Course 206: Levers of ROE
Net Margin and Asset Turnover
In this course
1 Introduction
2 Net Margin and Asset Turnover
3 Financial Leverage
4 The Risks of Debt-Driven Returns on Equity

Not all these levers are made equal. The first two levers, net margin and asset turnover, are measures of how efficient a company's operations are. It's pretty intuitive that increasing net margins--which means a company is turning a larger portion of its sales into profits--will increase profitability. A high asset turnover, which expresses how many times a company sells, or turns over, its assets in a year is also a sign of efficiency. The product of net margin and asset turnover is called return on assets, or ROA, and it is an excellent measure of operational profitability. The higher a company's ROA, the better. Some companies emphasize high net margins to pump up their ROA; others emphasize rapid turnover. For example, compare Coca-Cola KO against Cott COTTF, a Canadian producer of discount, non-brand-name soda. Between 1994 and 1998, Coke's net margins averaged 18%, while Cott's average net margin was less than 5%. Coke was able to leverage its strong brand name into higher prices, resulting in fat net margins. Cott, on the other hand, targeted the low end of the market with bargain prices, earning a slimmer profit margin on each sale but (hopefully) moving a lot more merchandise per unit of assets. Indeed, Cott's asset turnover during the same period was 1.7, compared with Coke's 1.1. But that wasn't nearly enough to offset Coke's much higher net margins, and Coke's ROA of 24% trounced Cott's 4%. This isn't to say that focusing on asset turnover at the expense of margins is always a bad thing. Wal-Mart WMT has lower margins than most other major retailers because it emphasizes lower prices. But Wal-Mart also generates a higher ROA than most of these competitors because it operates so efficiently that its asset turnover is much higher. In 1998, for example, Wal-Mart's asset turnover was 2.8, as opposed to 1.1 for old-line retailer Sears S and 2.0 for rival discounter Dayton-Hudson DH.

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