Sec 1 - Profitability Ratios

Question 1

Profitability Ratios

Answer 1

• These measure aspects of a firm’s operating (income/loss) results on a relative basis.

Question 2

Profit Margin (on Sales) =

Answer 2

• Profit Margin (on Sales) =
• Net Income / (Net) Sales
• Measures the net profitability on sales (revenue).

Question 3

Return on Total Assets =

Answer 3

• Return on Total Assets =
• (Net Income + (add back) Interest Expense (net of tax effect)) / Average Total Assets
• Measures the rate of return on total assets and indicates the efficiency with which invested resources (assets) are used.

Question 4

Return on Common Stockholders’ Equity =

Answer 4

• Return on Common Stockholders’ Equity =
• (Net Income - Preferred Dividend (obligation for the period only)) / Average Common Stockholders’ Equity (e.g. Beginning + Ending/2)
• Measures the rate of return (earnings) on common stockholders’ investment.

Question 5

Return on Owners’ (all Stockholders’) Equity

Answer 5

• Return on Owners’ (all Stockholders’) Equity =
• Net Income / Average Stockholders’ Equity (e.g. Beginning + Ending/2)
• Measures the rate of return (earnings) on all stockholders’ investment.

Question 6

Earnings Per Share (EPS – Basic Formula) =

Answer 6

• Earnings Per Share (EPS – Basic Formula) =
• (Net Income - Preferred Dividends (obligation for the period only)) / Weighted Average Number of Shares Outstanding (Common Stock)
• Measures the income earned per (average) share of common stock. Indicates ability to pay dividends to common shareholders.
• If a company issues dilutive shares, they will use a diluted EPS to consider the dilluted shares.

Question 7

Price-Earnings Ratio (P/E Ratio) =

Answer 7

• Price-Earnings Ratio (P/E Ratio) =
• Market Price for a Common Share / Earnings per (Common) Share (EPS)
• Measures the price of a share of common stock relative to its latest earnings per share. Indicates a measure of how the market values the stock, especially when compared with other stocks.

Question 8

Common Stock Dividends Pay Out Ratio =

Total Basis

&

Per Share Basis

Answer 8

• Common Stock Dividends Pay Out Ratio =
• Total Basis =
  
  • Cash Dividends to Common Shareholders / Net Income to Common Shareholder
• Per Share Basis =
  
  • Cash Dividends per Common Share / Earnings per Common Share
• Measures the extent (percent) of earnings distributed to common shareholders.

Question 9

Common Stock Yield =

Answer 9

• Common Stock Yield =
• Dividend per Common Share / Market Price per Common Share
• Measures the rate of return (yield) per share of common stock.

Question 10

Write off Inventory Effect

Answer 10

• Write off inventory will increase COGS; and
• decrease income; and
• decrease any rate of return using Net Income as a numerator
• Examples are:
  
  • Profit Margin
  • Return on Assets
  • Return on Equity
  • Earnings Per Share

Question 11

Purchase treasury stock

Answer 11

• Purchase treasury stock: the number of outstanding shares is reduced, thus reducing the denominator of EPS. There is no immediate impact on earnings. Thus, the EPS ratio increases .