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 Trinity Industries Inc's (TRN) 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 = $142.2 million
To pass, the company needs to have a positive net income. Trinity Industries passes.
- Operating Cash Flow 2011 = $425.3 million
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. Trinity Industries 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 = 5.27%
ROA in 2011 = 6.95%
Net income growth, 2010 = $303.8 million to 2011 = $425.3 million, a increase of 40.00%
Total Asset growth, 2010 = $5.760 million to 2011 = $6.121 million, a difference of 6.27%
In 2010 to 2011,Trinity Industries ROA rose from 5.27% to 6.95%. Trinity Industries 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 = $425.3 million
Net Income 2011 = $142.2 million
To pass, the operating cash flow must exceed the net income. Trinity Industries 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 = $5.760 billion
Total Assets - 2011 = $6.121 billion
Equals an increase of 6.27%
Total Liabilities 2010 = $3.995 billion
Total liabilities 2011 = $4.257 billion
Equals an increase of 6.55%
Trinity Industries increase in total assets was less than the percentage increase of total liabilities. Total assets increased by 6.27%, while the total liabilities increased by 6.55%. As the total assets does not exceed the total liabilities, Trinity Industries does not pass.
- 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 = 2.13
Current Ratio 2011 = 2.07
Trinity Industries current ratio went from 2.13 in 2010 to 2.07 in 2011. As Trinity Industries current ratio decreased, Trinity Industries does not pass.
- Shares Outstanding
2010 Shares Outstanding = 79.80 million
2011 Shares Outstanding = 80.20 million
To pass, the company's shares must increase less than by 2%. Trinity Industries decrease in shares was .5%. Trinity Industries 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 = $465.9 million / $2.155 billion = 21.62%
Gross Margin 2011 = $592.2 million/ $3.075 billion = 19.25%
The gross profit margin decreased slightly in 2011 from 2010. The gross margin went from 21.62% to 19.25%. Even though the gross margin only fell a small amount Trinity Industries 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 = $2.155 billion
Sales growth - 2011 sales = $3.075 billion
42.69% sales increase
Asset growth - Assets in 2010 = $5.760 billion
Asset growth - Assets in 2011 = $6.121 billion
Asset increase of 6.27%
As the sales growth is exceeding the asset growth, this implies that the company is producing revenue on its assets. Trinity Industries passes.
Based on the nine tests that Trinity Industries received on profitability, debt and capital, and operating efficiency, the company received six passes out of nine - this is a good grade for financial health. The company did not pass the TL/A ratio, Working Capital and the Gross Margin aspects of the test. The TL/A ratio implies that some of the company's assets were purchased through debt. The Working Capital aspect of the analysis implies the company's margin of safety or cushion available to the creditors is slightly less than a year ago and the Gross Margin aspect of the analysis implies that the company was less efficient in its manufacturing and distribution during the production process. Even though the company's financial health is good with six passes out of nine, more work on the debt and capital aspects of the company need to be addresses.
As Trinity Industries passed six out of nine tests, this shows that the company is 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.