Determining a company's financial health is a very important step in making a decision whether or not to invest or to stay invested. There are many different ways to compute a company's financial health. In this test, I will be taking into consideration Dollar General Corporation's (DG) profitability, debt and capital, and operating efficiency. Based on this criteria, we get to see sales, returns, margins, liabilities, assets, returns and turnovers.
Profitability is a class of financial metrics that are used to assess a business' ability to generate earnings as compared with expenses and other relevant costs incurred during a specific period of time.
In this section we will look at four tests of profitability. They are: Net Income, Operating Cash Flow, Return on Assets and Quality of Earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.
- Net Income 2011 = $766.69 million
To pass, the company needs to have a positive net income. Dollar General passes.
- Operating Cash Flow 2011 = $1.490 billion
Operating Cash Flow is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.
To pass, the company needs to have a positive operating cash flow. Dollar General passes.
- ROA - Return On 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."
ROA in 2010 = 6.57%
ROA in 2011 = 7.91%
Net income growth, 2010 = $627.86 million to 2011 = $766.69 million, a gain of 22.11%
Total Asset growth, 2010 = $9.546 billion to 2011 = $9.688 billion, a gain of 1.48%
In 2010 to 2011, the company's ROA grew. Dollar General passes.
- Quality of Earnings
Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory.
Operating Cash Flow 2011 = $1.490 billion
Net Income 2011 = $766.69 million
To pass, the operating cash flow must exceed the net income. Dollar General passes, Operating Cash Flow exceeds net income.
Debt and Capital
The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.
- Total Liabilities to Total Assets or TL/A ratio.
TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.
Total Assets - 2010 = $9.546 billion
Total Assets - 2011 = $9.688 billion
Equals an increase of 1.48%
Total Liabilities 2010 = $5.491 billion
Total liabilities 2011 = $5.020 billion
Decrease of 9.38%
Dollar General's increase in total assets was more than the percentage increase of total liabilities. Total assets increased by 1.48%, while the total liabilities decreased by 9.38%. As the total assets percentage exceeded the total liabilities percentage, Dollar General passes.
- Working Capital
Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.
Current Assets / Current liabilities
Current Ratio 2010 = 1.73
Current Ratio 2011 = 1.50
Dollar General's current ratio went from 1.73 in 2010 to 1.50 in 2011. As Dollar General's current ratio dropped, Dollar General does not pass.
- Shares Outstanding
2010 Shares Outstanding = 341.51 million
2011 Shares Outstanding = 338.09 million
To pass, the company's shares must increase less than by 2%. Dollar Tree's shares decreased by 1.01%. Dollar General passes.
Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally-efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.
- Gross 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.)
Gross Margin 2010 = $4.176 billion / $13.035 billion = 32.03%
Gross Margin 2011 = $4.697 billion/ $14.807 billion = 31.72%
The gross profit margin did not increase in 2011 from 2010. The gross margin went from 32.03% to 31.72%. Dollar General does not pass.
- Asset Turnover:
The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue.
The numerator of the asset turnover ratio formula shows revenues found on a company's income statement and the denominator shows total assets which is found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.
Sales growth - 2010 sales = $13.035 billion
Sales growth - 2011 sales = $14.807 billion
13.59% sales increase
Asset growth - Assets in 2010 = $9.546 billion
Asset growth - Assets in 2011 = $9.688 billion
Asset increase of 1.48%
As the sales growth is exceeding the asset growth, this implies that the company is producing revenue on its assets. Dollar General passes.
Based on the nine tests that Dollar General received on profitability, debt and capital, and operating efficiency, the company received seven passes out of nine - this is a good grade for financial health. The company did not pass the Working Capital and the Gross Margin metric of the test. The working capital metric implies that the company has fewer assets compared with its liabilities than the previous year and the gross margin implies that the company was not as efficient in it manufacturing and distribution. As the company's revenue and income has been steadily increasing over the past few years there are no red flags raised.
As Dollar General passed seven out of nine tests, this shows that Dollar General is very profitable and is using its assets to produce revenue. Based on the nine tests, overall the company is showing good results.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.