Retail Investing: Metrics You Should Pay Attention to

Retail Investing: Metrics You Should Pay Attention to

In retail investing, there are also financial metrics that you should pay attention to. Here are four of those useful financial indicators.

Returns on Revenues

For any retail operations, the Return on Revenue (ROR) is a cornerstone. The ROR tells you how much net income is gotten from the top-line revenues. Almost as important is the gross margin return on investment, which refers to the gross margin profit on the cost of the inventory.

When you make more per unit that has been sold, it becomes easier to produce the bottom line net profits. The ROR has two basic components:

The Balance Sheet: a retail store maintains inventory, which is considered an asset on the balance sheet. When you throw it with the P&L statement, you can get some idea about how the product is selling.

Cash Flow Statement: it’s possible for a business to become profitable even when they are generating negative cash flow. The opposite can also be true. Usually, it can be as simple as the payment terms that you have with suppliers.

Return on Invested Capital

The return on invested capital, which is sometimes called the four wall cash contribution, refers to the amount of profit generated from each store. When the store can return the invested capital required to open it, the retailer can grow its overall profit much faster.

Return on Total Assets

Return on the total assets tells you about the amount of operating profit made from the assets. Within the retail industry, this number differs depending on the business.

Specialty retailers require less space, fixtures, inventory, et cetera.  On the flipside, home improvement stores run in much bigger retail footprints. That means they also need much greater assets.

Not because they have to use more means these stores are inferior. It only refers to the cost of doing business in that certain industry. The more important thing is how the retailer’s return on total assets fares with the broader competition.

For instance, if the store is generating a return on total assets of 10 percent and the competitor does 20 percent, it may mean that the competitor is operating with more efficiency.

Return on Capital Employed

The return on capital employed tells something about the efficiency of the retailers when it comes to using their capital, defined as earnings before interest and taxes (EBIT) divided by the capital used, which is usually represented by total assets minus current liabilities.

On the other hand, the more appropriate definition of capital employed would be shareholders’ equity plus the overall debt.

The ROCE, therefore, is a pretax look at its return on debt and equity, which is not the same from the ROIC, which is the after tax (dividends paid) look at the profitability.

Although the ROCE is a more indicative figure than the return on equity, it also has some limitations. For example, if a retailer in the auto parts business bought back $1 billion worth of its own stock in a given years and resulted to its book value turning negative, both the ROE and ROCE are impacted negatively, despite the fact that it came up with close to $1 billion in net profit.

David Lockhart