FACULTY OF MANAGEMENT STUDIES

Sector specific ratios and

valuation










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Sector wise key ratios
Banking Industry
Credit to deposit ratio: This ratio indicates how much of the advances lent by banks is
done through deposits. It is the proportion of loan-assets created by banks from the deposits
received. The higher the ratio, the higher the loan-assets created from deposits. Deposits
would be in the form of current and saving account as well as term deposits. The outcome of
this ratio reflects the ability of the bank to make optimal use of the available resources.
Capital adequacy ratio: A bank's capital ratio is the ratio of qualifying capital to risk
adjusted (or weighted) assets. The RBI has set the minimum capital adequacy ratio at 9%
for all banks. A ratio below the minimum indicates that the bank is not adequately capitalized
to expand its operations. The ratio ensures that the bank do not expand their business
without having adequate capital.
It must be noted that it would be difficult for an investor to calculate this ratio as banks do not
disclose the details required for calculating the denominator (risk weighted average) of this
ratio in detail. As such, banks provide their CAR from time to time.
Considering that the Indian banking sector has been growing at a strong pace, all the
leading banks, both private and public have been expanding operations at a strong pace. As
such, their CAR ratios are well above the prescribed limit of 9%. Private Banks such
as HDFC Bank, Axis Bank and ICICI Bank have in fact increased their CAR over the past
four to five years.
Non-performing asset ratio: The net NPA to loans (advances) ratio is used as a measure
of the overall quality of the bank's loan book. An NPA are those assets for which interest is
overdue for more than 90 days (or 3 months). Net NPAs are calculated by reducing
cumulative balance of provisions outstanding at a period end from gross NPAs. Higher ratio
reflects rising bad quality of loans.
The NPA ratio is one of the most important ratios in the banking sector. It helps identify the
quality of assets that a bank possesses. If we look at the chart below, we can clearly see a
differentiation between India's largest banks. A bank such as ICICI Bank would garner one
of the highest NPA ratio amongst private banks on the back of its aggressive nature. As the
banks lends out strongly to customers, the chances of them defaulting also rises. Plus,
considering that private banks charge higher interest costs would only make things more
difficult for its customers. At the same time, the NPA ratio of a relatively much conservative
bank such as HDFC Bank would remain low.
Provision coverage ratio: The key relationship in analysing asset quality of the bank is
between the cumulative provision balances of the bank as on a particular date to gross
NPAs. It is a measure that indicates the extent to which the bank has provided against the
troubled part of its loan portfolio. A high ratio suggests that additional provisions to be made
by the bank in the coming years would be relatively low (if gross non-performing assets do
not rise at a faster clip).

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Return on assets ratio: Returns on asset (ROA) ratio is the net income (profits) generated
by the bank on its total assets (including fixed assets). The higher the proportion of average
earnings assets, the better would be the resulting returns on total assets.
P/BV ratio: P/BV is a valuation ratio and is arrived at by dividing the market price of a share
with the respective company's book value per share. Now, book value is equal to the
shareholder's equity (share capital plus reserves and surplus). Book value can also be
arrived at by subtracting current liabilities and debt from total assets. For the banking and
finance companies, book value is calculated as 'share capital plus reserves minus
miscellaneous assets not written off. This formula then takes care of the bank's NPAs and
gives a correct picture. P/BV is a good metric to value stocks of companies in the capital-
intensive industries like banks, which have large amount of tangible assets in their books
(balance sheet). If a company is trading at a P/BV of less than 1, this indicates any or both of
the two - Investors believe that the company's assets are overvalued, or the company is
earning a poor return on its assets.
A high P/BV indicates vice versa, i.e., markets believe the company's assets to be
undervalued or that the company is earning and is expected to earn in the future a high
return on its assets. Book value also has a relationship with the 'Return on Equity' of a
company. In fact, book value can also be termed as equity (equity capital plus reserves and
surplus). As such, for a company that earns a high return on equity, investors would be
ready to give the stock a high P/BV multiple.
Healthcare
Operating margin: Operating margin indicates the organization's profitability from
operations, including investment-related decisions and interest and depreciation expense.

Operating EBIDA margin: This metric indicates the organization's profitability from daily
operating activities excluding capital-related decisions and interest and depreciation
expense.

Days cash on hand: Days cash on hand is a liquidity measure. It represents the number of
days an organization could support its operating expenses without collecting any additional
cash.

Debt to capitalization: Debt to capitalization is a measure of financial leverage and reflects
the organization's level of debt compared to its cumulative earnings or funds balance.

Capital spending: Capital spending measures the organization's level of capital
expenditures as a percentage of annual depreciation expense.




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Other important ratios and their calculation
Ratio Formula
Operating margin (%)
(Total operating revenues - Total operating expenses) / (Total operating
revenues) x 100
Excess margin (%)
(Total operating revenues + Non-operating revenues - Total operating
expenses)
/ (Total operating revenues + Non - operating revenues) x 100
Debt service coverage (x)
(Excess of Revenues ove Expenses + Deprec + Interest Exp) / (Principal +
interest payments)
Current ratio (x) (Current Assets / Current Liabilities)
Cash on hand (days)
((Cash and Cash Equivalents + Board Designated Funds for Capital) * 365)
/ (Total operating expenses - depreciation and amortization expenses)
Cushion ratio (%)
(Cash + Short Term Investments + Unrestricted Long Term Inv ) /
(Principal + interest payments)
Accounts receivable (days) (Net patient accounts receivable x 365) / net patient revenues
Average payment period (days) (Current Liabilities) / ((Total Expenses - Depreciation) / 365))
Average age of plant (years) (Accumulated Depreciation) / (Depreciation Expense)
Debt-to-capitalization (%) (Long term debt) / (Long term debt + Net Assets) x 100
Capital expense (%) (Interest Expense + Depreciation Expense) / (Total Expenses) x 100
Some ratios specific to healthcare
Metric and Definition
Occupancy rate Average daily census/Number of staffed beds
Inpatient payer mix Number of Medicare or Medicaid patients/Total number of patients
Medicare case-mix Medicare Case-Mix Index
Average length of stay Total number of inpatient days/Total number of admissions
Expense per discharge (Total operating expenses + other expenses)/Adjusted discharge
Average age of plant Accumulated depreciation/Annual depreciation expense
Outpatient mix Total outpatient (inpatient equivalent) days/Total patient days
Revenue per discharge (Net patient revenue + nonpatient revenue)/Adjusted discharge
FTEs per bed Total FTEs/Occupied beds
Telecom
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): An indicator of a
company's financial performance calculated as revenue less expenses
(excluding tax, interest, depreciation and amortization).

Churn Rate: The rate at which customers leave for a competitor. Largely due to fierce competition,
the telecom industry boasts - or, rather, suffers - the highest customer churn rate of any industry.
Strong brand name marketing and service quality tends to mitigate churn.

Average Revenue Per User (ARPU): Used most in the context of a telecom operator's subscriber
base, ARPU sometimes offers a useful measure of growth performance. ARPU levels get tougher to
sustain competition, and increased churn exerts a downward pressure. ARPU for data services have
been slowly increasing. Some other important ratios for this sector

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Oil and Gas Sector
Reserve Ratios
Reserve replacement ratio- A metric used by investors to judge the operating performance
of an oil and gas exploration and production company. The reserve-replacement ratio
measures the amount of proved reserves added to a company's reserve base during the
year relative to the amount of oil and gas produced. During stable demand condition
environments a company's reserve replacement ratio must be at least 100% for the
company to stay in business long-term; otherwise, it will eventually run out of oil.
Reserve life ratio- It is used to measure the number of years production could continue at
the current rate without adding any new reserves.
Also various analytical ratios can be calculated such as lifting costs (lease operating
expenses per barrels of oil equivalent (boe) or thousands of cubic feet equivalent
(mcfe)produced during a period) and finding costs (costs associated with increasing
reserves during a particular period).

As opposed to industrial companies, the quantitative measures of E&P performance are
based primarily on the ability to replace and grow resources at a favorable cost. Rather than
EBITDA (earnings before depreciation, interest, taxes, and depreciation and amortization),
analysts usually consider EBITDAX a primary pricing metric for E&P companies. EBITDAX
represents EBITDA before exploration costs for successful efforts companies. For full cost
firms, exploration costs are embedded in depreciation and depletion, so EBITDAX equalizes
both accounting types. Exploration costs in successful efforts companies are typically labelled
or referred to in the financial statements as exploration, abandonment, and dry hole costs.
In addition, other noncash expenses such as impairments, accretion of asset retirement

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obligation, and deferred taxes should be added back in calculating EBITDAX.
FMCG Sector
Last 5 years revenue growth (CAGR) and what is the reason for the growth. If encouraging
growth has come about due to continuous new product introductions and growth in market
share, it is an encouraging sign.
Operating margin trend What sort of margins is the company earning, vis-a-vis its peers.
Whether the trend is improving or is there a continuous decline. Find out reasons for both. If
it is improving due to efficiencies in supply chain and product focus, it is encouraging. If it is
declining continuously due to hike in advertising spends etc., it is a sign of the company
facing intense competition. However, if the margin decline is a blip and has come as a result
of a new product introduction, it is a good long-term sign.
Look at the company's cash flows and the working capital efficiencies. It will give you an
idea of the company's bargaining power as well as its ability to utilize its resources and
supply chain.
Look at the return ratios, especially ROCE (return on capital employed) trend. It will give
you an idea how effective the company is in optimising its resource strengths. Also, look at
the dividend paying track record. A healthy dividend payout, i.e., the ratio of dividends to
earnings, is also a good indicator of the company's willingness to share wealth with small
shareholders.
It is also important to look at the P/E (price to earnings multiple) and market capitalisation
to sales, which the company is trading at vis-a-vis its peers. Growth oriented companies' will
most likely be trading at a premium to peers based on these parameters. If so, then one has
to gauge whether that premium is justified. If the premium is unrealistically high then it may
not be a good idea to invest at that juncture. After all, valuations have to justify the
company's prospects.
Retail Sector
Gross Profit Ratio: Gross profit ratio represents the average amount of money made per
sales dollar. It reflects pricing strategy: how much you mark up prices and how deeply you
markdown. The Retail Management Advisors targets a 50 percent gross profit ratio for
apparel clients. Calculate this ratio by dividing gross profit by net sales, figures found on the
income statement.
Operating Expense Ratio: To learn how much of every sales dollar goes toward operating
expenses, a retailer looks at the operating expense ratio or expense-to-sales ratio, which is
computed by dividing total non-merchandise expenses by net sales. Operating expense ratio
should run between 20 percent and 45 percent of sales, depending on the business model.
Inventory Turnover: The inventory turnover ratio tells a retailer how often she completely
sells and replenishes her stock. A high turnover indicates she keeps her merchandise
selection new; a low turnover signals that she has capital tied up in stock that must be sold

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at a lower cost -- and profit margin -- to move. Too rapid a turnover hurts sales by limiting
selection.
Current and Quick Ratios: The current ratio measures a store's ability to pay its short-term
debt. The equation divides current assets by current liabilities, found on the balance sheet.
Retail Management Advisors recommends a current ratio of at least 2.0, adding that credit
problems loom below a 1.5 ratio. A related measurement, the quick ratio, excludes inventory
from current assets for a better indication of ability to raise cash quickly to satisfy debt due
within the year. A quick ratio of less than 1 is a red flag, according to Carter.
ROA and Debt to Equity: The return on assets ratio paints a picture over time of a retail
operation's growth. Calculated from the division of pre-tax profit listed on the profit and loss
statement by the total assets figure found on the balance sheet, ROA varies by market
segment. Jewelers averaged an ROA of 3.6 in 2011, according to the Retail Owners
Institute, while candy stores achieved an ROA of 8.4. Creditors also review the debt-to-
equity ratio, measured by total liabilities divided by net worth, which compares the owner's
investment to the financed portion of a business. A healthy debt-to-equity ratio exceeds 1 to
1, according to the Retail Management Advisors.
Infrastructure Sector
Working Capital Ratio
A companys working capital ratio is calculated by taking current assets divided by current
liabilities. This financial ratio seems simple but it gives the reader the ability to measure the
companys efficiency and short term health. A major concern of the user would be that the
company doesnt appear to have an adequate amount of current assets to fulfill their current
liabilities. A company that is operating efficiently and with low risk of defaulting on current
debt will show improvement in their working capital ratio from period to period indicating that
they are generating an increase in current assets (i.e. cash, receivables) with less or equal
liabilities. Users would like to see a ratio as high as possible but at least greater than a 1 to 1
ratio.
Debt to Equity Ratio
The debt to equity ratio is used frequently in the construction industry as a financial covenant
in bank loans or as a financial health measurement tool. The ratio is calculated by taking the
total debt on the balance sheet and dividing it by the total equity in the company. This ratio
measures a companys financial leverage. In many cases the ratio, when acting as a
financial covenant, will have a maximum calculation in which the borrower cant exceed in
order to stay compliant with the bank loan. The banks purpose for the covenant is to keep
their risk of collection on the loan at a low level. Depending on the size of the company, t he
debt to equity ratio ceiling usually ranges from approximately 3 or 4 to 1. Unlike the working
capital ratio the lower your debt to equity ratio, the less risky your position appears.
Gross Profit Analysis
The gross profit percentage is probably the most widely used financial ratio in the
construction industry, which is calculated by subtracting job costs from contract revenue and

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dividing the result by contract job costs (as opposed to revenue in other industries). While it
does give you valuable insight for your break-even analysis and other important business
projections, it more importantly measures the profitability of each of the companys jobs on
an overall basis over a specific period of time. The gross profit calculations critical use in the
construction industry is in the fade analysis. The fade analysis measures the difference
between a) the gross profit of a job at its completion versus, b) the estimated gross profit of
the job at inception, as well as interim points during the jobs life. Financial statement users
frequently ask questions relating to jobs that have a profit fade. Understanding that it is
important for a company to try to limit jobs that have profit fades, it is also important to
understand why the jobs profit faded and how to correct the issue so fades are less likely to
exist in the future.
Contracts Receivable Turnover
The contracts receivable turnover ratio has therefore become a more important ratio for
financial statement users. This ratio is calculated by taking your revenue for a given period
and dividing it by the average contracts receivable from the beginning and end of that period.
This will give the user significant insight on collectability of receivables and the overall
customer base of the company. If the turnover ratio has decreased over years, then your
receivables are taking longer to collect, and questions will arise regarding the status of your
jobs and clients.
Valuation Metrics
Technology: In this space there are really two metrics that matter the most, sales growth
and EPS growth. EV/Sales will be used if you are thinking about investing in growth
companies (IPO valuations). If youre investing in large tech it is more about EV/EBITDA
(cash flow) and P/Es, if youre investing in growth stocks it is more about year over year
sales growth and EPS growth since many do not have positive earnings.
Metrics Basis: IT spend will help tech companies, GDP is usually a driver for IT spend,
changes in products impact margins (software has higher margins for example) also you
should track the cost of items going into each tech product
(Note: Software would be similar but it gets a higher multiple due to higher margins ie: gross
margins are usually near 90%, this is why take out multiples for software companies would
be higher than say a hardware company, better margins drive better multiples)
Consumer: This space is about sales growth, operating margin growth (look for earnings
growth, P/E multiples) and returns on your assets. For the consumer segment you want to
open stores with or without debt, get them cash flow positive, open more stores and repeat.
So with this in mind ROA, ROE and margins become significant metrics to follow. Finally,
you want to make sure your debt load is manageable.
Metrics Basis: Weather impacts consumer sales (warm weather means more people
shopping), Sales/square foot is a good metric to follow (how efficient are your stores),
monthly data comes out regarding sales for consumer companies and same store sales calls
are also tracked religiously.

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Auto/Transport: Auto: This space is also heavily focused on EBITDA and some will use
metrics such as EBITDAP (the P stands for pension obligations which makes sense for a
company like Ford). In addition, this space can utilize the DCF valuation as cash flow is
much more predictable relative to a small medical technology stock. Transport: Similar to
Auto, the focus is again on EBITDA or EBITDAR (the R stands for rent). Again this depends
on the company but with a gun to your head stick with simple EBITDA metrics for both.
Metrics Basis: In this industry one key point of course is IHS Automotive data (Worldwide
sales, European vs. North America etc.). In addition, when looking at the auto space one
should look at the Seasonally Adjusted and Annualized Rate (referred to as the SAAR).
Finally, one should remember Automotive is highly cyclical, recall the 2008 disaster so GDP
growth is also a factor for auto sales.
Financials: Another large industry but key metrics here include book value, returns on
assets and equity and of course loan ratios. Companies will trade on P/BV ratios and
tangible book value per share will also be a key metric. The space is broad for example a
REIT will see more focus on consistent dividends and of course interest rates while banks
zero in on loan ratios and tangible book value and finally credit card companies track
charge-offs and portfolios of loans.
Metrics: Changes in interest rates impact bond prices and loans in general so this is a key
metric to watch. Credit companies will look for charge offs and as mentioned with REITs you
are looking for stable book value and consistent dividend payments.
Medical: The medical space is tougher to value with simple metrics because if a product is
approved and is a game changer (for example a cure for cancer) the stock will move triple
digits within days. With that said a good way to value the firm is by valuing their product lines
or using a sum of the parts analysis
Metrics: Available market is put in both metrics and valuation as the market you are
attempting to penetrate will determine the value of your product, again if you can cure cancer
you have addressed a major market with an extremely desirable and valuable solution.
Beyond product approvals you are also looking for changes in governmental laws
Oil & Gas: In this space we again turn more to EBITDA metrics (or EBITDAX which
excludes some differentiated tax issues) as we are dealing with large numbers and recurring
income which allows for the use of a DCF as well. Finally for oil and gas you can use the Net
Asset Value model (NAV) where you no longer assume perpetual growth and instead look at
reserves moving to zero.
Metrics: Simplistically you are looking for large reserves and production of oil/gas or
otherwise. In addition, changes in legislation and drilling rights/laws significantly impact your
financial model.

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Detailed Ratio table