Buying Stocks (value investing) using financial ratio : Profitibility Analysis
Wednesday, March 9, 2011
Return On Capital Employed (ROCE):
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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:
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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:
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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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