Compare Asset Turnover across Different Sectors

In the article “Calculate Asset Turnover Ratio”, we explained what asset turnover ratio is and why it is important to a company. We also used Caterpillar’s real net income statement and balance sheet to show how to calculate a company’s asset turnover ratio. Furthermore, in the article “DuPont Equation and Its Implication”, it is showed that actually asset turnover ratio is one of the components that affect company’s return on equity. In this article, we are going to compare asset turnover ratio across different sectors to see if asset turnover ratio difference exists or not.

Methodology

Sector Categorization

We categorize companies into nine sectors based on Yahoo Finance definition. The nine sectors are Basic Materials, Conglomerates, Consumer Goods, Financial, Healthcare, Industrial Goods, Services, Technology, and Utilities.

Company Selection

Among all tradable companies, we choose those that can be traded by options. The reason for that is because we would like to select companies that have certain liquidity. The company that can be traded by options means that they have certain liquidity. Currently there are 2825 companies that is option tradable.

Profit Margin Calculation

1. use Stock Financial Statements Download (SFSD) to batch download all target companies’ most recent net income and balance sheet statement
2. calculate each company’s asset turnover ratio by formula: Revenue/Average Total Asset
3. Compile the calculated company asset turnover according to the sector it belongs to
4. use the median asset turnover number of the specific sector to represent the sector’s profit margin
Note the median is used instead of average to avoid the distortion due to long tail distribution

Result

Following table is the calculation result
 


There are several observations we can make from this table:
1. Among those 9 sectors, Consumer Goods and Services have high asset turnover ratio
2. If we take a look at the compiled data from article “Compare Profit Margin across Different Sectors”, consumer goods and service sectors have low profit margin.
3. For Consumer Goods sectors, we do expect to see low profit margin and high asset turnover ratio because consumer products tend to have low profit margin and company earns profit by high volume sales. As for Services sector, need to investigate further to find out the reason.
4. Financial Sector has extremely low asset turnover ratio

Further Analysis

We can further breakdown the data more into different industries inside each sector. Click here to download the raw data
By investigating industry breakdown data, we can found out the reason why Services sector also has high asset turnover ratio is because some industries in Services sector are actually retailers such as drugs wholesale. The real ‘service’ industries such as business service and management service do have low asset turnover ratio and that’s what we expect.
Following is the screenshot of asset turnover ratio distribution among Services sector.
 

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Compare Profit Margin across Different Sectors

In the article “Calculate Profit Margin”, we explained what is profit margin and why it is important to a company. We also used Caterpillar’s real net income statement to show how to calculate a company’s profit margin. Because profit margin is a ratio to measure a company’s profitability, we would like to know if different business sectors have different profit margin due to the nature of the business operation. In this article, we are going to compare profit margin across different sectors to see if profit margin difference exists or not.

Methodology

Sector Categorization

We categorize companies into nine sectors based on Yahoo Finance definition. The nine sectors are Basic Materials, Conglomerates, Consumer Goods, Financial, Healthcare, Industrial Goods, Services, Technology, and Utilities.

Company Selection

Among all tradable companies, we choose those that can be traded by options. The reason for that is because we would like to select companies that have certain liquidity. The company that can be traded by options means that they have certain liquidity. Currently there are 2825 companies that is option tradable.

Profit Margin Calculation

1. use Stock Financial Statements Download (SFSD) to batch download all target companies’ most recent net income statement
2. calculate each company’s profit margin ratio by formula: Net Income / Revenue
3. Compile the calculated company profit margin according to the sector it belongs to
4. use the median profit margin number of the specific sector to represent the sector’s profit margin
Note the median is used instead of average to avoid the distortion due to long tail distribution

Result

Following table is the calculation result

Sector	Sample Number	Median Profit Margin
Financial	521	0.17
Utilities	92	0.08
Technology	518	0.06
Industrial Goods	232	0.06
Basic Materials	357	0.06
Consumer Goods	253	0.05
Services	574	0.04
Healthcare	274	0.04
Conglomerates	4	0.035

There are several observations we can make from this table:
1. In this particular year (2012), financial sector has incredibly high profit margin compared to other sectors. We believe it has something to do with rebound from financial crises.
2. Exclude Financial sector, utilities sector has the highest profit margin, followed by technology, industrial goods, and basic materials sectors
3. Conglomerates sector has the lowest profit margin. However, it’s hard to make a conclusion because the sample is too small (only 4)

Further Analysis

We can further breakdown the data more into different industries inside each sector. Click here to download the raw data


From the breakdown table, we can see that there are some industries that could have high profit margin even though the sector they belong to has low profit margin. Take Cigarettes industry for example, it belongs to consumer goods sector, which has median profit margin 5%. However, this industry has median profit margin 25%.
We can plot the raw data to see the distribution:
It is obvious that even belongs to the same sector, profit margin across different industries can be huge different. Take consumer sector for example, cigarettes industry can have 25% profit margin, while farm products industry only has 1% profit margin

DuPont Equation and Its Implication

In the article “Calculate Profit Margin”, we mentioned that even though we prefer a company with high profit margin, it does not necessary mean this company has high return on equity. To the end, return on equity (ROE) is still one of the most important ratios to influence investment decisions. However, there is a relationship between ROE and profit margin. In this article, we are going to derive the relationship between ROE and profit margin (DuPont Equation) and explain how to use it to make investment decision.
 

ROE Decomposition

Return on Equity (ROE) is a ratio to measure the return on the shareholder’s equity. That’s the reason why it influences investment decision so much. The formula of ROE is simple:
ROE = Net Income / Average Shareholder’s Equity
Note here we use average shareholder’s equity instead of shareholder’s equity for calculation. It is because shareholder’s equity never constant during the fiscal period. It is better to use averaged shareholder’s equity during the fiscal period than the one at the end of fiscal period.
We can make first level decomposition of the above formula:
ROE = (Net Income / Average Total Assets) * (Average Total Assets / Average Shareholder’s Equity)
In the article “Calculate Financial Leverage”, we showed how to calculate financial leverage from debt-equity ratio. Because a company’s total assets = debt + equity,
=> Average Total Assets / Average Shareholder’s Equity = Financial Leverage
=> ROE = Return on Assets * Financial Leverage
We can further decompose return on assets (ROA):
ROA = Net Income / Average Total Assets
= (Net Income / Revenue) * (Revenue/Averaged Total Assets)
While Net Income / Revenue is profit margin and Revenue / Averaged Total Assets is
Asset turnover ratio
Now we derived the final format of DuPont equation:
ROE = ROA * Financial Leverage
= (Net Income/Revenue) * (Revenue/Averaged Total Assets) * (Averaged Total Assets/Averaged Shareholder’s Equity)
=> ROE = Profit Margin * Asset Turnover Ratio * Financial Leverage
 

Implication

From the formula above, it implies that we can always breakdown a company’s ROE into three elements: profit margin, asset turnover ratio, and financial leverage. By breaking down a company’s ROE into these three elements allows us to further investigate the main driver of a company’s ROE.
 

High Profit Margin as ROE Driver

Some industries tend to have high profit margin as their ROE driver. That means they tend to sell less units of product but each unit sold need to have high profit margin to have competitive edge
 

High Asset Turnover Ratio as ROE Driver

Some industries tend to have high asset turnover ratio as their ROE driver. That means they try to sell as many goods as possible in order to maintain proper ROE. Sudden drop of sales volume might hurt their ROE
 

High Financial Leverage as ROE Driver

Some industries tend to have high financial leverage as their ROE driver. That means they try to generate profit by borrowing other people’s money. However, high financial leverage accompanies high financial risk.

Calculate Asset Turnover Ratio

In the article “Calculate Profit Margin” and “Calculate Financial Leverage”, we showed how to calculate the profit margin from the company’s net income statement and its financial leverage from the balance sheet statement. In this article, we are going to discuss the asset turnover ratio, which is less heard from public. However, with the understanding of profit margin, financial leverage, and asset turnover ratio, we can breakdown return on equity (ROE) into these three elements and give us more insight in terms of the source of a company’s ROE. We are going to use net income and balance sheet statement from MSN Money website as an example to show you how to calculate asset turnover ratio
 

What is Asset Turnover Ratio

Asset turnover ratio is a ratio to measure business’s efficiency to generate revenue by using its asset. The higher the asset turnover ratio a company has, the more efficient a company is to generate revenue by its asset. The basic idea behind asset turnover ratio is that a company’s asset is a valuable resource. Generally a company increases its asset either from the contribution of shareholders or through the debt issuance. If a company can’t operate its asset efficiently, (e.g. generate revenue) investors might put their resources (money) to somewhere else to have better usage.
Asset Turnover Ratio = Revenue / Averaged total asset
Note we use averaged total asset during the fiscal period instead of total asset at the end of fiscal period because total asset fluctuates during the fiscal period while revenue is generated. It makes more sense to use averaged total asset to calculate the ratio
 

Calculate Asset Turnover Ratio from Net Income and Balance Sheet Statement

Because we need to know both a company’s revenue and averaged total asset in order to calculate asset turnover ratio, we need both the company’s net income and balance sheet statement in order to calculate asset turnover ratio. In the following example, we are going to use net income and balance sheet statement from company Caterpillar (CAT) to show how to calculate Caterpillar’s asset turnover ratio. You can access Caterpillar’s net income statement and balance sheet statement from MSN Money website or you can use or product, Stock Financial Statements Download, to download and export Caterpillar’s net income and balance sheet statement into .CSV format. Followings are screenshots of both downloaded net income and balance sheet statements
 

 

 

From its income statement, Caterpillar has total revenue $65875M in 2012. From its balance sheet statement, Caterpillar has averaged total asset ($81446M+$89356M)/2 = $85401M in 2012
=> Caterpillar’s asset turnover ratio in 2012 = 65875/85401 = 0.77
 

Commentary

So far we have showed you how to calculate a company’s asset turnover ratio based on its net income and balance sheet statement. Take Caterpillar for example, its asset turnover ratio is 0.77 in 2012. That means for every $1 dollar worth of asset, Caterpillar will generate $0.77 dollar revenue. However, just like profit margin, asset turnover ratio itself doesn’t give us a big picture in terms of how the company does overall. It is possible for a company to have high asset turnover ratio yet its ROE is low. In the next article, we are going to introduce DuPont formula and show you the relationship among ROE, profit margin, financial leverage, and asset turnover ratio.