The investor must understand the past cost and margin structure and changes in the same. The purpose is to look at the long-term trends of cost and margin. The future is unknown, but this assessment can provide cues as to what can happen in the future.
Here is an example of two companies in the paint sector.
Asian Paints
The operating margin is in the range of 16% - 22%. ROCE ranges from 59%-30% and consistently declining. The decline in the ROCE numbers must be assessed.
Akzo Nobel
The operating margin is in the range of 8% - 14%. ROCE ranges from 13% - 28%.
Both these companies operate in the same sector and have to deal with similar competitive forces. But clearly, Asian Paints enjoys a high margin and high ROCE.
Bharti Airtel
Once a leader in the telecom sector enjoys a high operating margin but low ROCE.
This company may not qualify for the quality tag and as per Buffet’s definition belong to the gruesome category i.e. high Capex requirement and low return on investments.
Disclaimers
Investment in securities market are subject to market risks. Read all the related documents carefully before investing.
The securities quoted are for illustration only and are not recommendatory.
Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.
Details of the advisor
Advisor: Ankur Kapur
SEBI RIA No.: INA100001406
BASL Member ID: BASL1337