- Another common financial ratio is return on sales.
Return on sales is a measure of a company's profitability.
Return on sales is computed as net income
divided by total revenue.
For Walmart, return on sales is 2%,
computed as $10 billion of net income
divided by $500 billion in revenue.
This means that if Walmart has sales of $100,
the shareholders of Walmart get to keep $2
after all the expenses including interest
and income taxes have been paid.
This return on sales number
is also sometimes called the profit margin.
By comparison, Target's profit margin is a robust 4%.
If we had the time,
we could do an interesting item-by-item comparison
of Walmart and Target to see why Walmart's return on sales
is just half as large as Target's.
Now for a high tech company such as Google or Apple
or Microsoft, return on sales is often over 20%.
The sales of high tech businesses can be very profitable.
Businesses like Target and Walmart
that sell groceries and commodities have a very thin margin.
Now another commonly used financial ratio
is asset turnover.
Asset turnover is a measure of efficiency
and is computed as sales divided by total assets.
For Walmart, asset turnover is 2.4,
which means that for every dollar of assets,
Walmart is able to generate 2.4 dollars of sales each year.
The higher the asset turnover number,
the more efficient the company is at using its assets
to generate sales.
For Target, asset turnover is just 1.8.
Now let me illustrate the difference
between these two companies,
Walmart and Target in terms of efficiency.
If I gave Walmart $100 in assets
and I gave the same $100 in assets to Target,
Walmart would be able to use the $100 in assets
to generate an additional $60 in sales each year.
You see the importance of efficiency
as measured here by asset turnover.
Now another widely used financial ratio,
perhaps the most famous financial ratio
is return on equity, called ROE by its friends.
ROE is a measure of the overall profitability
of shareholder investment
and it's computed as net income divided by equity.
For Walmart, ROE is 12%
computed as $10 billion in net income
divided by $81 billion in equity.
Remember that the equity number in the balance sheet
is the amount invested in Walmart
by the company's shareholders.
So for the year ended January 31, 2018,
Walmart's shareholders earned 12% on their investment.
On the other hand, Target's shareholders had a return
on equity of 25%.
That's a huge number.
The shareholders of Target were much happier in this year
than were the shareholders of Walmart
because the Target shareholders earned 25%
on their investment,
whereas the Walmart shareholders earned just 12%,
as a rule of thumb,
most companies have return on equity
somewhere between 10 and 20%.
Well, we see that Walmart is in the normal range.
If you see a company with a return on equity more than 20%,
that company's awesome.
If you see a company with a return on equity
of less than 10%, it's not so good.