Thread by @myfinology

Ratios can be misleading if you don't read between the lines! 🧐

For instance,
Company A margin = 5%
Company B margin = 12%

If both companies are eerily similar, which company will you invest in?

Blind guess: Company B?

You could be wrong. Here's why ⤵️

What if we say, despite a low margin, company A generates more Return On Invested Capital (ROIC) than company B! 🤯

Company A's ROIC = 90%
Company B's ROIC = 60%

Don't believe?

Let's breakdown ROIC to understand better ⤵️

#investing

ROIC = Profit / Capital

This can be split into:
Margin = Profit / Revenue
Turnover = Revenue / Capital

So, ROIC = Margin * Turnover

Company A:
Margin = 5%
Turnover = 18 times
ROIC = 90%

Company B:
Margin = 12%
Turnover = 5 times
ROIC = 60%

To sum up,

When capital turnover ratio is high, the company can afford to have a low margin, and still deliver an exceptional return on capital! 🚀

Not all low margin businesses are necessarily bad.

#Investment #Share

Next time someone tells you that his business has very low margins, ask him about its turnover ratio before making judgments about the quality of the business. 😶

Don't just read ratios, pause, take a moment & ask yourself: "Why so?"