Classroom | When investing in auto companies, what are the key parameters I should look at? (Equity: Part 16)

Following are the key parameters you must look at while evaluating Auto companies for investment.

Volumes: The sales of a company are a good reflection of consumer demand. It refers to the total number of vehicles produced or sold in a period. Typically, companies report sales made to the dealers, which may be different from retail sales, but the trends generally converge. Year-on-year growth comparisons are better than sequential and do adjust for seasonal variations, such as festival periods. Steady growth is what you would want to see and a slowdown can be a worrying sign.

Realisation: This is the money a company earns on the sale of a vehicle. It is calculated by dividing revenue by volume. Ideally, investors would want to see this amount increase. That can be due to either an increase in prices or a change in product mix, that means the company is selling more high-value vehicles.

Revenue: It is the income received by a company from sales and is the combination of volume and price-led sales growth. You would like to see this trend also move up, with volume contributing equally if not more to sales growth compared to the effect of price increases.

Gross Profit: This is the profit a company makes after deducting costs associated with making and selling its products. A higher number here leaves enough on the table for the company to meet its other expenses.

Gross margin: It is the percentage of revenue that exceeds the cost of goods sold. It is calculated by dividing gross profit by revenue and then multiplying by 100. A higher number here is a good sign.

EBITDA: Earnings before interest, tax, depreciation and amortization or EBITDA, is a measure of a company's operating performance. Also called operating profit, it is a bare-bone evaluation tool that strips any influence of financing and accounting decisions as well as taxes.

EBITDA margin:  Expressed as a percentage, the EBITDA margin is calculated by dividing EBITDA by revenue and then multiplying by 100. Investors use EBITDA margin to evaluate how the core business of the company is performing and if this measure shows a stable or increasing trend, then it is taken as a positive signal. In an automobile company, factors such as a sharp increase in material costs or discounts can affect margins. Also, the start of a new project can also depress profitability until sales from the new unit stabilise.

Net profit: It is the earnings after accounting for all expenses and taxes. An automobile company's debt structure and its capital expenditure plans and treasury management will influence heads such as interest costs, depreciation and other income. These are the items that will add or subtract from the EBITDA, apart from taxes, to yield net profit.