Find the Metric

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I was first introduced to the idea of finding the one (maybe two) most important metric that means the most for a particular company when I was attending SMU pursuing my MBA. I took a personal investing class that was taught by an adjunct professor and it was one of the top classes that I took. He didn’t cover the standard financial and portfolio theory that you hear in traditional finance classes. Instead, he ran his own investment outfit and used was in the investment group that owned the Texas Rangers with George W Bush. I learned a lot about investing from this class, and one of the things that has always stuck with me was to find the one metric that can be used to investigate a company (or industry).

Some industries have a metric or two that is well-known, and can be used to measure the health of a company and potentially use to compare companies in the same industry. Sometimes you, as an investor, need to figure out what makes the company tick and come up with your own metric. Other times, a company will define a metric that is used in their Quarterly and Annual Reports. If the company defines the metric, it must be examined to decide if that metric is truly valuable and useful.

Why one metric? For most companies, revenue and profit is generated by one line of business and it is up to you, as an investor, to decide how the revenue and profit are generated in a business. I’m an investor in InfuSystems ($INFU) and the company’s main source of revenue is from renting out a fleet of infusion pumps. The company buys infusion pumps to add to their fleet, and then rents the pumps to patients for the useful life of the pump. The earnings of the company are determined by this return on the rental fleet. If the company cannot rent the pumps, profit is going to be affected dramatically. You can read more about my initial thoughts on InfuSystems if you want some more background.  In this case, the company came up with the metric – Rental Pump Return.  The metric represents the return on $1 invested in the pump fleet.  As you can see below, $INFU is managing to get a ~45%-55% return on each dollar invested in the pump fleet.  Using the metric, we can decide, over time, if problems are starting to appear (lower return on investment).

INFU Rental Pump Return

 

 

The process allows an investor to trim the not so important noise and focus on what drives a particular business.  For some industries, some pretty standard metrics are used and can be relied upon.  For instance, for retail stores the metric revenue per sq ft is widely used to decide the health of the business.  Some people may use Same Store Sales Growth.  It is up to each person to decide the best metric to use for their investments, but the process makes an investor really figure out the business and what drives profits.

 

Here is a list of some industry specific metrics

Insurance: Combined ratio
Claims ratio
Money Managers: Assets under management
Retail: Same store sales growth
Revenue per square foot
Gasoline margin spread
Real Estate: Square feet per share
Revenue per square foot
Spread between Return on Assets and Borrowing Costs
Oil&Gas Exploration: Reserves per share
Production BOE per day per share
Reserve life
Replacement cost per BOE
Oil Integrated: Crack spread
Oil&Gas Services: Rig counts
Banks: Bad Debt percent
Manufacturing: Contract backlog
Telecoms: Number of customers
Churn rate
Airlines: Load factor
Utility: Spark spread
Transportation: rail traffic
truck tonnage index
air cargo revenues

Deciding on a metric to use does not eliminate the need to perform other financial analysis on the company.  The metric should be used in conjunction with other financial ratios but is specific to examining the health of the profit driver of the business.

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Tagged on: investing, metrics, stocks