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 Coca-Cola Company's (KO) 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 - $35.119 billion x 33.62% = $11.809 billion
- 2011 - $46.542 billion x 18.42% = $8.572 billion
Coca-Cola's earnings decreased from $11.809 billion in 2010 to $8.572 billion in 2011 or a decrease of 37.76%.
2. Five-year historical look at earnings growth
- 2007 - $5.981 billion, 17.73% increase over 2006
- 2008 - $5.807 billion, 2.99% decrease
- 2009 - $6.824 billion, 17.51% increase
- 2010 - $11.809 billion, 73.05% increase
- 2011 - $8.572 billion, 37.76% decrease
In analyzing Coca-Cola's earnings growth over the past five years, you see it a positive earnings trend. Even though the company reported a couple of down years the overall trend is positive. Over the past five years, Coca-Cola's earnings have been increasing and have shown a 43.32% 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 Coca-Cola's gross profits for the past two years:
- 2010 - $35.119 billion - $12.693 billion = $22.426 billion
- 2011 - $46.542 billion - $18.216 billion = $28.326 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 Coca-Cola's gross margin over the past 5 years you can see very consistent results. The 2011 gross margin is the highest margin at 64.39% while the lowest margin of 60.86% reported in 2011 was below the 5 year average of 63.45%
- 2007 - $18.451 billion / $28.857 billion = 63.94%
- 2008 - $20.570 billion / $31.944 billion = 64.39%
- 2009 - $19.902 billion / $30.990 billion = 64.22%
- 2010 - $22.426 billion / $35.119 billion = 63.86%
- 2011 - $28.326 billion / $46.542 billion = 60.86%
The consistency 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 - $13.741 billion
- 2011 - $10.732 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, Coca-Cola's operating margin has been good with 2010 reporting the highest operating margin in the last 5 years at 39.13%:
- 2007 - $7.252 billion / $28.857 billion = 25.13%
- 2008 - $8.446 billion / $31.944 billion = 26.44%
- 2009 - $8.231 billion / $30.990 billion = 26.56%
- 2010 - $13.741 billion / $35.119 billion = 39.13%
- 2011 - $10.732 billion / $46.542 billion = 23.06%
As the operating margin has been very even over the past 5 years, this implies that there has been relatively the same 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.
Coca-Cola's net profit in 2011 decreased compared to 2010 and is well slightly below the 5 year average of 22.59%:
- 2007 - $5.981 billion / $28.857 billion = 20.72%
- 2008 - $5.807 billion / $31.944 billion = 18.19%
- 2009 - $6.824 billion / $30.990 billion = 22.02%
- 2010 - $11.809 billion / $35.119 billion = 33.62%
- 2011 - $8.572 billion / $46.542 billion = 18.42%
Again Coca-Cola's net profit margin has been relatively consistent except for 2010 when the margin spiked up to 33.62%. As the net profit margin has been even this implies the company is able to keep close to the same percentage of its earnings as 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.
Coca-Cola's SG&A % Sales has been relatively consistent over the past 5 years except for the spikes in 2007 and in 2011. These spikes imply that management has been spending more of their sum of all direct and indirect selling expenses during these years:
- 2007 - $10.945 billion / $28.857 billion = 37.93%
- 2008 - $6.079 billion / $31.944 billion = 19.03%
- 2009 - $5.659 billion / $30.990 billion = 18.26%
- 2010 - $7.199 billion / $35.119 billion = 20.50%
- 2011 - $12.111 billion / $46.542 billion = 26.02%
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 Coca-Cola's ROA over the past 5 years, we can see the ratio has been very steady expect for a drop in 2011. The ROA dropped from 16.19% in 2010 to 10.17% in 2011.
- 2007 - $5.981 billion / $43.269 billion = 13.82%
- 2008 - $5.807 billion / $40.519 billion = 14.33%
- 2009 - $6.824 billion / $48.671 billion = 14.02%
- 2010 - $11.809 billion / $72.921 billion = 16.19%
- 2011 - $8.572 billion / $79.974 billion = 10.17%
The current ROA of 10.17% is lower than the 5 year average of 13.70%. This implies that management was less 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 - $5.981 billion / $21.525 billion = 27.78%
- 2008 - $5.807 billion / $20.047 billion = 28.96%
- 2009 - $6.824 billion / $23.872 billion = 28.58%
- 2010 - $11.809 billion / $41.918 billion = 28.17%
- 2011 - $8.572 billion / $48.339 billion = 17.73%
Coca-Cola's ROE dropped from 28.17% in 2010 to 17.73% in 2011, revealing that the company is generating less profits compared to the shareholder equity. You can also see that the company's 2011 ROE is quite a bit below the 5 year average of 26.24%.
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 (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, Coca-Cola's free cash flow has been positive and increasing:
- 2007 - $7.150 billion - $1.648 billion = $5.502 billion
- 2008 - $7.571 billion - $1.968 billion = $5.603 billion
- 2009 - $8.186 billion - $1.993 billion = $6.193 billion
- 2010 - $9.532 billion - $2.215 billion = $7.317 billion
- 2011 - $9.474 billion - $2.920 billion = $6.554 billion
The latest number, also on the plus side, indicates that Coca-Cola 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.
Coca-Cola's cash flow margin is positive, so it does not have to take these measures to continue operating:
- 2007 - $7.150 billion / $28.857 billion = 24.77%
- 2008 - $7.571 billion / $31.944 billion = 23.70%
- 2009 - $8.186 billion / $30.990 billion = 26.41%
- 2010 - $9.532 billion / $35.119 billion = 27.14%
- 2011 - $9.474 billion / $46.542 billion = 20.35%
In analyzing Coca-Cola's earnings growth over the past five years, you can see a positive earnings trend. Even though the company reported a couple of down years the overall trend is positive. Over the past five years, Coca-Cola's earnings have been increasing and have shown a 43.32% increase over its 2007 earnings.
As illustrated above, the listed profit margins have shown relatively consistent results for Coca-Cola. When comparing the current 2011 Gross profit margin, Operating and Net Profit margins to the 5 year averages the current results are lower. This is one area of the company to watch going forward.
Like the profitability margins the ROA and ROE show similar results. The current 2011 ROA and ROE are lower than the 5 years averages. This demonstrates that management has not been as efficient at tapping the company's assets and equity to generate earnings as the 5 year average.
With free cash flow and the free cash flow margin both displaying positive cash, Coca-Cola has enough cash to develop new products, make acquisitions, pay dividends and reduce debt without having to borrow or raise money to maintain operations.
The analysis of Coca-Cola's profitability tells the story of a solid company with some declining margins. Over the past 5 years, earnings have increased while some of the listed profit margins have slipped in 2011. Coca-Cola has a large amount of free cash at hand, which means it will likely continue to grow 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.