Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Why KPIs are an essential tool to decoding a company’s performance
Firms operating in different industries have their own yardsticks for performance, beyond the usual metrics like pre-tax profit, revenue and cash flow.
These key performance indicators or KPIs for short can help you spot positive or negative trends before they show up in the P&L or balance sheet. And having a handle on the key KPIs for specific sectors can help you decipher updates from sector constituents.
GETTING BUMS ON SEATS
Load factor essentially reveals how effectively airlines fill their flights by comparing how many miles they fly per seat and per passenger. Because airlines have lots of fixed costs the load factor has a significant bearing on profitability.
RevPAR assesses how well a hotel can fill its rooms, which is calculated by multiplying the average daily room rate by the occupancy rate.
Like-for-like sales offer an insight into the underlying performance of these consumer-facing companies as they strip out any impact from acquisitions or the opening of new outlets or premises.
STRONG FOUNDATIONS FOR HOUSEBUILDERS
UK house prices have recently come under pressure, and this is starting to be reflected in the average selling prices achieved by the listed contingent of housebuilders. If house prices continue to decline, these businesses will have to drive sales at higher volumes to achieve growth.
Investors should also focus on forward sales, which reveal homes that have been ordered but not yet bought by prospective owners, providing a measure of visibility on future sales.
CHECKING BANKS READINESS FOR STORMY TIMES
In the wake of the financial crisis there has been greater onus on banks to demonstrate their ability to withstand adverse economic conditions.
An emerging metric in the wake of the crisis has been the common equity tier 1 ratio (CET1). Expressed as a percentage, this measures a bank’s core equity capital against its overall risk-weighted assets.
In other words it shows how much money they have put aside to cover their riskier assets. Current regulations require a CET1 of at least 8%.
RATIOS AND GRADES DECIPHERED
The insurance sector can be tricky to unravel, but one of the most important metrics to wrap your head around is the combined ratio. This reveals the difference in what’s being paid by customers in premiums and what’s being paid out to customers in claims by the insurer.
A combined ratio of under 100% implies profitability, and the lower the number the better its underwriting operations are performing.
Another set of hard-to-understand companies are the miners, references to terms like ‘ore grade’ can be confusing.
An ore is a type of rock that contains minerals and metals which can be extracted. The grade describes the concentration of metal and plays an important role in determining the costs of extraction
As a rule of thumb, high quality mines generally boast higher production grades as the precious metal can be extracted with relatively less effort, which results in lower costs.
In contrast, lower metal grades are generally worse as it will take the miner more effort and money to extract the metal and could lead to increased operating costs.
For their counterparts in the oil and gas sector, useful terms include: operating costs per barrel – which shows how much a company spends to produce each individual barrel of oil; the reserves replacement ratio – which measures the extent to which the company replaces reserves lost to production; and the level of proved and probable or 2P reserves – which are those reserves of oil and gas which geological analysis suggests are more likely than not to be recoverable. (LMJ)