Looking at a company's profitability is a very important step in understanding the 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 Emerson Electric Company's (NYSE:EMR) 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 - $21.039 billion x 10.29% = $2.164 billion
- 2011 - $24.222 billion x 10.23% = $2.480 billion
Emerson Electric's earnings increased from $2.164 billion in 2010 to $2.480 billion in 2011 or by 14.6%.
2. Five-year historical look at earnings growth
- 2007 - $2.136 billion, 15.77% increase over 2006
- 2008 - $2.412 billion, 12.92% increase
- 2009 - $1.724 billion, 39.9% decrease
- 2010 - $2.164 billion, 25.52% increase
- 2011 - $2.480 billion, 14.6% increase
In analyzing the earnings growth of Emerson Electric over the past five years, you see Emerson Electric has had a range of $1.724 billion in 2009 to $2.480 billion in 2011. Even through the recession of 2008 into 2009 the company's earnings remained relatively consistent. Over the past few years Emerson Electric earnings have recovered nicely and is posting earnings 16.10% higher than 2007.
3. Gross Profit = Total sales - cost of sales
In 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 - $21.039 billion - $12.713 billion = $8.326 billion
- 2011 - $24.222 billion - $14.665 billion = $9.557 billion
4. 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.)
- 2007 - $8.065 billion / $22.131 billion = 36.44%
- 2008 - $8.938 billion / $23.751 billion = 37.63%
- 2009 - $7.560 billion / $20.102 billion = 37.60%
- 2010 - $8.326 billion / $21.039 billion = 39.57%
- 2011 - $9.557 billion / $24.222 billion = 39.45%
In looking at the gross margin over the past 5 years we see the company was become more efficient in its manufacturing and distribution during the production process. Even though the gross margin decreased from 2010 to 2011, over the past 5 years the company has increased its gross margin by 8.26%.
5. Operating income = Total sales - operating expenses
The amount of profit realized from the operations of a business 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 - $2.879 billion
- 2011 - $3.631 billion
6. 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.
- 2007 - $3.093 billion / $22.131 billion = 13.98%
- 2008 - $3.645 billion / $23.751 billion = 15.35%
- 2009 - $2.450 billion / $20.102 billion = 12.18%
- 2010 - $2.879 billion / $21.039 billion = 13.68%
- 2011 - $3.631 billion / $24.222 billion = 14.99%
Over the past 5 years Emerson Electric's operating margin has been very consistent ranging from 12.18% in 2009 to 15.38% in 2008. The 2011 operating margin of 14.99 is above the current 5 year average of 14.03%. As the operating margin is strong the company will to be able to pay for its fixed costs, such as interest on debt.
7. Net Profit Margin = Net income / total sales
A ratio of profitability calculated as net income divided by revenue, 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.
- 2007 - $2.136 billion / $22.131 billion = 9.66%
- 2008 - $2.412 billion / $23.751 billion = 10.16%
- 2009 - $1.724 billion / $20.102 billion = 8.58%
- 2010 - $2.164 billion / $21.039 billion = 10.28%
- 2011 - $2.480 billion / $24.222 billion = 10.23%
Emerson Electric's net profit in 2011 decreased compared to 2010 but is still up on the 5 year average of 9.78%. As the net profit margin is strong it implies that the company is able to keep a greater percentage of the company's sales.
8. 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 with other companies in the same industry can give some idea of whether management is spending efficiently or wasting valuable cash flow.
- 2007 - $4.569 billion / $22.131 billion = 20.64%
- 2008 - $4.915 billion / $23.751 billion = 20.69%
- 2009 - $4.416 billion / $20.102 billion = 21.97%
- 2010 - $4.817 billion / $21.039 billion = 22.89%
- 2011 - $5.328 billion / $24.222 billion = 22.00%
As the SG&A % Sales decreased compared to 2010, it implies that management is spending less efficiently. Over the past 5 years the SG & A sales percentage has been rising. This is one aspect of the company to keep an eye on. There are no red flags here but the expenses have been rising.
9. 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."
- 2007 - $2.136 billion / $19.680 billion = 9.66%
- 2008 - $2.412 billion / $21.040 billion = 10.16%
- 2009 - $1.724 billion / $19.763 billion = 8.58%
- 2010 - $2.164 billion / $22.843 billion = 10.28%
- 2011 - $2.480 billion / $23.861 billion = 10.23%
In looking at the ROA over the past 5 years we can see the ratio has been very consistent. The 5 year average for the Return on Assets is 9.78% with a low of 8.58%. As the return of Assets for 2011 is 10.23% it is higher than the 5 year average this implies that management was more efficient at using its assets to generate earnings compared to their 5 year average.
10. ROE - Return on Equity = Net income / shareholder's equity
As shareholder's equity is measured as a firm's total assets minus its total liabilities it reveals the amount of net income returned as a percentage of shareholders equity. The return on equity measures a corporation's profitability by revealing how much profit a company generates with the amount shareholder's are invested.
- 2007 - $2.136 billion / $8.772 billion = 24.35%
- 2008 - $2.412 billion / $9.113 billion = 26.46%
- 2009 - $1.724 billion / $8.555 billion = 20.15%
- 2010 - $2.164 billion / $9.792 billion = 22.09%
- 2011 - $2.480 billion / $10.399 billion = 23.84%
As the ROE increased from 22.09% in 2010 to 23.84% in 2011, it reveals that the company is generating more profits when compared to the shareholder's equity. The company's 2011 ROE is inline with the 5 year average of 23.37%.
11. Free Cash Flow = operating cash flow - capital expenditure
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (NYSE: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.
- 2007 - $3.016 billion - $681 million = $2.335 billion
- 2008 - $3.293 billion - $714 million = $2.579 billion
- 2009 - $3.086 billion - $531 million = $2.555 billion
- 2010 - $3.292 billion - $524 million = $2.768 billion
- 2011 - $3.233 billion - $647 million = $2.586 billion
Even though the Emerson Electric's free cash flow has decreased by 7% compared to 2010, it is not of concern as Emerson Electric still has 2.586 billion in free cash. As the latest number is positive it implies that Emerson Electric has enough cash to develop new products, make acquisitions, pay dividends and reduce debt.
12. 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.
- 2007 - $3.016 billion / $22.131 billion = 13.63%
- 2008 - $3.293 billion / $23.751 billion = 13.86%
- 2009 - $3.086 billion / $20.102 billion = 15.35%
- 2010 - $3.292 billion / $21.039 billion = 15.64%
- 2011 - $3.233 billion / $24.222 billion = 13.34%
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 Emerson Electric will not have to borrow or raise money to keep operating.
In analyzing the earnings growth of Emerson Electric over the past five years, you see Emerson Electric has had a range of $1.724 billion in 2009 to $2.480 billion in 2011. During the recession of 2008 into 2009 the company's earnings remained relatively consistent. Over the past few years Emerson Electric earnings have recovered nicely and is now posting earnings 16.10% higher than 2007.
As illustrated above, all of the listed profit margins have remained very consistent over the past 5 years. The gross profit margin has increased over the past 5 years, with an increase of 8.26% over 2007. The only profit margin that could be of concern is the SG&A. The SG&A has been trending upward over the past 5 years. The 2011 SG&A of 22.0% is 6.58% higher than the 2007 SG&A of 20.64%. Even though the SG&A has been trending upward over the past years, the rest of the profit margins remain strong and consistent.
As the ROA and ROE are consistent, this implies that management is efficient at using its assets and equity to generate earnings.
As the free cash flow and the free cash flow margin both display positive cash, this indicates that Emerson Electric Company 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 Emerson Electric's profitability, it displays very even results. Based on the above analysis, Emerson Electric has displayed good earnings with consistent results in profitability.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.