What should be your thinking process when analyzing companies?


What should be your thinking process when analyzing companies?

 This blog is not meant to give you a list of ratios, which you can use in order to analyze the performance of different companies. The purpose here is to help you think in unconventional ways and make your own ratios. You can have different ratios applied to different industries and even different segments of the same company.

Let's take for example, the transport industry. Companies like CJ Darcl Logistics Ltd. have businesses of shipping your goods from one city to another and from one state to another. These companies work like ancillary companies, the reason being they give support to all other physical product based companies to deliver their products to where their customers exist. They usually use trucks to deliver a lot of products. Now, the question is how can I analyze the performance of this company. For, the transport industry I can use the ratio, revenue earned per 1,000 km, or profit earned per 1,000 km.

The above ratio will give me some very critical information. I will be able to gauge how efficient is the company in generating revenue. If I compare two transport companies and use this ratio. The one with a higher revenue per 1,000 km will be more efficient. But what about the two ratios, revenue per 1,000 km earned and profit per 1,000 km earned. The less the difference between these ratios, the better is the company able to manage the expenses (accounting, finance cost, marketing, staff costs etc.) of the company.

Also, you need to be aware that all ratios can't be applied for all companies. For eg. the inventory turnover ratio cannot be applied to the transport company because you will get some really weird figures. Inventory turnover is the cost of goods sold divided by the average inventories. This ratio tells you how many times a company has sold and replaced its inventory.

For CJ Darcl, cost of goods sold - 2,000 crores (approx)
                      average inventories - 1.2 crore (approx)

This gives you the inventory turnover ratio of 1,666 (2,000/1.2). Do you know what this means. The company is able to sell and replace their inventory 4.56 times per day (1,666/365). Is that even possible. No right. The reason being transport companies are into providing services and most of their assets (i.e. trucks etc.) form part of fixed assets. Now, since they don't sell any product, they almost have nil inventory and therefore, this ratio gives you a bizarre information. So, the takeaway here is that don't blindly apply some ratio to 2 different companies like CJ Darcl and Philips bulbs and say that CJ Darcl is better because it has better inventory turnover ratio.

Let's take another industry, say for example, the gaming industry. The gaming industry is difficult to valuate because trends come and go. So we need to take that into factor. But okay, take for example 2 mobile games. How do you tell which game is better for an investor to put his money into. You can work on this situation in a number of ways. First, you can see what is the growth rate of active users. The growth rate of active users will help you gauge the future revenues of the games and also compare which game will reach a certain user count faster. Also, one can have the revenue earned per user (be it premium feature purchase or ad revenues) to see which business is able to capitalise more of every single user of his game. Another way, could be to check the market size of the niche in which the game is made. Here, you can calculate, the market size captured ratio i.e. the active users of the game divided by the total users in the niche. For eg. if there are 2 games, one being a car racing game and one being an aptitude/mind game. The gaming industry is more focused on bringing leisure and not a lot of application of mind, where you become tired in 20 minutes. So, clearly the car racing niche will have more potential customers and the aptitude game will have less number of potential customers. Also, one another factor that determines is which country is the game being released in. If the game is released only in Mexico, then you probably will not witness the growth like a game which is released in China and US. An investor who is putting his money pre-release of the game, will prefer the game released in China and US. According to statista.com the maximum number of installs for a game happen in China and US.


Also, sometimes a single company can be involved in diverse businesses, take for example, reliance industries, it is involved in various industries such as electronics, clothing, grocery, telecom, oil, etc. What you should focus on here is, that don't simply take the figures mentioned in the consolidated statement and use that ratio to compare it with Airtel. It won't make any sense. What you are supposed to do is take the standalone statement of just Jio and use its figures to compare the performance of both Airtel and Jio. The simple reason behind this is you compare apples to apples and not apples to mobile phones (sounds weird right).

What I want you to learn from this blog is, understand the industry in which the company is, make use of the right ratios and be realistic in your approach when comparing two or more companies. Hope, you can now get out of the mindset of the guy who learned cash ratio, debt to equity ratio (not that they don't make sense, they do) and start applying some unconventional ratios to understand the companies in a better way.

Thanks for reading!

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Comment on any query you had like me to address.

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