Looking at a company's profitability is a very important step in understanding a company. Profitability is essentially why the company exists and is a key component in a reason for investing or to stay invested in a company. There are many metrics in calculating profitability, but in this test I will look at Deere and Company's (DE) Earnings and Earnings Growth, Profit Margins, Profitability Ratios and Cash Flows. With these four main sections we will understand more about the company's profitability and if this summary is compared with other companies in the same sector, you will be able see who has been most profitable.
Earnings and Earnings Growth
1. Earnings = sales x profit margin
- 2010 - $26.004 billion x 7.2% = $1.87 billion
- 2011 - $32.012 billion x 8.7% = $2.78 billion
Deere's Earnings increased from $1.87 billion in 2010 to $2.78 billion in 2011.
2. Earnings per share = net income / shares outstanding
- 2010 - $1.87 billion / 422.18 million = $4.30
- 2011 - $2.78 billion / 406.07 million = $6.85
Deere and Company's Earnings per share increased from $4.30 in 2010 to $6.85 in 2011.
3. Five year historical look at earnings growth
- 2007 - $1.82 billion, 1.2% decrease from 2006
- 2008 - $2.04 billion, 12% increase
- 2009 - $871 million, 57.3% decrease
- 2010 - $1.87 billion, 114.69% increase
- 2011 - $2.78 billion, 48.66% increase
In analyzing the growth of Deere and Company over the past 5 years, the company has had strong sales growth. Over the past 5 years the company has averaged an earnings growth of 23.37%.
Profit Margins
4. Gross Profit = Total sales - cost of sales
When analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin.
- 2010 - $26.004 billion - $17.742 billion = $6.304 billion
- 2011 - $32.012 billion - $22.227 billion = $7.691 billion
5. Gross Profit Margin = Gross Income / Sales
The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue / sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.)
- 2010 - $6.304 billion / $26.004 billion = 24.24%
- 2011 - $7.691 billion / $32.012 billion = 24.02%
As the gross profit margin decreased, it implies that management was less efficient in it's manufacturing and distribution in the production process than the year previous. The gross margin went from 24.24% to 24.02%. As the gross margin decreased Deere and Company does not passes.
6. Operating income = Total sales - operating expenses
The amount of profit realized from a businesses operations after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses and then removes depreciation. These operating expenses are costs which are incurred from operating activities and include things such as office supplies and heat and power.
- 2010 - $3.025 billion
- 2011 - $4.222 billion
7. Operating Margin = operating income / total sales
Operating margin is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt.
If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.
- 2010 - $3.025 billion / $26.004 billion = 11.63%
- 2011 - $4.222 billion / $32.012 billion = 13.18%
As Deere and Company's Operating Margin increased it leaves more cash for the company to pay for its fixed costs. As the operating margin increased Deere and Company passes.
8. Net Profit Margin = Net income / total sales
A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.
Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.
- 2010 - $1.040 billion / $26.004 billion = 4%
- 2011 - $1.848 billion / $32.012 billion = 5.7%
As Deere and Company's net profit increased it implies that the company is more profitable than it was a year ago. To pass the net income must increase. Deere and Company passes.
9. SG&A % Sales = SG&A / total sales
Reported on the income statement, it is the sum of all direct and indirect selling expenses and all general and administrative expenses of a company.
High SG&A expenses can be a serious problem for almost any business. Examining this figure as a percentage of sales or net income compared to other companies in the same industry can give some idea of whether management is spending efficiently or wasting valuable cash flow.
- 2010 - $2.968 billion / $26.004 billion = 11.41%
- 2011 - $3.168 billion / $32.012 billion = 9.9%
As the SG&A % Sales decreased it implies that management is spending more efficiently. To pass the SG&A % Sales must decrease. Deere and Company passes.
Profitability Ratios
10. ROA - Return on Assets = Net income / total assets
ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."
- 2010 - $1.865 billion / $26.004 billion = 7.17%
- 2011 - $2.799 billion / $32.012 billion = 8.74%
As the ROA increased from 7.17% in 2010 to 8.74% in 2011, it implies that management is using it's assets to generate earnings. Deere and Company passes.
11. ROE - Return on Equity = Net income / shareholder's equity
The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.
- 2010 - $1.865 billion / $6.29 billion = 29.65%
- 2011 - $2.799 billion / $6.8 billion = 41.16%
As the ROE increased from 29.65% in 2010 to 41.16% in 2011, it reveals that the company is generating more profits from the money shareholders have invested. Deere and Company passes.
Cash Flows
12. Free Cash Flow = operating cash flow - capital expenditure
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.
- 2010 - $2.282 billion - $761 million = $758.71 million
- 2011 - $2.326 billion - $1.056 billion = $1.27 billion
As the final number in free cash flow is growing and positive it is a pass. If the free cash flow is negative, it will require more research to find out if the company is making large investments. As Deere and Company's free cash flow is positive the company passes.
13. Cash flow margin = Cash flow from operating activities / total sales
The higher the percentage, the more cash available from sales.
If a company is generating a negative cash flow, which would show up as a negative number in the numerator in the cash flow margin equation, then even as it is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.
- 2010 - $2.282 billion / $26.004 billion = 8.77%
- 2011 - $2.326 billion / $32.012 billion = 7.26%
As the company's cash flow margin is positive, it does not have to borrow money or raise money to keep operating. Even though the number is positive the margin has slipped. To pass, the cash flow margin must be positive and growing. Deere and Company does not pass.
Summary
In analyzing Deere and Company's profitability it is clear that the company is very profitable. The company's Earnings and Earnings growth has been strong with an average increase of 23.37% over the past 5 years. Even though the economic recession had a great impact on Deere and Company's sales in 2009 the company has recovered nicely.
Deere and Company passed all aspects of the Profit margins segment of analysis except for the Gross Margin. The Gross Margin slipped from 24.24% in 2010 to 24.02% in 2011. This implies that the company was not as efficient in its manufacturing and distribution during the production process. The company had healthy increases in the Operating Margin, Net profit margin and decreased SG&A % Sales. Based on the criteria, Deere and Company received 3 passes out of 4 on the Profit margins segment of analysis.
Deere and Company passed both aspects of the profitability ratio segment of the analysis. The company had healthy increases in it's ROA and ROE. As both segments of the analysis displayed positive growth, Deere and Company received 2 passes out of 2.
Deere and Company passed one of the two aspects of the cash flow summary. As the free cash margin declined slightly, it is something to keep an eye on, but because the margin fell less than 2%, it does not raise too many concerns. As the company's Free Cash Flow displayed positive results, the company receives 1 pass out of 2.
In analyzing Deere and Company's. profitability it is clear that the company has been very profitable over the past few years. Most aspects of profitability are positive, so there are no red flags raised with these aspects of Deere and Company's profitability.
For more fundamental information on Caterpillar, see Deere & Company: Inside The Numbers
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DE over the next 72 hours.
