Question

What does analyzing companies against their industry using ratio analysis tell us? What ratios would you use to do the analysis and why?

Answer 1

Analyzing companies against their industry ratio tells us about
a) Profitability: It tells about the profitability with respect to its equity, assets and capital employed as compared to the industry standards or benchmark. It also provides information about the returns to the equity holders.
b) Solvency: It provides information about its short term and long term debt servicing ratio with respect to industry standards. It tells us whether the company can pay off its debts regularly without hampering the business.
c) Liquidity: Certain ratios inform us whether the company has more liquid assets or illiquid assets. they help us in comparing liquidity position of the company with respect to industry/
d)Operational Effeiciency: The asset turnover, sales turover and inventory turnover ratio can give us agood picture about the operational efficiency of the company with respect to industry standards.

I would use Quick Ratio (Acid test ratio to determine) Liquidity ratio as it ignores the illiquid assets like inventory which can’t be converted to cash very fast.
Quick Ratio = (Current Assets- Inventories)/Current Liabilities.

Inventory turnover, asset turnover can be used for operation efficiency because it gives inventory turnover represent the number of times inventory is utilized for production. Higher turnover would indicate how efficiently inventory is managed. Inventory Turnover= Cost of Goods sold /Average inventory.
Asset turnover would indicate the efficient utilization of assets. Asset turnover= Sales/Total Assets

I would also use interest coverage ratio to determine the paying capacity of company for long term debt. Interest coverage ratio = EBIT/ Interest

I would use ROE ,ROTA , Net profit margin to determine profiatbility as these are important ratio for equity holders and potential investors.
ROE= EAT/Equity, ROTA = EAT/ Total Assets, Net profit Margin = Net profit/ Sales.

Best of Luck,. God Bless