Wednesday, November 18, 2009

Why Doesn't the Revenues per Employee Ratio (R/E Ratio) Get More Respect?

One obscure way of measuring how efficient a company operates is the amount or sales or revenues that are generated for each employee at the company, also known as the Revenues per Employee Ratio or R/E Ratio. It is also sometimes referred to as the Sales per Employee Ratio or S/E ratio. I've written about the R/E ratio in the past a couple times, but there doesn't appear to be much interest in this metric.

The concept is simple. Let's assume there are two companies in the same industry generating the exact same amount of revenues. But Company A has 1,000 employees and Company B has 10,000 employees. Which company do you think would generate higher net earnings? Which stock do you think would perform better?

Let's take some real life examples, using the technology sector. With only 19,665 employees and raking in $182.95 billion in revenues, Google (GOOG) is by far the top large cap tech company with the highest R/E ratio at $9,303,330 for every employee. And to top things off, the stock is up 79% so far this year. Apple (AAPL) is close behind with an R/E ratio of $5,408,163 and the stock is up an amazing 127% for the year. Then there is Amazon (AMZN) at $2,746,376 per employee. Amazon has a top return year-to-date of 142%.

Now let's look at some of the tech stocks that don't have as high an R/E ratio. Yahoo (YHOO) has a revenue per employee ratio far below the others at $1,646,323 and the stock was only up 24%. Both Dell (DELL) and IBM (IBM) generate almost identical revenues per employee at $410,000 and are up about 49% for the year; not even close to the returns for Apple or Amazon. And Hewlett Packard (HPQ) only has a R/E ratio of $372,866 and has the lower year-to-date return to show for it at 38%.

So next time you are trying to decide which stock you want to buy in a particular industry or sector, take a close look at the R/E ratio.

Author owns AAPL, AMZN, and YHOO.

By Fred Fuld at Stockerblog.com

4 comments:

Marc said...

I think people prefer to use OIBDA(profit margin). That way the cost of employees is lumped in with other costs and you get an apples to apples comparison. For example, your valuation would be completely off for companies with high raw materials cost or high leases required to do business using RPE.

Stockerblog said...

You could say the same thing about the Price Sales ratio which also doesn't take into consideration the same things you mentioned. Yet it has historically been a very effective ratio for stock analysis.

Marc said...

True. Within a specific sector any ratio can be effective, but that's even got limitations. For instance, company A has retail outlets full of low paid high school kids. Company B, a direct competitor, has fewer employees, but hires only highly paid PH.D.s. and focuses on automation. They have equivalent revenues. Does revenue per employee really give you good results?

My main point, poorly conveyed, is that the Shareholder has access to the bottom line not the top hence margin ratios like p\e are more popular. Plus it eliminates a lot of the noise in the data like I illustrated above.

That's why I speculate it doesn't gain more popularity or respect. It's easier to just use use margin based ratios.

Stockerblog said...

I agree that the P/E is more popular. However, as a forecasting tool, there has found to be no meaningful link between a stock's P/E or its dividend yield and its future return (“Cognitive Biases in Market Forecasts.” Fisher, Kenneth L., and Meir Statman. The Journal of Portfolio Management, Fall 2000: 72-81.) However, the Price to Sales ratio has been shown to be a significant forecasting tool (What Works on Wall Street by James O'Shaughnessy. McGraw Hill, 2005).

I would submit that the noise in the data would be avoided by using top line numbers as opposed to bottom line numbers, because the bottom line can be so variable, even at the same company. If companies are in the same sector or industry, they are more likely to have similar raw materials costs, similar lease rates, similar types of employees, etc. This is what makes the R/E ratio an interesting comparative metric for such companies.