Buying Stocks (value investing) using financial ratio : Profitibility Analysis

Wednesday, March 9, 2011

Return On Capital Employed (ROCE):

ROCE measurement is more comprehensive profitability indicator because it measures management's ability to generate earnings from a company's total pool of capital. As a general thumb rule, ROCE should be greater than company's average borrowing rate to remain profitable.

Return On Equity:

ROE ratio is an important measure of a company's earnings performance. The ROE tells common shareholders how effectively their money is being employed.  In general return on equity ratios in the 15-20% range as representing attractive levels of investment quality.

While highly regarded as a profitability indicator it does not throw light on the  disproportionate amount of debt in a company's capital structure that could translate into a smaller equity base. Thus, a small amount of net income (the numerator could still produce a high ROE off a modest equity base).

ROE must be used as a complimentary to ROCE to determine profitability. 

Profit Margin Analysis:

Gross Profit Margin 
Total revenue from goods sold - total expense in production 

Operating Profit Margin
Gross Profit Margin - Operating Expenses (General administrative cost)

Net Profit Margin 
Simply as a company's profit margin. It is calculated after paying tax. companies use a variety of techniques to manipulate this, so, Operating Profit Margin must be used to compliment it.



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