1. ROE :- It has been a well known fact that high ROE i.e. above 20% is very good for a company but what if this ROE is inflated? We all know ROE = Net Profit / Average Equity. Now say a company which is having a high Debt say DE > 1 then does the ROE reflect true picture of the company? Not at all. Also if the Tax rate is low (suppose the company is enjoying some tax holiday or a high deferred tax liability ) or the interest rate is low which ultimately make the cost of debt comes down to a very low level then the ROE can be very well inflated. So lets go down to the next tool ROCE.
2. ROCE :- ROCE is the EBIT/ Average Capital Employed i.e. (Average Capital Employed = Average Equity + Average Debt ). So this should give you some better insight but this also can not show the actual insight of the story always.
3. Penetration Vs Replacement Cycle :- We often get confused between this two. We can say a industry is saturated when it's penetration as well as replacement cycle is both high[e.g. :- Mobile Phone]. We can say an industry is secular when it's replacement cycle is low irrespective of it's penetration level [e.g. :- FMCG, Pharma, Electricity etc]. We can say a sector is sun-sign where penetration is low irrespective of the replacement cycle [e.g. :- Two Wheeler sector 9%, Air Conditioner sector 5% as on 2015 ISI reports ].
4. Cost of Capital :- Cost of capital is a very good measure for an estimate of a business running or operating cost i.e. a business must generate more ROCE than it's cost of capital. But this also can be very well inflated . Say a company is not paying out any dividend or gradually decreasing it's dividend payout rate. In that case the cost of capital will be very low and sometimes may even be negative since cost of equity will be negative but this will not give you a real picture of business running cost.
5. Working Capital :- In simple terms it is the day to day running cost of business i.e. current asset - current liabilities. i.e. if the business purchase something on credit and sells it in cash then it will be -ve hence a very good sign of a business. Which is very common for a retail business. But even it this case we have to see the debtor's cycle [in case of +ve working capital because even though it is an asset but the company still have to materialize this into cash ]and creditor's cycle[in case of -ve working capital because ultimately it is a liability] as well.
6. SSGR :- The SSGR stands for the growth rate a company can achieve without making any new investment. But it does not consider the free cash flow. Also negative or low dividend growth rate company could very well inflate this number. So we must consider dividend pay out growth rate and free cash flow along with it.
2. ROCE :- ROCE is the EBIT/ Average Capital Employed i.e. (Average Capital Employed = Average Equity + Average Debt ). So this should give you some better insight but this also can not show the actual insight of the story always.
3. Penetration Vs Replacement Cycle :- We often get confused between this two. We can say a industry is saturated when it's penetration as well as replacement cycle is both high[e.g. :- Mobile Phone]. We can say an industry is secular when it's replacement cycle is low irrespective of it's penetration level [e.g. :- FMCG, Pharma, Electricity etc]. We can say a sector is sun-sign where penetration is low irrespective of the replacement cycle [e.g. :- Two Wheeler sector 9%, Air Conditioner sector 5% as on 2015 ISI reports ].
4. Cost of Capital :- Cost of capital is a very good measure for an estimate of a business running or operating cost i.e. a business must generate more ROCE than it's cost of capital. But this also can be very well inflated . Say a company is not paying out any dividend or gradually decreasing it's dividend payout rate. In that case the cost of capital will be very low and sometimes may even be negative since cost of equity will be negative but this will not give you a real picture of business running cost.
5. Working Capital :- In simple terms it is the day to day running cost of business i.e. current asset - current liabilities. i.e. if the business purchase something on credit and sells it in cash then it will be -ve hence a very good sign of a business. Which is very common for a retail business. But even it this case we have to see the debtor's cycle [in case of +ve working capital because even though it is an asset but the company still have to materialize this into cash ]and creditor's cycle[in case of -ve working capital because ultimately it is a liability] as well.
6. SSGR :- The SSGR stands for the growth rate a company can achieve without making any new investment. But it does not consider the free cash flow. Also negative or low dividend growth rate company could very well inflate this number. So we must consider dividend pay out growth rate and free cash flow along with it.
