My Favorite Ratios (Part 2)

Wild geese that fly with the moon on their wings,

These are a few of my favorite things

Photo: Gracie Stinson. Source: Morguefile

My favorite financial ratios combine a company’s efficiency at generating cash from its marketplace with a willingness to deliver cash to their shareholders. I focus on three indicators: Return on Invested Capital (ROIC), Cash from Operations divided by Net Income, and Shareholder Yield. It’s a fine theory, but how well does it work in practice?

Let’s compare two wild geese, the tech giants IBM and CISCO. They aren’t exactly the same, but they have similar business models—selling hardware, software, and services to other companies. Over the past 10 years, here’s how their financial ratios and total return looked:

Data Source: Bloomberg

Over the past ten years IBM has had a superior ROIC and has returned more cash to its shareholders. Its shareholder yield has been roughly 3% higher than Cisco’s, and their total return for the time period has been about 2% per year higher. Both companies appear to have similar ratios of cash from operations to net income. But analyzing how these ratios have changed over time provides even more insight.

Source: Bloomberg

Cisco started out with a 20% ROIC, and their stock boomed. But IBM gradually increased its ROIC from 10% to 20%, while Cisco’s went the opposite way, and their equity prices followed suit—until recently. But note their cash flow! Over the past decade, IBM’s cash flow to net income ratio has halved, falling from 2.0x to 1.1x. Recently, their free cash flow hasn’t even been sufficient to maintain their stock buyback program, and they’ve borrowed to support it. Obviously, this can’t continue: the balance sheet will become bloated, and ROIC will fall. This may be part of the reason why IBM’s share price has fallen since early-2013.

These indicators provide an interesting picture of why the equities of the two tech titans may have performed as they have. Both firms are solid, blue-chip companies committed to their shareholders, although their financials have diverged. We know that valuation matters, but economic performance matters too. Hopefully any silver, white, wintery problems they are having will melt into a spring of positive returns.

Douglas R. Tengdin, CFA

Chief Investment Officer

By |2017-07-17T12:22:40+00:00August 12th, 2015|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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