a recommendation to buy or sell shares).
Spirax-Sarco Engineering
The first thing I do is set up a Custom Results table in SharePad with some key financial numbers and performance ratios. I only have to do this once and then I can use this table to look at any share I wish to.
(Note that ROCE is calculated using average capital employed but the table above shows year end capital employed)
As you can see, Spirax-Sarco ticks many of the boxes of a high quality business which forms the key part of my investing strategy. It has:
- High profit margins.
- High returns on capital employed (ROCE).
- Is good at converting its profits into cash.
- Doesn't spend too much of its cash flow on new assets in order to maintain and grow its profits. Its capex as a percentage of operating cash flow (its capex ratio) is below my threshold of 30%.
I can see the trends in performance and key ratios but I can't see what has caused these changes from year to year. For example, is a decrease in ROCE down to a small change in profits or a large increase in capital employed. It's not too difficult to do this.
By clicking the green Sharing button I can export my custom financial table to a spreadsheet and then do some quick calculations.
What I am looking to do is work out the company's incremental or change in performance for key ratios over a number of periods.
To do this you simply calculate the actual change (in numbers) in key financial metrics from one year to the next and then get your spreadsheet to do some quick number crunching for you.
The incremental performance ratios you are calculating and how to calculate them are as follows:
- EBIT margin = change in EBIT/change in Turnover
- Capital turnover = change in Turnover/change in Capital employed
- ROCE = change in EBIT/change in Capital employed
- Operating cash conversion = change in Op cash flow/change in EBIT
- Free cash conversion = change in Free cash flow/change in Post tax profit
- Capex ratio = change in Capex/change in Operating cash flow
- Free cash flow margin = change in free cash flow/change in turnover
I will also look at cumulative changes over a five year period to judge business performance over a reasonable period of time.
Let's see how Spirax-Sarco has been getting on.
|
Spirax Sarco Changes £m |
2012 |
2013 |
2014 |
2015 |
2016 |
5y Cum. |
|
Turnover |
11.7 |
27.7 |
-11.1 |
-11.1 |
90.2 |
107.4 |
|
Norm EBIT |
3.2 |
14.6 |
-0.4 |
-3.7 |
28.0 |
41.7 |
|
Norm post-tax |
1.6 |
8.6 |
-1.9 |
-1.0 |
19.8 |
27.1 |
|
Capital employed |
33.2 |
16.8 |
32.9 |
-40.3 |
149.1 |
191.7 |
|
Capex |
-19.5 |
-1.0 |
5.8 |
-1.1 |
1.4 |
-14.4 |
|
Operating cash flow |
38.3 |
14.1 |
-3.2 |
17.1 |
40.8 |
107.1 |
|
FCF |
53.4 |
10.9 |
-9.3 |
16.8 |
25.5 |
97.3 |
|
Incremental: |
||||||
|
EBIT margin |
27.1% |
52.9% |
3.6% |
33.2% |
31% |
38.9% |
|
Capital Turnover |
0.35 |
1.65 |
-0.34 |
0.28 |
0.60 |
0.56 |
|
ROCE |
9.6% |
87.1% |
-1.2% |
9.1% |
18.8% |
21.8% |
|
Op cash conversion |
1,206.1% |
96.6% |
799.3% |
-465.5% |
145.7% |
256.8% |
|
FCF conversion |
3,375.8% |
127.5% |
485.7% |
-1,723.9% |
128.8% |
359.7% |
|
Capex ratio |
-50.8% |
-7.3% |
-182.3% |
-6.5% |
3.4% |
-13.4% |
|
FCF margin |
454.9% |
39.4% |
83.5% |
-151.7% |
28.3% |
90.6% |
What you can see is that incremental performance can be quite lumpy from year to year and is affected by things such as acquisitions and disposals of business as well as underlying performance and investment in new assets.
It is positive to see that incremental profit margins have generally been very high. This is often a sign of something called operating leverage where extra sales are spread over a fixed cost base which means that profits increase faster than sales and boost margins.
Incremental cash generation has been very good as shown by very high incremental operating and free cash flow conversion ratios.
This cash flow performance is shown very clearly when looking at cumulative performance over five years. Spirax has turned £107.4m of additional turnover into £97.3m of additional free cash flow which equates to an impressive incremental free cash flow margin of more than 90%.
InterContinental Hotels
IHG has gone through a big change in its business model in recent years. It has moved from being an owner of hotels to a franchisor of them. The move to this asset-light approach has delivered impressive incremental returns and free cash generation.
|
IHG Changes £m |
2012 |
2013 |
2014 |
2015 |
2016 |
5y cum. |
|
Turnover |
55.2 |
64.3 |
-91.8 |
49.6 |
90.4 |
167.5 |
|
Norm EBIT |
47.4 |
-47.8 |
53.6 |
50.9 |
83.6 |
187.8 |
|
Norm Post-tax |
73.8 |
-199.5 |
72.3 |
31.2 |
82.6 |
60.3 |
|
Capital employed |
206.1 |
-161.4 |
-90.4 |
632.4 |
-381.2 |
205.5 |
|
Capex |
16.5 |
76.6 |
-7.7 |
-19.4 |
26.8 |
92.8 |
|
Operating cash flow |
15.9 |
101.6 |
-48.0 |
72.0 |
175.8 |
317.3 |
|
FCF |
-16.2 |
24.4 |
-63.8 |
99.2 |
114.4 |
158.0 |
|
Incremental: |
||||||
|
EBIT margin |
86% |
-74.4% |
-58.4% |
102.7% |
92.6% |
112.1% |
|
Capital Turnover |
0.27 |
-0.40 |
1.02 |
0.08 |
-0.24 |
0.82 |
|
ROCE |
23% |
29.6% |
-59.3% |
8.1% |
-21.9% |
91.4% |
|
Op cash conversion |
33.5% |
-212.5% |
-89.5% |
141.5% |
210.2% |
169% |
|
FCF Conversion |
-22% |
-12.2% |
-88.3% |
318.4% |
138.6% |
261.9% |
|
Capex ratio |
104% |
75.4% |
16% |
-27% |
15.2% |
29.2% |
|
FCF margin |
-29.5% |
37.9% |
69.5% |
200.3% |
126.6% |
94.3% |
Diploma
Diploma's results have not been as stellar. Profit margins and ROCE have declined slightly - mainly due to acquisitions - but still remain at high levels. Incremental cash generation has been very good.
|
Diploma Changes £m |
2013 |
2014 |
2015 |
2016 |
2017 |
5y cum. |
|
Turnover |
29.6 |
25.3 |
20.3 |
28.0 |
48.8 |
152.0 |
|
Norm EBIT |
7.3 |
-3.9 |
13.5 |
3.1 |
4.4 |
24.4 |
|
Norm Post-tax |
4.6 |
2.6 |
7.4 |
2.2 |
3.8 |
20.6 |
|
Capital employed |
11.6 |
6.2 |
10.4 |
36.8 |
42.7 |
107.7 |
|
Capex |
1.8 |
1.1 |
-2.4 |
2.1 |
-0.6 |
2.0 |
|
Operating cash flow |
9.9 |
5.7 |
-0.9 |
7.1 |
14.5 |
36.3 |
|
FCF |
23.3 |
3.1 |
2.1 |
3.3 |
11.3 |
43.1 |
|
Incremental: |
||||||
|
EBIT margin |
24.7% |
-15.4% |
66.5% |
11.1% |
9% |
16.1% |
|
Capital Turnover |
2.55 |
4.08 |
1.95 |
0.76 |
1.14 |
1.41 |
|
ROCE |
62.9% |
-62.9% |
129.8% |
8.4% |
10.3% |
22.7% |
|
Op cash conversion |
135.6% |
-146.2% |
-6.7% |
229% |
329.6% |
148.8% |
|
FCF Conversion |
506.5% |
119.2% |
28.4% |
150% |
297.4% |
209.2% |
|
Capex ratio |
18.2% |
19.3% |
266.7% |
29.6% |
-4.1% |
5.5% |
|
FCF margin |
78.7% |
12.3% |
10.3% |
11.8% |
23.2% |
28.4% |
Diageo
Diageo has had a patchy performance over the last five years with a very modest cumulative ROCE.
Its profit margins and ROCE have also declined but in the last year it looks as it has got itself back into a good shape with an uplift in ROCE and free cash flow generation. It needs to keep on doing this.
|
Diageo Changes £m |
2013 |
2014 |
2015 |
2016 |
2017 |
5y cum. |
|
Turnover |
541.0 |
-1,045.0 |
555.0 |
-328.0 |
1,565.0 |
1,288.0 |
|
Norm EBIT |
604.0 |
-300.0 |
-430.0 |
51.0 |
761.0 |
686.0 |
|
Norm Post-tax |
895.0 |
31.0 |
-234.0 |
-396.0 |
602.0 |
898.0 |
|
Capital employed |
2,586.0 |
-1,620.0 |
2,746.0 |
1,966.0 |
334.0 |
6,012.0 |
|
Capex |
152.0 |
6.0 |
-4.0 |
-132.0 |
12.0 |
34.0 |
|
Operating cash flow |
-1.0 |
-313.0 |
765.0 |
-96.0 |
817.0 |
1172.0 |
|
FCF |
-205.0 |
-237.0 |
782.0 |
99.0 |
590.0 |
1,029.0 |
|
Incremental: |
||||||
|
EBIT margin |
111.7% |
28.7% |
-77.5% |
-15.6% |
48.6% |
53.3% |
|
Capital Turnover |
0.21 |
0.65 |
0.20 |
-0.17 |
4.69 |
0.21 |
|
ROCE |
23.4% |
18.5% |
-15.7% |
2.6% |
227.8% |
11.4% |
|
Op cash conversion |
-0.2% |
104.3% |
-177.9% |
-188.2% |
107.4% |
170.9% |
|
FCF Conversion |
-22.9% |
-764.5% |
-334.2% |
-25% |
98% |
114.6% |
|
Capex ratio |
-15,200% |
-1.9% |
-0.5% |
137.5% |
1.5% |
2.9% |
|
FCF margin |
-37.9% |
22.7% |
140.9% |
-30.2% |
37.7% |
79.9% |
A final word
As with most financial analysis you are looking at what has happened in the past and it is what happens in the future that matters to the success or otherwise of your investments. However, I hope you will agree that this relatively simple exercise is a useful addition to an analyst's toolkit and can be very helpful in identifying good or bad companies.
Phil Oakley's debut book - out now!
Phil shares his investment approach in his new book How to Pick Quality Shares. If you've enjoyed his weekly articles, newsletters and Step-by-Step Guide to Stock Analysis, this book is for you.
Share this article with your friends and colleagues:
If you have found this article of interest, please feel free to share it with your friends and colleagues:
We welcome suggestions for future articles - please email me at analysis@sharescope.co.uk. You can also follow me on Twitter @PhilJOakley. If you'd like to know when a new article or chapter for the Step-by-Step Guide is published, send us your email address using the form at the top of the page. You don't need to be a subscriber.
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.