Investment, Coding and Actuary

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Ratios rattle: Price to Book, DSO and Turns

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Price to Book is probably the less value ratio, with many companies nowadays do not need a lot of land and factories to make a very high-margin product. But here’s how we can do the ratio nevertheless:

EV/SE = ((Shares Out x Price) + Debt-Cash) / Shareholders’ equity

As a rule of thumb, some value investors will shun any companies that trade above 2 times book value or more.

DSO: Days Sales Outstanding is a measure how many days worth of sales the current accounts receivable (A/R) represents.

A company with a lower amount of days worth of sales outstanding is getting its cash back quicker and hopefully putting it immediately to use, getting an edge on the competition.

Step 1: Calculate Accounts Receivables Turnover

A/R Turnover = Sales for period / Average A/R for period

Remember that the fresher the info the better. By “turn,” we mean the number of times it completely clears all of the outstanding credit. The Turns higher the better.

DSO = Current accounts receivable / (Sales for period / Days in period)

This tells you roughly how many days worth of sales are outstanding and not paid for at any given time. The lower this number is, the better it is for the company.

By comparing DSOs for various companies in the same industry, you can get a picture of which companies are managing their credit better and getting money in faster on their sales. This is a crucial edge to have because money that is not tied up in accounts receivable is money that can be used to grow the business.

Before we move on, let’s do this exercise on our Amazon and eBay B/S.

Days Sales Outstanding 2003-12 2004-12 2005-12 2006-12 2007-12 2008-12 2009-12 2010-12 2011-12 2012-12
eBay 30.12 26.04 22.6 21.89 20.78 19.57 17.62 17.18 17.79 19.5
Amazon 8.47 8.73 10.17 11.47 13.58 14.59 13.51 13.74 15.78 17.73

Data from Morningstar.

Looks like ebay has been doing very well in reducing DSO while Amazon is getting sluggish in collecting the receivables.

One more metric to look at is Inventory Turnover.

The less money that’s filling up your distribution channels, the more money you will have to do all the other things a company needs done — marketing, advertising, research and development, acquisitions, expansions, and so on. You want a company to turn its inventories as often as possible during the year in order to free up that working capital to do other things.

The step 1 is to find the COGS for the past 12 months.

      Inventory turnover = Cost of goods sold / Average inventory for period

And as I remember from the CFA exams, there is also a Payable Period Turnover:

   Inventory turnover = Cost of goods sold / Average A/P for period

The Turnover ratios are also known as efficiency ratios.

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Author: jam3sch3n

An actuarial student with a keen interest in investment and coding.

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