Attempting to understand a company's financials is not an easy process. Unfortunately, many investors tend to grab onto one ratio and use that as a sign of whether to invest. For example, I've heard people say that when the P/E ratio is above 50, it makes the stock overvalued, and as a result they won't consider putting money into the company.
I, on the other hand, believe that it's impossible to make a sound investment decision just based on looking at one financial ratio. Therefore, in this series, I'll examine five metrics: profit margin, total debt to assets, current ratio, inventory turnover, and revenue per employee. If you're familiar with all of them, you can skip this next section and jump right into the super ranking system for the focus of today's article: automakers.
Financial jargon made simple
Profit Margin: This is simply net income divided by revenue. It's intended to show how well management oversees costs. If an enterprise is struggling with cost control, this number will be very low. Therefore, the higher the ratio, the better it is for that business. For a more detailed explanation of this, check out "Return on Equity: Profit Margin."
Total Debt to Assets: This is exactly what the title implies. To get this number, divide the debt of a company by all the assets. It shows to what degree a corporation's assets are paid for through debt. Generally speaking, when it's low, creditors are more willing to give out additional loans at a lower cost.
Current Ratio: This liquidity ratio takes current assets and divides them by current liabilities. It is a measure of the extent to which current assets are able to cover current liabilities. By and large, the higher it is, the better off the company is in the short run.
Inventory Turnover: In the automobile industry, inventory accounts for a significant part of the business. To get at this figure, divide revenue by the total amount of inventory. This metric determines how many times a year a product goes through the cycle of being sold and restocked. Generally for car companies, the larger the number, the better it is for the corporation.
Revenue Per Employee: This is self-explanatory. It tells you how efficiently the employees are working by stating how much money the average worker makes for the company. Management wants this figure to be as high as possible to maximize efficiency.
And now we combine them into a super ranking system
I've taken the seven largest auto producers by market cap and compared their financials. For each column, I give out up to six points: The best automaker in a given category gets six, and the worst gets zero. I subsequently tally them up, and the one with the greatest amount of points comes out as the winner.
Toyota (NYS: TM)
Volkswagen (OTC: VLKAY.PK)
Daimler (OTC: DDAIF.PK)
Honda (NYS: HMC)
Ford (NYS: F)
Nissan (OTC: NSANY.PK)
General Motors (NYS: GM)
All figures as of 10/22/11.
Foolish bottom line
It may come as a surprise to you that GM racked up the most amount of points -- 22 out of a possible 30, followed closely by Ford at 20 points. Most notably, GM's profit margin and debt to assets trounced the average. And unfortunately for Toyota, slow and steady does not win the race, as it only narrowly beat Daimler out of the last-place spot. Of course, this is not a comprehensive test, and this table can't possibly tell the full story of what's going on. However, I believe it's a good starting point for understanding which one of these big players would serve as the best investment for you.C
At the time thisarticle was published Fool contributor Igor Meyerson and The Motley Fool own shares of Ford.Motley Fool newsletter services have recommended buying shares of Ford and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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