What it's worth to you

Measuring profitability is no simple task, and bigger isn't always more valuable.

Posted: December 10, 2007

What makes a company valuable?

In the stock markets, where software writers, oil refiners, toy-makers and bomb builders compete for the same investor dollars, it doesn't matter what you make, or even how much you sell;

it's how much profit investors expect you're going to keep that determines share prices.

Thirteen Philadelphia-area companies rank on the Standard & Poor's list of 500 big publicly traded corporations. The most valuable is Comcast Corp., the Philadelphia-based cable TV, Internet and phone company, which earned $2.5 billion on gross sales of $25 billion last year, and was worth $64 billion - based on the price Wall Street assigns to its shares - on the Nasdaq Stock Market at the start of November. Second is DuPont Co., the Wilmington chemical-maker.

DuPont earned $3.1 billion on sales of $27 billion last year - both higher than Comcast - but was worth only $45 billion on the New York Stock Exchange, one-third less than Comcast, because of investors' perception it is growing more slowly.

Oil refiner Sunoco Inc. and drug distributor AmerisourceBergen Corp. sold billions of dollars more in products than either DuPont or Comcast, but their profits were smaller, and traders gave each a much lower market value. Pharmaceutical and petroleum prices may be rising, but those revenues are not going straight to the big companies' bottom line.

Bigger does not mean more profitable. Stock prices are supposed to reflect a company's future earnings capacity. While a share of the typical S&P 500 company trades at about 18 times earnings, small, low-profit companies including telemarketing contractor ICT Group Inc., of Newtown, and Internet retailer GSI Commerce Inc., of King of Prussia, have traded lately at much higher prices, compared with their earnings.

Besides comparing prices with past and expected profits, investors use an array of simple ratios to weigh competing investments. Return on assets (ROA) was popular a century ago when Claymont, Del., accountant John J. Raskob developed its use to advise the du Pont family on the diversification of the family fortune from explosives into chemicals and General Motors Corp. But service-oriented companies have few tangible assets whose value can be measured; even modern industrial companies often try to keep the property they own at a minimum, inflating their ROA.

Return on common equity (ROE) is a common measure of corporate profit per investor share, but massive shareholder repurchases by old-line industrial companies - which reduce the number of shares on the market - have boosted ROE values without actually showing higher profitability. Return on capital (ROC) provides a less-distorted measure comparing aggregate returns to aggregate investment in a company, but it is hard to calculate for banks and real estate companies.

It is easier to look backward than forward. Over the three years ended Sept. 30, GSI tripled its share price, while Pitman-based industrial-equipment-maker K-Tron International Inc. did even better, more than quadrupling its value. Insurers Cigna Corp. and Philadelphia Consolidated Holding Corp. more than doubled as their industry recovered from a long slump - though mortgage insurer Radian Group Inc. lost half its value as home-mortgage defaults soared, and other home mortgage stocks also tumbled.

Of course, as securities salesmen warn in the fine print, past performance is no guarantee of future results.


Contact staff writer Joseph N. DiStefano at 215-854-5957 or jdistefano@phillynews.com.

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