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How can you judge measure a company’s performance other than through NPAT? NPAT (Net Profit After Tax) is a useful guide but it should not be the sole measure of judging a company’s performance. After all, it does not take into account other significant factors, such as investments made in the business, changes in market conditions, or the company’s overall financial stability.
So, here are 5 metrics that you can use in conjunction with NPAT to measure a company’s performance.
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1. Cash flow from operations
Cash flow from operations is one way to measure a company’s performance. All ASX companies must release cash flow statements at their half-yearly and annual results. Furthermore, all companies that are not profitable must release this figure every quarter.
Cash flow from operations measures the amount of cash a company generates from its daily business activities, such as sales and operations. It shows how much cash is actually coming in and going out of the company, providing insight into its ability to fund ongoing operations, invest in growth, and pay off debts. It does not take account of cash flows from investing and financing activities. A company with negative operating cash flow may nonetheless release positive cash flow statements just from capital raisings. Conversely a company with positive operating cash flow may record a negative cash flow statement because of high investments that may pay themselves back in the long-run.
In short, cash flow from operations can identify potential issues with a company’s cash position that may not be obvious when only examining its profitability. But, as is the case with all metrics we mention here, it should only be used as one way to measure a company’s performance.
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2. Return on Equity (ROE)
ROE is a measure of how well a company has utilized its shareholders’ money to generate profits. It is calculated by dividing net income by total equity (as calculated on the balance sheet and is expressed as a percentage. By measuring ROE, investors can evaluate whether the company’s management team is creating value from their investments.
In general, a higher ROE indicates that more profit has been made from every dollar invested in the company and vice versa. ROE can be a useful indicator for investors when assessing potential investments, but it should not be used as the sole factor in making investment decisions. For all but the top companies, investors may have to calculate this measure themselves. Even though the data will be available, companies won’t always calculate the figure themselves.
Of all the metrics on our list of ways to judge a company’s financial performance, this might be the most relevant to equity investors as those who have chipped money into the company. However, it is just one metric that can be utilised.
3. Return on Assets (ROA)
ROA is another way to judge a company’s performance and is similar to ROE. But rather than looking at shareholders’ equity, it looks at how well the company is utilizing its assets to generate earnings. ROA is calculated by dividing net income by total assets and is also expressed as a percentage.
Like ROE, a higher ROA indicates that a company is generating more profit from its investments and is utilizing its assets effectively. However, it is important to note that not all assets are created equal, and some may generate more income than others. For example, a manufacturing company may have a higher ROA if it invests more in equipment and machinery rather than in office furniture.
4. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation)
EBITDA is a company’s earnings before the aforementioned expenses. Those expenses are not considered part of a business’ day to day operations (except of course tax). Naturally, EBITDA will be higher than a company’s NPAT because it excludes these items.
Many companies will use this metric (both profitable and non-profitable companies alike). But the world’s most famous investor, Warren Buffett (and his business partner Charlie Munger), despise companies that use EBITDA in their reporting – going to the point of pledging not to invest in companies that use it. The pair is critical because they believe that some companies may attempt to manipulate their EBITDA numbers.
On one hand the numbers could include one-time gains or other non-operating activities that artificially increase their earnings when times are good, but do the opposite when times are tough.
Why are we mentioning this as a way to evaluate a company’s performance considering Warren Buffett’s dislike? Because many companies still do nonetheless. You won’t find EBITDA in a company’s audited accounts but companieswill mention it in their results presentations and media release. Granted, EBITDA might be useful when comparing companies in the same industry – as a way to look at operating efficiency.
5. Earnings Per Share (EPS)
EPS, or earnings per share, is a arguably the most used metric for evaluating a company’s performance. It is calculated by dividing a company’s net income by its outstanding shares of common stock. However, many investors and analysts argue that EPS is too limited as a measure of a company’s overall performance.
One of the limitations of EPS is that it does not take into account a company’s debt or cash position. A company with high debt levels may have a lower EPS, but that doesn’t necessarily mean it is performing poorly. On the other hand, a company with a large cash reserve may have a higher EPS, but that does not necessarily indicate its performance is strong.
Moreover, EPS is also influenced by share buybacks and stock options, which can artificially boost the earnings per share without actually increasing the company’s profit. As a result, investors should take these factors into account when using EPS to evaluate a company’s performance.
The best way to measure a company’s performance is using several ways
To get a better understanding of a company’s financial health and overall performance, investors should not just consider a ‘one-size-fits-all’ metric because there is no such metric. While individual metrics can be a useful for judging a company’s performance, it should not be the only factor used to judge the company’s health. Investors should consider several financial metrics to get a more accurate and complete picture of a company’s current state and future prospects.
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