Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists, and a key component of deciding to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at United Technologies Corporation's (NYSE:UTX) 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 by comparing this summary to 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 - $54.326 billion x 8.05% = $4.373 billion
- 2011 - $58.190 billion x 8.56% = $4.979 billion
United Technologies' earnings increased from $4.373 billion in 2010 to $4.979 billion in 2011 or by 13.85%.
2. Five-year historical look at earnings growth
- 2007 - $4.224 billion, 14.49% increase over 2006
- 2008 - $4.689 billion, 11.00% increase
- 2009 - $3.829 billion, 22.46% decrease
- 2010 - $4.373 billion, 14.20% increase
- 2011 - $4.979 billion, 13.86% increase
In analyzing United Technologies' earnings growth over the past five years, you see it has had one down year and four positive growth years. This is very positive sign, because in the 2009 down year, the company reported earnings of $3.829 billion, then bounced back strongly in 2010 to report earnings of $4.373 billion. Over the past five years, United Technologies earnings have been increasing and have shown a 17.87% increase over its 2007 earnings.
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. Here are United Technologies' gross profits for the past two years:
- 2010 - $54.326 billion - $39.414 billion = $14.912 billion
- 2011 - $58.190 billion - $42.153 billion = $16.037 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.).
In analyzing United Technologies' gross margin over the past 5 years you can see positive growth. The 2011 gross margin is the highest margin at 27.56% while the lowest margin was still a very respectable 25.87% in 2009:
- 2007 - $14.837 billion / $55.716 billion = 26.63%
- 2008 - $15.482 billion / $59.119 billion = 26.19%
- 2009 - $13.564 billion / $52.425 billion = 25.87%
- 2010 - $14.912 billion / $54.326 billion = 27.44%
- 2011 - $16.037 billion / $58.190 billion = 27.56%
The strength in the gross margin implies that management has been very consistent in their efficiency of manufacturing and distribution during the production process.
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, 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 - $7.186 billion
- 2011 - $8.099 billion
6. Operating Margin = operating income / total sales
Operating margin is a measure of the proportion of a company's revenue that 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.
Over the past 5 years, United Technologies operating margin has been good with 2011 reporting the highest operating margin in the last 5 years at 13.91%:
- 2007 - $7.050 billion / $55.716 billion = 12.65%
- 2008 - $7.509 billion / $59.119 billion = 12.70%
- 2009 - $6.377 billion / $52.425 billion = 12.16%
- 2010 - $7.186 billion / $54.326 billion = 13.23%
- 2011 - $8.099 billion / $58.190 billion = 13.91%
As the operating margin is increasing, this implies that there is more of a percentage of total sales left over, for paying for variable costs of production, such as wages and raw materials.
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.
United Technologies net profit in 2011 increased compared to 2010 and is well above the 5 year average of 7.88%:
- 2007 - $4.224 billion / $55.716 billion = 7.58%
- 2008 - $4.689 billion / $59.119 billion = 7.93%
- 2009 - $3.829 billion / $52.425 billion = 7.30%
- 2010 - $4.373 billion / $54.326 billion = 8.05%
- 2011 - $4.979 billion / $58.190 billion = 8.56%
The current net profit margin is up, implying the company is able to keep more of its earnings then in previous years.
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 provide insight as to whether management is spending efficiently or wasting valuable cash flow.
United Technologies' SG&A % Sales has been very consistent over the past 5 years, implying that management has been very consistent in their sum of all direct and indirect selling expenses:
- 2007 - $6.109 billion / $55.716 billion = 10.96%
- 2008 - $6.724 billion / $59.119 billion = 11.37%
- 2009 - $5.672 billion / $52.425 billion = 10.81%
- 2010 - $5.865 billion / $54.326 billion = 10.80%
- 2011 - $6.310 billion / $58.190 billion = 10.84%
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."
In looking at United Technologies' ROA over the past 5 years, we can see the ratio has been very steady. The ROA had a high in 2008 at 8.25% while the next year the company posted a ROA of 6.87%:
- 2007 - $4.224 billion / $54.575 billion = 7.74%
- 2008 - $4.689 billion / $56.837 billion = 8.25%
- 2009 - $3.829 billion / $55.762 billion = 6.87%
- 2010 - $4.373 billion / $58.493 billion = 7.48%
- 2011 - $4.979 billion / $61.452 billion = 8.10%
The current ROA of 8.10% is higher than the 5 year average of 7.69%. This implies that management was more efficient at using the company's assets to generate earnings compared to its 5 year average.
10. ROE - Return on Equity = Net income / shareholder's equity
As shareholder 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 shareholders are invested.
- 2007 - $4.224 billion / $21.355 billion = 19.78%
- 2008 - $4.689 billion / $15.763 billion = 29.75%
- 2009 - $3.829 billion / $20.066 billion = 19.08%
- 2010 - $4.373 billion / $21.385 billion = 20.45%
- 2011 - $4.979 billion / $21.880 billion = 22.76%
United Technologies' ROE increased from 20.45% in 2010 to 22.76% in 2011, revealing that the company is generating more profits compared to the shareholder equity. You can also see that the company's 2011 ROE is slightly above the 5 year average of 22.36%.
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.
Over the past 5 years, United Technologies free cash flow has been positive and increasing:
- 2007 - $5.330 billion - $1.153 billion = $4.177 billion
- 2008 - $6.161 billion - $1.216 billion = $4.945 billion
- 2009 - $5.353 billion - $826 million = $4.527 billion
- 2010 - $5.906 billion - $865 million = $5.041 billion
- 2011 - $6.590 billion - $983 million = $5.607 billion
The latest number, also on the plus side, indicates that United Technologies 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, it shows up as a negative number in the numerator in the cash flow margin equation. This means that, even as the company 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.
United Technologies' cash flow margin is positive, so it does not have to take these measures to continue operating:
- 2007 - $5.330 billion / $55.716 billion = 9.57%
- 2008 - $6.161 billion / $59.119 billion = 10.42%
- 2009 - $5.353 billion / $52.425 billion = 10.21%
- 2010 - $5.906 billion / $54.326 billion = 10.87%
- 2011 - $6.590 billion / $58.190 billion = 11.32%
In analyzing United Technologies' earnings growth over the past five years, you can see that the company has had one down year and four positive growth years. This is very positive sign, as even after the 2009 down year, the company bounced back strongly in 2010. Over the past five years, United Technologies earnings have largely increased. Additionally, the company has shown a 17.87% increase over its 2007 earnings.
As illustrated above, the listed profit margins have shown positive results for United Technologies. Moreover, the Gross profit margin, Operating and Net Profit margins have all shown positive results, while the SG&A % to sales have been very consistent over the past 5 years.
By showing positive ROA and ROE results, the company has demonstrated that management can efficiently tap the company's assets and equity to generate earnings.
With free cash flow and the free cash flow margin both displaying positive cash, United Technologies has enough cash to develop new products, make acquisitions, pay dividends and reduce debt without having to borrow or raise money to maintain operations.
Our analysis of United Technologies' profitability tells the story of a solid company. Over the past 5 years, earnings have increased and all of the listed profit margins have shown positive results. And the company has a large amount of free cash at hand, which means it will likely continue on its current growth path for the foreseeable future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.