If you’ve been investing in the retail sector for some time now, it’s possible you already know it’s a diverse and dynamic sector. That’s why some investors find it difficult to accurately analyze their investments in retail companies. Luckily, we listed down the most important metrics an investor should look at in the retail sector.
Return of Revenues
The return of revenues (ROR) is the cornerstone of any retail operation. It shows you how much income the company got from top-line revenues.
This is nearly as important as gross margin return on investment, which refers to the gross margin profit on the cost of your inventory.
Every retail store maintains an inventory, which is also considered an asset on the balance sheet. When you analyze it alongside the P&L statement, it can tell you a lot about how the product is performing.
When you divide the inventory into the 12-months’ revenue, you get the number of inventory turns in those 12 months. Higher number is better.
Grocery stores often have lower margins. As a result, they often need to turn inventory more times than luxury retailers.
Cash flow Statement
Companies may be able to be profitable but still generate negative cash flow. The opposite happens as well, which is when the business loses money to generate positive cash flow.
Look for companies that make money while also generating positive cash flow. What’s better are companies that generate free cash flow, which is the money from operations after subtracting the account capital expenditures.
Return on Invested Capital
Return on invested capital, or the “four-wall cash contribution,” refers to the amount of profit that is generated per store.
The faster the store can return its invested capital required to open the store, the faster it can grow its overall profits.
If a new store averages $2 million in annual sales in the first year open and its four-wall contribution is $200,000, a $300,000 investment for building and opening the store is repaid in 18 months.
Doing the math, the return on invested capital is 67%. Successful retailers look for store revenues and four-wall contribution to grow in years two and three. If this doesn’t happen, there might be a huge problem.
Return on Total Assets
The return on total assets refers to the amount of operating profit is made from its assets. Of course, bigger number means better. Within the retail sector, the number will vary depending on the type of business.
Specialty retailers require less retail space, inventory, fixtures, and others. Home improvement stores, on the flipside, run in much larger retail footprints. Therefore, they require greater assets.
But having to use more doesn’t automatically make these stores inferior. Simply, that’s the price of doing business in that particular niche.
Return on Employed Capital
This metric tells us how efficiently the retailers spend their capital. This is also defined as earnings before interest and taxes (EBIT) divided by the capital employed, which in turn is the total assets minus current liabilities.
On the other hand, the more appropriate definition of capital employed would be shareholders’ equity plus the net debt.
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