Determining a company's financial health is a very important step in making a decision on 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 considering Entergy Corporation's (NYSE:ETR) profitability, debt and capital, and operating efficiency. Based on this criteria, we get to see sales, returns, margins, liabilities, assets, returns and turnovers.
All numbers sourced from Morningstar.
Profitability is a class of financial metrics that are used to assess a business' ability to generate earnings, 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 = $1.367 billion
To pass, the company needs to have a positive net income. Entergy Corp. passes.
- Operating Cash Flow 2011 = $2.013 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. Entergy Corp. 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 = 3.28%
ROA in 2011 = 3.35%
Net income growth, 2010 = $1.270 billion to 2011 = $1.367 billion, a increase of 7.63%
Total Asset growth, 2010 = $38.685 billion to 2011 = $40.702 billion, an increase of 5.21%
In 2010-2011, Entergy Corps ROA increased from 3.28% to 3.35%. Entergy Corp 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 = $2.013 billion
Net Income 2011 = $1.367 billion
To pass, the operating cash flow must exceed the net income. Entergy Corporation 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 = $38.685 billion
Total Assets - 2011 = $40.702 billion
Equals an increase of 5.21%
Total Liabilities 2010 = $30.189 billion
Total liabilities 2011 = $31.646 billion
Equals an increase of 4.82%
Entergy's increase in total assets was more than the percentage increase of total liabilities. Total assets increased by 5.21%, while the total liabilities increased by 4.82%. As the total assets exceeded the total liabilities, Entergy Corp 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 = 1.56
- Current Ratio 2011 = 0.73
Entergy Corps current ratio went from 1.56 in 2010 to 0.73 in 2011. As Entergy Corps current ratio decreased, Entergy Corp. does not pass.
- Shares Outstanding
2010 Shares Outstanding = 178.75 million
2011 Shares Outstanding = 176.36 million
To pass, the company's shares must increase less than by 2%. Entergy Corps shares decreased by 1.35%. Entergy Corp 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 = $7.053 billion/ $11.488 billion = 61.39%
- Gross Margin 2011 = $6.916 billion/ $11.229 billion = 61.59%
The gross margin increased from 61.39% in 2010 to 61.59% in 2011. As the gross margin Increased, Entergy Corp passes.
- 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 = $11.488 billion
Sales growth - 2011 sales = $11.229 billion
2.30% sales decrease
Asset growth - Assets in 2010 = $38.685 billion
Asset growth - Assets in 2011 = $40.702 billion
Asset increase of 5.21%
As the sales growth did not exceed the asset growth, this implies that the sales did not keep up with the asset growth. Entergy Corp does not pass.
Based on the nine tests that Entergy Corp. received on profitability, debt and capital, and operating efficiency, the company achieved seven passes out of nine - this is a very strong grade for financial health. Entergy Corporation declined in the working capital and the asset turnover aspects of the test. The working capital implies the company does not have as much liquidity as the year before, while the asset turnover aspect of the test implies that the sales did not keep up with the asset growth in 2011. Both of these declines were not major nor raised any red flags, but these are some of the areas to watch going forward. Based on the nine tests, overall, the company is showing very good results with seven passes out of nine.
This shows that Entergy Corporation is very profitable, and very efficient. Based on the nine tests, overall, the company is showing very strong results. For more on Entergy Corporation, see Room To Grow For Entergy Corp.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.