Investment analysts use a variety of key ratios, such as return on equity (ROE), return on assets (ROA), and price-earnings ratio (P/E), to gauge a company's well being. One number that doesn't get a lot of attention is the sales-per-employee ratio. While it does have its limitations, this ratio does give investors some sense of a company's productivity and financial health.
What Is the Sales-per-Employee Ratio?
The name indicates how the sales/employee ratio is calculated: a company's annual sales divided by its total employees. Annual sales and employee numbers are easily located in published statements and annual reports.
The sales-per-employee ratio provides a broad indication of how expensive a company is to run. It can be especially insightful when measuring the efficiency of businesses such as banks, retailers, consultants, software companies and media groups. "People businesses" lend themselves to the sales per employee ratio.
Interpreting the ratio is fairly straightforward: companies with higher sales-per-employee figures are generally considered more efficient than those with lower figures. A higher sales-per-employee ratio indicates that the company can operate on low overhead costs, and therefore do more with less employees, which often translates into healthy profits.
Consider the software maker Qualcomm. In 2003, the company generated $690,000 in sales per employee. By comparison, software giant Microsoft generated about $500,000 in sales per employee. This suggests that Qualcomm is making more of its workforce and demonstrates why the stock market consistently awards Qualcomm a higher valuation than other technology stocks.
Compare Apples with Apples
The sales-per-employee ratio is best used to compare companies that are similar. Retailers and other service-oriented companies that employ a lot of people, for instance, will have dramatically different ratios than software firms. For example, Starbucks Coffee is a highly efficient retailer, but because it employs nearly 74,000 full and part-time staff, its sales-per-employee figure of $55,000 seems to pale in comparison to Qualcomm's $690,000 per employee.
Companies that concentrate on selling and distributing products will typically enjoy much higher sales-per-employee figures than firms that manufacture goods. Manufacturing is typically very labor intensive, while sales and marketing activities rely on fewer people to generate the same sales numbers. In manufacturing, each employee can usually assemble only a certain number of products. Increasing production requires more employees. By contrast, marketing and sales activities can increase without necessarily adding staff. Take the sports footwear maker Nike: since making the decision to outsource its manufacturing to other companies, the firm's sales-per-employee ratio has skyrocketed.
Early-stage businesses typically have low sales-per-employee numbers. Companies involved in developing new technology, for example, often have meager sales-per-employee figures in their early years. Sonus Pharmaceuticals, for instance, generated only $610 per employee in 2003. But the firm's sales-per-employee multiple will grow as its lead drug products, which are still in the trial stage, are expected to gain wider sales eventually.
You should also be careful about employee numbers stated in the financial reports. Some companies employ sub-contractors, which are not counted as employees. This kind of discrepancy can put a wrinkle in your analysis and comparison of sales-per-employee figures.
Trends Are Important
Be sure to watch sales-per-employee ratios over several years to get a reliable idea of performance. Don't jump to conclusions without examining trends over time. A jump in sales-per-employee efficiencies can be just a blip. For instance, big job cuts often translate into a temporary ratio boost as remaining employees work harder and take on extra tasks. But research shows such a boost can quickly reverse as workers burn out and work less efficiently.
A steadily rising sales-per-employee ratio can mean a number of things:
• increasingly streamlined organizations;
• recent capital investment that improves efficiency;
• great products that are selling faster than those of competitors.
Also, a company that consistently generates rising sales with a stable or shrinking work force can usually boost profits more rapidly than one that can't make additional sales without adding more workers. An improving sales-per-employee ratio frequently precedes growth in profit margins. A climbing sales-per-employee number could mean that the company is growing but has not hired more employees to handle the added workload.
Again, be careful. If numbers change dramatically, it's worthwhile to take a closer look.
Although you need to be careful when using this ratio, you can tell a lot about a company and its future from its sales-per-employee figures. Investors can get a quick sense of the company's financial health and of how the company fares against its peers. While the ratio doesn't tell the whole story, it certainly helps.