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 while deciding to invest or to stay invested in a company. There are many metrics involved in calculating profitability, but for this test, I will look at Waste Management Incorporation's (WM) Earnings and Earnings Growth, Profit Margins, Profitability Ratios and Cash Flow.
Through the above-mentioned four main metrics, 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 which has been the most profitable.
Earnings and Earnings Growth
1. Earnings = sales x profit margin
• 2010 - $12.515 billion x 7.61% = $953 million
• 2011 - $13.378 billion x 7.18% = $961 million
Waste Management's Earnings increased from $953 million in 2010 to $961 million in 2011 or by .8%.
2. Earnings per share = net income / shares outstanding
• 2010 - $953 million / 481.31 million = $1.98
• 2011 - $961 million / 468.78 million = $2.05
Waste Management's earnings per share increased from $1.98 in 2010 to $2.05 in 2011.
3. Five-year historical look at earnings growth
• 2007 - $ 1.163 billion, 2.87% decrease over 2006
• 2008 - $1.087 billion, 7% decrease
• 2009 - $994 million, 9.35% decrease
• 2010 - $953 million, 4.3% decrease
• 2011 - $961 million, .8% increase
In analyzing the earnings growth of Waste Management Inc over the past five years, you can see WM has been under the $1 billion earnings mark for the past 3 years. The last time the company was under the $1 billion earnings mark was in 2004 when the company reported an earnings of 939 million. Over the past five years, the company has averaged earnings growth of -4.54%.
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 - $12.515 billion - $776 million = $11.739 billion
• 2011 - $13.378 billion - $1.071 billion = $12.307 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 - $11.739 billion / $12.515 billion = 93.79%
• 2011 - $12.307 / $13.378 billion = 91.99%
As the gross profit margin decreased, it implies that management was less efficient in its manufacturing and distribution in the production process than the year previous. The gross margin went from 93.79% to 91.99%. As the gross margin decreased Waste Management does not pass.
As I noticed the margins getting tighter, I thought it necessary to look at previous gross margins to see if there was a correlation between the earnings and the margin.
• 2007 - 94.22%
• 2008 - 93.93%
• 2009 - 95.86%
In looking at the gross margins for the past 5 years we see the highest margin in 2009 at 95.86% which is a very healthy number, but over the past 5 years the margins have decreased 4 times.
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 that are incurred from operating activities and include things such as office supplies and heat and power.
• 2010 - $2.116 billion
• 2011 - $2.028 billion
7. Operating Margin = operating income / total sales
Operating margin is a measure 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 - $2.116 million / $12.515 billion = 16.90%
• 2011 - $2.028 million / $13.378 billion = 15.15%
As Waste Management's Operating Margin has decreased, it leaves less cash for the company to pay for its fixed costs. As the operating margin decreased, Waste Management Inc. does not pass this metric.
As I noticed the operating margins getting tighter, I thought it necessary to look at previous margins to see if there was a correlation between the earnings and the margin.
• 2007 - 16.93%
• 2008 - 16.68%
• 2009 - 16.00%
In looking at the Operating Margin over the past 5 years, you can see that it has declined 4 of the past 5 years.
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 - $953 million / $12.515 billion = 7.6%
• 2011 - $961 million / $13.378 billion = 7.2%
As Waste Management's net profit decreased, it implies that the company is less profitable than it was a year ago. To pass, the net income must increase. Waste Management Inc does not pass.
To get a greater picture of the net profit margin, I took a look at the past 5 years to see if I could find a trend.
• 2007 - 8.87%
• 2008 - 8.11%
• 2009 - 8.43%
Again, in analyzing the net profit margin we see that over the past 5 years Waste Management's Net Profit Margins have decreased 4 times.
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 - $8.093 billion / $12.515 billion = 64.66%
• 2011 - $8.569 million / $13.378 billion = 64.05%
As the SG&A % Sales decreased, it implies that management is spending more efficiently. To pass, the SG&A % Sales must decrease. Waste Management Inc passes.
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 - $953 million / $21.476 billion = 4.43%
• 2011 - $961 million / $22.569 billion = 4.25%
As the ROA decreased from 4.43%% in 2010 to 4.25% in 2011, it implies that management was less efficient in using its assets to generate earnings. Waste Management does not pass.
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 - $953 million / $6.260 billion = 15.22%
• 2011 - $961 million / $6.191 billion = 15.52%
As the ROE increased from 15.22% in 2010 to 15.52% in 2011, it reveals that the company is generating more profits from the money shareholders have invested. Waste Management passes.
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 - $2.275 billion - $1.104 billion = $1.171 billion
• 2011 - $2.469 billion - $1.324 billion = $1.145 million
As the final number in free cash flow fell by 2.2%, this is inline with most of the analysis as many of the numbers are slowly declining. As the number is still positive it implies that the company has enough cash to develop new products, make acquisitions, pay dividends and reduce debt.
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 - $2.275 billion / $12.515 billion = 18.18%
• 2011 - $2.469 billion / $13.378 billion = 18.45%
As the company's cash flow margin is positive, it does not have to borrow money or raise money to keep operating. As the cash flow margin is positive , this suggests that it will not have to borrow or raise money to keep operating. Waste Management passes.
In analyzing the earnings growth of Waste Management Inc over the past five years, you can see WM has been under the $1 billion earnings mark for the past 3 years. The last time the company was under the $1 billion earnings mark was in 2004 as the company was growing. Over the past five years, the company has averaged earnings growth of -4.54%.
As illustrated above, the profit margins have declined. Even though the revenue for WM was up last year and the earnings were also up, the gross margin, operating margin and the net profit margin were all down. The only positive margin in this part of the analysis was the SG&A to sales, where it decreased, to imply that management was spending more efficiently. Waste Management received 1 passes out of 4 on the Profit margins segment of the analysis.
The ROA and ROE are mixed as the ROA (return on assets) was down but the ROE (return on equity) was up. As the ROA was down, this implied that management was less efficient at using its assets to generate earnings than a year ago. As the ROE was up it implied that the company generated more earnings with the money shareholders invested.
As the free cash flow and the free cash flow margins both indicate positive cash flow, this indicated that Waste Management has enough cash to develop new products, make acquisitions, pay dividends and reduce debt without having to borrow or raise money to keep operating.
In analyzing Waste Management's profitability, it displays mixed results. The positives are: the company has positive earnings growth over 2010, has a declining SG&A to sales percentage and positive cash flow. The negative aspects of the analysis are: the declining profit margins and overall earnings decrease since 2006. Even though the company has produced positive earnings compared to 2010, I have a concern with the declining profit margins, as most of the profit margins have declined 4 of the past 5 years. As the aspects of profitability are mixed, I would consider this stock a hold, but be aware of declining profit margins and declining earnings going forward.
For more fundamental analysis on Waste Management read my article: Waste Management: Inside The Numbers
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.