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Explain ratios specific to particular industries and how ratios help forecast earnings

CFA® Level I · Financial Statement Analysis · Financial Analysis Techniques · FSA.5.f

The idea

General ratios travel badly between industries, so each sector has its own measures of what drives results. Retailers are judged on same-store sales growth and sales per square metre; hotels on occupancy and revenue per available room, which is occupancy times the average daily rate; airlines on load factor and revenue per available seat mile; banks on net interest margin and on capital ratios such as common equity Tier 1 capital divided by risk-weighted assets. The same ratios become forecasting tools: an analyst projects the operating driver, such as store count or room nights, applies a sales-per-unit figure to reach revenue, then applies margin and expense ratios to work down to earnings. The forecast is only as good as the assumption that those ratios are stable, so the analyst should test them against their history and the company's plans.

A practice question

From the question bank, with the reason each wrong option is wrong.

Which measure is most useful for judging the organic sales performance of a retailer that is opening new stores?

  1. Total revenue growthWhy not: Mixes in sales from newly opened stores, so it cannot separate expansion from existing-store performance.
  2. Net interest marginWhy not: A banking measure of lending spread. It has no bearing on how a retailer's stores are trading.
  3. Same-store sales growth — correct

Same-store sales compare stores open in both periods, so growth from new openings is stripped out and what is left is how the existing estate is performing.

A harder one

A hotel operator reports an occupancy rate of 75% and an average daily rate of 160. Its revenue per available room (RevPAR) is:

  1. 213.33Why not: Divides the rate by occupancy. RevPAR multiplies them, since empty rooms earn nothing.
  2. 120.00 — correct
  3. 40.00Why not: Multiplies the rate by the vacancy rate of 25% rather than by occupancy.

RevPAR = occupancy x average daily rate = 0.75 x 160 = 120.

The hardest tier

Sales of 2,000 are forecast to grow 6%. The operating margin is expected to stay at 12%, interest expense is 40 and the tax rate is 25%. Forecast net income is:

  1. 160.8 — correct
  2. 190.8Why not: Applies tax straight to operating profit, leaving out the interest expense of 40.
  3. 150.0Why not: Applies the margin to this year's sales of 2,000 without the 6% growth.

Sales = 2,000 x 1.06 = 2,120. EBIT = 0.12 x 2,120 = 254.4. Pre-tax = 254.4 - 40 = 214.4. Net income = 214.4 x 0.75 = 160.8.

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