What is Equity Turnover?

This ratio is one of the most important ratios used by the organization to find out how much revenue the shareholder’s equity can generate over a year.

Most investors calculate this ratio before investing in the company because, through this ratio, they can understand how much they would directly affect the company’s revenue.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Equity Turnover Ratio (wallstreetmojo.com)

Equity Turnover Formula

Equity Turnover Formula = Net Sales / Average Shareholders’ Equity

Now the question is what you would consider as sales.

When you make sales, it is net sales, not gross salesGross SalesGross Sales, also called Top-Line Sales of a Company, refers to the total sales amount earned over a given period, excluding returns, allowances, rebates, & any other discount. read more. A gross sale is a figure inclusive of the sales discount and sales returns. We would take the net sales, which means we must exclude sales discount and sales returns (if any) from the gross sales to get the right figure.

To calculate the average shareholders’ equity, we need to consider the shareholders’ equity at the beginning of the year and end. And then, we would find the mean of the sum of the total equity (beginning + end).

You may also like – Ratio Analysis DefinitionRatio Analysis DefinitionRatio analysis is the quantitative interpretation of the company’s financial performance. It provides valuable information about the organization’s profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.read more Excel Based Comprehensive Analysis

Interpretation

It isn’t easy to interpret the Equity Turnover Ratio. But if you take a general perspective, an increased proportion provides a positive indication, and a decreased proportion indicates a negative connotation.

However, there are a couple of things about the ratio we need to pay heed to. Let’s have a look at them –

  • The equity turnover ratio varies greatly depending on the industry’s capital intensive. For example, if we consider the turnover ratio of the oil refinery industry, it would be much less than a service business; because the oil refinery needs large capital investment to generate sales. So the comparison of ratios should be made among companies that belong to the same industry. If any company wants to increase the equity turnover ratio to attract more shareholders, it may skew the equity by increasing the debt percentage in the capital structure. This move is very risky as by doing this, the organization is taking on the burden of too much debt, and eventually, they have to pay the debt with interest.

Equity Turnover Ratio Example

Let’s do the calculation to determine the equity turnover ratio for both companies.

First, as we have been given Gross Sales, we need to calculate the Net Sales for both companies.

And as we have the equity at the beginning of the year and the end of the year, we need to find out the average equity for both companies.

Now, let’s calculate the equity turnover ratio for both companies.

As mentioned before, if these companies are from similar industries, we can compare the turnover ratio of both of them. For Company A, the equity turnover ratio is more than Company B. That doesn’t mean Company A is doing much better than Company B. It just means that somehow from the ratio, we can conclude that Company A can generate better revenue out than their average shareholders’ equity than Company B.

It may happen that Company A has reduced the percentage of equity in the capital structure by increasing the debt to attract more shareholders. In that case, the increased proportion doesn’t indicate a positive result.

Nestle Example

Let’s look at the income statement first, and then we would have a glance at their balance sheet for the years 2014 and 2015.

Consolidated income statement for the year ended 31st December 2014 & 2015

A consolidated balance sheet as of 31st December 2014 & 2015

source: Nestle 2015 Financial Statements

Now let’s calculate the equity turnover ratio of Nestle for the years 2014 & 2015.

As Nestle  belongs to the FMCG industry, revenue and equity are almost equal. We can say the FMCGFMCGFast-moving consumer goods (FMCG) are non-durable consumer goods that sell like hotcakes as they usually come with a low price and high usability. Their examples include toothpaste, ready-to-make food, soap, cookie, notebook, chocolate, etc.read more sector is very much capital intensive. But what is the oil refinery industry? Is the industry capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more? What would be the equity turnover ratio of the oil refinery industry? Let’s have a look.

IOC Example

In this section, we will pull out a few data from the Indian Oil Corporation’s annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more, and then we will calculate the equity turnover ratio for the years 2015 and 2016.

First, let’s look at the revenue of Indian Oil Corporation for the year ended 31st March 2016.

Let’s have a glance at the share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company’s initial public offerings, common shares or preference stocks to the public. It appears as the owner’s or shareholders’ equity on the corporate balance sheet’s liability side.read more of Indian Oil Corporation for the year ended 31st March 2016.

source: IOC annual reports

As Indian Oil Corporation is a very capital-intensive corporation, the turnover is around five and more. But let’s say we are calculating the equity turnover of a service industry where the need for capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc.read more is much lesser; in that case, the turnover would be much more.

Home Depot Case Study – Investigating the Rise in Equity Turnover

Home Depot is a retail supplier of home improvement tools, construction products, and services. It operates in the US, Canada, and Mexico.

When we look at Home Depot’s Equity turnover, we see that until 2012, turnover was relatively stable at around 3.5x. However, since 2012, Turnover of Home Depot has started climbing steeply and currently stands at 11.32x (growth of around 219%)

What are the reasons for such an increase –

source: ycharts

Equity turnover can increase either because of an increase in sales, a decrease in equity, or both.

# 1 – Evaluating Home Depot’s Increase in Sales

Home Depot Sales increased its revenue from $70.42billion to $88.52, an increase of approximately 25% in 4 years. This increase of 25% in 4 years has contributed to the increase in turnover; however, its contribution is somewhat restricted.

#2 – Evaluating Home Depot’s Shareholder’s Equity

We note that the shareholder’s equity of Home Depot has decreased by 65% in the last four years. It means the denominator has been reduced by more than half.

If we look at Home Depot’s Shareholder’s Equity section, we find the possible reasons for such a decrease.

  • Accumulated Other Comprehensive Loss has resulted in lowering shareholders’ equity in both 2015 and 2016. It stood at -818 million in 2016 and -452 in 2015. Accumulated other comprehensive losses are adjustments primarily related to foreign currency translationsForeign Currency TranslationsThe accounting method in which companies with international businesses translate the financials of their international subsidiaries into their domestic or functional currency in order to meet financial reporting requirements is known as foreign currency translation.read more.Accelerated Buybacks were the second and most important reason for the decrease in Shareholder’s equity in 2015 and 2016. We note that Home Depot bought back 520 million shares (approximately $33.19 billion) and 461 million shares (~ value $26.19 billion) in 2016 and 2015, respectively.

Top Companies with High Equity Turnovers

Here are some of the top companies by market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more and equity turnovers. We note that Boeing has a turnover of 26.4x.

Internet Industry Example

  • Internet companies have low turnovers. We note that the average Equity Turnover of the top internet companies is 1.0xAlphabet (Google) turnover is 0.7x, while that of Facebook is 0.5x

Oil & Gas Example

  • Oil & Gas companies have low turnovers. We note that the average Equity Turnover of the top Oil & Gas EP companies is 0.5xDevon Energy has an above-average equity turnover of 0.9xConcho Resources has a below-average equity turnover of 0.3x

Restaurant Industry Equity Turnovers

  • Restaurant companies have a higher equity turnover. The average turnover of top restaurant-based companies is 4.6xPlease note that Domino’s Pizza has a negative turnover of -1.5xDunkin Brands, on the other hand, has an above-average turnover of 11.0x

Software Application Industry Equity Turnovers

  • Like internet companies, Software application companies also have equity turnover closer to 1x. The top 10 companies in software applications have an average turnover of 1.4x

Negative Equity Turnovers Examples

Negative Turnover arises when the Shareholder’s Equity becomes negative.

  • Kimberly Clark has a negative equityNegative EquityA negative equity balance is one in which the liabilities in shareholder’s equity exceed the assets for reasons such as accumulated losses over years, high dividend payments, borrowing money instead of issuing new shares to cover accumulated losses, and amortization of intangibles.read more turnover of -131.9xMarriott International has a negative turnover of -5x

Limitations

Even if the Equity Turnover Ratio can be helpful for shareholders before investing in a company, this ratio has some limitations that the potential investors and the company, which is calculating the ratio, should keep in mind.

  • Asset Turnover Ratio Cash Conversion CycleCapital Gearing RatioWorking Capital Ratio

In the final analysis

The equity turnover ratio may seem useful to the equity investors and even for the company, which is more equity capital intensive. But for the rest of the investors and companies, other ratios are more useful than equity turnover ratio, e.g., return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more, return on investment, debt-equity ratio, inventory turnover ratioInventory Turnover RatioInventory Turnover Ratio measures how fast the company replaces a current batch of inventories and transforms them into sales. Higher ratio indicates that the company’s product is in high demand and sells quickly, resulting in lower inventory management costs and more earnings.read more, etc. Like cash ratioCash RatioCash Ratio is calculated by dividing the total cash and the cash equivalents of the company by total current liabilities. It indicates how quickly a business can pay off its short term liabilities using the non-current assets.read more, this ratio is also not being used much, but if you want to get a big picture of net sales and want to compare the net sales and the equity, you would be able to understand through this ratio.