Equity Turnover Ratio

What is Equity Turnover?

Equity turnover is the ratio between the net sales of a company and average equity a company holds over a period of time; this helps in deciding whether the company is creating enough revenues to make sure it worth for the shareholders to hold the equity of the company.

Equity Turnover Ratio

It is the proportion of the Company’s revenue to its shareholder’s equity. Have a look at the above Equity Turnover chart of Google and Amazon. We note that while Amazon is operating at a turnover of 8.87x, Google’s turnover is a mere 0.696. What does this mean for Amazon and Google? Is Amazon utilizing its equity better than Google?

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

Most investors calculate this ratio before investing in the company because, through this ratio, they are able to understand how much they would directly affect the revenue of the company.

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For 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 would take 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 which is inclusive of the sales discount and/or sales returns. We would take the net sales, and that means we need to 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 take into account the shareholders’ equity at the beginning of the year and at the end of the year. And then, we would find the mean of the sum of the total equity (beginning + end).

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Interpretation

It is difficult to interpret Equity Turnover Ratio. But if you take a general perspective, an increased proportion provides a positive indication, and a decrease 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 a lot, depending on how capital intensive the industry is. For example, if we take into account the turnover ratio of the oil refinery industry, it would be much lesser than a service business; because oil refinery needs large capital investment to generate sales. So the comparison of ratio should be done 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 the burden of too much debt, and eventually, they have to pay the debt with interest.

Equity Turnover Ratio Example

ParticularsCompany A (in US $)Company B (in US $)
Gross Sales100008000
Sales Discount500200
Equity at the beginning of the year30004000
Equity at the end of the year50006000

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

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

ParticularsCompany A (in US $)Company B (in US $)
Gross Sales100008000
(-) Sales Discount(500)(200)
Net Sales95007800

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

ParticularsCompany A (in US $)Company B (in US $)
Equity at the beginning of the year (A)30004000
Equity at the end of the year (B)50006000
Total Equity (A + B)800010000
Average Equity [(A + B)/2]40005000

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

ParticularsCompany A (in US $)Company B (in US $)
Net Sales (X)95007800
Average Equity (Y)40005000
Equity Turnover Ratio (X/Y)2.381.56

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 the Company B. That doesn’t mean Company A is doing much better than Company B. It just means that somehow from the ratio, we are able to conclude that Company A is able to generate better revenue out of their average shareholders’ equity than Company B.

Now it may happen that Company A has reduced the percentage of equity in the capital structure by increasing the debt for attracting more shareholders. In that case, increases proportion doesn’t indicate a positive result.

Nestle Example

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

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

Nestle - Revenue - Equity Turnover

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

Nestle - Shareholders Equity - Equity Turnover Ratio

source: Nestle 2015 Financial Statements

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

In millions of CHF20152014
Sales (M)8878591612
Total Equity (N)6398671884
Equity Turnover  (M/N)1.391.27

As Nestle belongs to the FMCG industry, revenue and equity is almost equal. We can say the FMCG 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 would 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.

Rupees in croresMarch 2016March 2015
Gross Sales421737.38486038.69
(-) Sales Discount(65810.76)(36531.93)
Net Sales355926.62449506.76

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.

Rupees in croresMarch 2016March 2015
Share Equity2427.952427.95
Rupees in croresMarch 2016March 2015
Net Sales  (I)355926.62449506.76
Share Equity (J)75993.9666404.32
Equity Turnover (I/J)4.686.77

source: IOC annual reports

As Indian Oil Corporation is a very capital intensive corporation, the turnover is around 5 and more. But let’s say that we are calculating the equity turnover of a service industry where the need of 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 up steeply and currently stands at 11.32x (growth of around 219%)

What are the reasons for such an increase –

Home Depot - Increasing Equity Turnover

source: ycharts

Equity turnover can increases either because of an increase in sales or 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.

Home Depot Revenue Increase - Equity Turnover Ratio

source: ycharts

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

We note that shareholder’s equity of Home Depot has decreased by 65% in the last 4 years. It means the denominator has been reduced by more than half.

Home Depot Equity Decrease - Equity Turnover Ratio

source: ycharts

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

Home Depot - Equity Decrease
  1. Accumulated Other Comprehensive Loss has resulted in the lowering of 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.
  2. 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 (approx value of $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.

S. NoNameEquity TurnoverMarket Cap ($ million)
1Boeing                         26.4                              101,201
2United Parcel Service                         42.0                                 92,060
3Charter Communications                       195.1                                 86,715
4Lockheed Martin                         20.5                                 73,983
5Costco Wholesale                         10.5                                 73,366
6Yum Brands                         10.7                                 33,905
7S&P Global                         15.6                                 31,838
8Kroger                         18.0                                 31,605
9McKesson                         22.6                                 29,649
10Sherwin-Williams                         12.2                                 28,055

source: ycharts

Internet Industry Example

S. NoNameEquity TurnoverMarket Cap ($ million)
1Alphabet                           0.7                              568,085
2Facebook                           0.5                              381,651
3Baidu                           1.0                                 61,684
4Yahoo!                           0.2                                 42,382
5JD.com                           5.4                                 40,541
6NetEase                           0.9                                 34,009
7Twitter                           0.6                                 12,818
8Weibo                           0.8                                 10,789
9VeriSign                         (1.1)                                   8,594
10Yandex                           1.0                                   7,405
Average                           1.0

source: ycharts

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

Oil & Gas Example

S. NoNameEquity TurnoverMarket Cap ($ million)
1ConocoPhillips                           0.7                                 62,063
2EOG Resources                           0.6                                 57,473
3CNOOC                           0.5                                 55,309
4Occidental Petroleum                           0.4                                 52,110
5Anadarko Petroleum                           0.6                                 38,620
6Canadian Natural                           0.5                                 32,847
7Pioneer Natural Resources                           0.6                                 30,733
8Devon Energy                           0.9                                 23,703
9Apache                           0.4                                 21,958
10Concho Resources                           0.3                                 20,678
Average                           0.5

source: ycharts

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

Restaurant Industry Equity Turnovers

S. NoNameEquity TurnoverMarket Cap ($ million)
1McDonald’s                           2.5                              101,868
2Starbucks                           3.6                                 81,221
3Yum Brands                         10.7                                 33,905
4Restaurant Brands Intl                           2.5                                 11,502
5Chipotle Mexican Grill                           2.2                                 11,399
6Darden Restaurants                           3.2                                   8,981
7Domino’s Pizza                         (1.5)                                   8,576
8Aramark                           7.1                                   8,194
9Panera Bread                           4.3                                   5,002
10Dunkin Brands Group                         11.0                                   4,686
Average                           4.6

source: ycharts

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

Software Application Industry Equity Turnovers

S. NoNameEquity TurnoverMarket Cap ($ million)
1SAP                           0.9                              112,101
2Adobe Systems                           0.8                                 56,552
3Salesforce.com                           1.5                                 55,562
4Intuit                           2.7                                 30,259
5Autodesk                           1.3                                 18,432
6Symantec                           0.7                                 17,618
7Check Point Software Tech                           0.5                                 17,308
8Workday                           1.0                                 17,159
9ServiceNow                           2.9                                 15,023
10Red Hat                           1.6                                 13,946
Average                           1.4

source: ycharts

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

Negative Equity Turnovers Examples

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

S. NoNameEquity TurnoverMarket Cap ($ million)
1Philip Morris Intl                         (2.1)                              155,135
2Colgate-Palmolive                       (56.1)                                 58,210
3Kimberly-Clark                    (131.9)                                 43,423
4Marriott International                         (5.0)                                 33,445
5HCA Holdings                         (5.6)                                 30,632
6Sirius XM Holdings                       (10.5)                                 22,638
7AutoZone                         (6.1)                                 20,621
8Moody’s                         (9.3)                                 20,413
9Quintiles IMS Holdings                         (9.0)                                 19,141
10L Brands                    (100.9)                                 16,914

source: ycharts

Limitations

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

  • The equity turnover ratio can be manipulated if the company wants to attract more investors. By changing the capital structure of the company (by injecting more debt into the capital), the company can change the turnover ratio altogether, which the investors may not understand all too well.
  • Equity always doesn’t generate revenue. It means if we would like to know the specific relationship between equity and revenue, there would be hardly anything to compare. However, if we compare equity with net income, it’s far more valid.
  • The equity turnover ratio is not applicable for a company that mainly focuses on debt for their capital necessity. Though it’s always advisable for a company to go for more equity and less debt, many companies find it useful to take debt instead of going for equity options.

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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 equity, return on investment, debt-equity ratio, inventory turnover ratio, etc. Like cash ratio, this ratio is also not being used much, but if you want to get a big picture on net sales and want to make a comparison between the net sales and the equity, through this ratio, you would be able to understand that.