Commodity SECTOR IN INDIA (Key Fundamental Ratios)

FUNDAMENTAL RATIOS AFFECTING THE COMMODITIES SECTOR

Fundamental Ratios used to analyze stocks in the consumer discretionary sector can be divided into 5 categories- namely Valuation Ratios, Solvency Ratios, Profitability Ratios, Efficiency Ratios and Liquidity Ratios.

VALUATION RATIOS

Price to Earnings is an important valuation metric used to analyze companies across industries. A high P/ E indicates that the company is overvalued by the markets with respect to it’s earnings. Companies in the commodities sector have a moderate P/E ratio. Any government regulation restricting its operations can have a widespread adverse impact. The price to book Value can also be used to analyze if a stock is overvalued or not. The PEG ratio, which compares the price of a stock to the company’s earnings growth is another important valuation metric. The ideal PEG is 1 but companies in the Commodities sector have a quite adverse PEG ratio of -58 indicating negative earnings on average.

Dividend Yield compares the dividend provided to investors with the stock’s price. Undervalued stocks with high dividend yields are called Income stocks. Small cap stocks in the Commodities sector comprise mainly of Income stocks.

SOLVENCY RATIOS

Companies in the commodities sector have a debt to equity ratio below 1 on average. This is a good indicator of the financial health of a sector. Interest Coverage ratio is another financial metric used to assess the solvency of companies. Companies in this sector have a favorable Interest Coverage Ratio implying they have enough earnings to cover their interest expenses.

PROFITABILITY RATIOS

Net Profit Margin, which compares the profits of a company to its total revenue, is used industry wide to assess profitability of companies. The commodities sector tends to have a lower Net Profit margin in comparison to it’s peers. These companies have huge expenses with regard to daily operations and face a number of restrictions from regulatory authorities. Hence the lower margins. Return on Capital Employed, which compares the returns generated by the company to its capital investments is another great metric to assess the profitability of these companies as they are heavily capital intensive.

EFFICIENCY RATIOS

Fixed Assets Turnover ratio is a very useful financial metric to analyze the efficiency of companies in the commodities sector. It compares the revenue generated with the average investment in fixed assets. Given that this sector is heavily dependent on fixed assets such as Plant and Machinery for their operations, the ratio is a good measure of the company’s efficiency in operations.

The Inventory Turnover Ratio can also be used to analyze how efficiently the company is managing it’s inventory. The ideal Inventory Turnover Ratio is 12, which implies the inventory has been sold out once every month. Companies in the commodities sector have an average Inventory Turnover Ratio around 6 which is not ideal. One reason for the same might be that most of these companies deal in industrial products and do not face fast moving consumer demand that runs out inventory quicker.

LIQUIDITY RATIOS

Current Ratio compares the short term assets of a company to its short term liabilities. The average current ratio in the commodities sector is 1.74 which is less than the ideal value of 2. The Quick ratio, which compares the cash and cash equivalents to the short term liabilities hovers around 1 in the sector which is an ideal value.