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Sales to Capital employed.

Printed From: The Equity Desk
Category: Market Strategies
Forum Name: Equity Valuation Techniques
Forum Discription: While valuing equities no individual technique works. Mostly it is a combination of techniques. Discuss the various techniques in equity valuation ranging from PE to RoE to Market Cap
URL: http://www.theequitydesk.com/forum/forum_posts.asp?TID=141
Printed Date: 20/Apr/2025 at 5:32pm


Topic: Sales to Capital employed.
Posted By: Vivek Sukhani
Subject: Sales to Capital employed.
Date Posted: 10/Aug/2006 at 11:07am
I was trying to find out a ratio which could give me some insight into the way a company is utilising its assets.I figured out and came across this ratio. This ratio is Sales/Capital Employed.It appears a very simple ratio, but it exposes a lot on the the way a company is utilising its asets.
 
Before pressing ahead, I would like to make some assumptions:
 
1.Attention must be made to the industry type.
2.One Year's ratio must not be only looked at. Rather the slope is important with the ratio values on the y-axis and time on the x-axis.
 
I beleive this ratio must be high as possible among the best players in a particular industry.Which in turn implies that either the turnover must be very high, or Capital Employed must be less.Low capital employed, throws some important points:
 
a. It shows the company has a tendency of paying good dividends(Dividend Policy). You cant have a low capital employed until and unless you return back the capital.
 
b. It throws a light on the solvency. Low Capital Employed, implies that there will generally be very negligible debt on the balance sheet. Therefore, it throws light on the Solvency of the company.
 
c.It will also show, what magic good business conditions can do.Because the capital employed will be less,chances are the assets which the company must be using must be nearly fully depreciated.Which means, there will be negligible depreciation to be borne by the company for increased production.Because of low fixed cost, you will have greater manuouverability.
 
Actually, this ratio wont be very high in most of the cases. You are unlikely to see a company with a double digit ratio yet, the figures may be distinctive enough to distinguish between very good, good and not-so-good companies.
 
Regards,
 
Vivek


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Jai Guru!!!


Replies:
Posted By: Vivek Sukhani
Date Posted: 10/Aug/2006 at 11:15am
I may be accused of why I am using this ratio , even a figure of low capital employed would have done.But then without taking into consideration, the element of effcienct couldnt have been in-built. I am merely trying to emphasize on the way company is trying to capitalise on per unit of capital employed.I beleive, this is what efficiency should mean to the investors(read, owners)

Posted By: Ajith
Date Posted: 11/Aug/2006 at 8:05am
This ratio is very interesting and would be even more useful if applied dynamically ,that is if one could visualize for which companies this ratio is going to turn favourable over a period of time.

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Ajith

Posted By: Vivek Sukhani
Date Posted: 11/Aug/2006 at 9:07am
Hi Ajith,
 
This ratio can also be modified some bit. We can deduct cash and bank balance from the capital Employed so that actual capital employed can be determined. By capital employed, I mean capital blocked in assets and investments. This will also refine the picture.There are companies which have trunk-loads of cash on their balance sheet. Therefore, such refinements, will bring such companies in the forefront.One example which I can give you is Porritts and Spencer Asia. This is perhaps the most uncomplicated annual Report I have ever come across.Its a true investor's delight.It has such a wonderful asset quality.If you manage to get your hands on this company's Annual Report, do read it...

Posted By: Ajith
Date Posted: 12/Aug/2006 at 9:18pm
                
         I will definitely check up on Porrits and Spencer Asia which I have never heard of.
         I will definitely be using this idea and ratio in future bearing in mind scaling up possiblities.The latter would ensure a high PE if not at the moment,then in future.Maybe, I am confusing a value pick idea with a growth stock idea.
         Regards,
 

Posted By: Ambarish
Date Posted: 12/Aug/2006 at 12:10pm
what you have mentioned here is a bit modified form of Roce which is operating profit divided by capital employed as it gives us a clerarer picture of how much amount of profit is being generated by the amount of asset investment if we compare sales with capital employed are we not avoiding the cost that is inucrred by that particular company for example in a steel company there raw material iron ore has a fluctuating cost now if we only look at sales we are disregardin this particular fact about the segment as because the increase in price of iron ore will lead to increase in amount of sale from previous sales and that will present a higher sales to capital ratio but lower ROCE so even when the sales to capital employed will go up shares will not.

Guess that we dont include investment in capital employed as it does not play any role in production process or operations What do you say?

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www.halwasiya.uni.cc
“Wining is not everything, it is the only thing”

Posted By: Ajith
Date Posted: 12/Aug/2006 at 8:53am
        
     You are perfectly right.No single ratio can be the sole tool or criteria.My own personal favourite for initial screening remains market capitalization in relation to business conditions/potential.
         However sales to capital employed is a unique tool to be used in conjunction with an assesment of business conditions,say for example when you expect business conditions and therefore margins to improve this ratio becomes superior to return on capital employed,I feel.


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Ajith

Posted By: basant
Date Posted: 12/Aug/2006 at 9:29am

You know with ratios the problem is one ratio might call a stock a buy and another one might label it as a sell. For instance if you analyse companies in high margin business any ratio that uses sales will calll it a sell but since the margins are high all net profit based ratios will label it as a buy. Try doing this for Infosys, WIpro a couple of Media companies and compare the same results with low margin businesses like retailing and the complexity would be clearly understood.

Still sales is a better judge for inter company comparisions within the same industry since it is the toughest to fudge.


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'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in

Posted By: Vivek Sukhani
Date Posted: 13/Aug/2006 at 1:24pm

Actually, I wanted to get into companies whose turnover was very high relative to the capital employed.I liked this ratio because I didnt want to bring margin game into picture at all.I have seen that in case you have a requisite turnover, increasing profits is not very difficult. And I have always beleived in the gradient game and wait for points of inflexion.Also, as far as ROCE is concerned, the Other Income can play a big spoilsport in some years, whereas in this ratio we are simply ignoring other income. As far as buy and sell signals are concerned, this is a ratio which will provide signals on points of inflexion. I dont think we should ever use any ratio for generating buys and sell signals sacrosanctly.Actually, this ratio points out what the company is doing with its returns over the years. I beleuve a company has its responsibilty towards the capital providers and good businesses run with minimum amount of capital.Simply observe this ratio for companies like Asian paints and Pidilite over the years and you will understand what rewards they have given to shareholders...

Ambarish, we must only exclude non-trade investment from calculation.Trade investment has a strategic purpose, and must be included in capital employed.


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