How To Use Common Size Analysis To Compare Companies To Peers

People constantly evaluate themselves, and others, in domains like attractiveness, wealth, intelligence, and success. According to some studies, as much as 10 percent of our thoughts involve comparisons of some kind.”

Quote source: Psychology Today

Comparisons in the investing world are not different; there are many forms of comparison, some flattering, some not. But the use of comparisons to help you find the best investment is called common size analysis.

Common size analysis allows us to compare our company across its many years of performance, plus comparing one company to others in the same/different industry, or to benchmarks. All of those comparisons allow us to see what is important, trends, or any other items that might help us make the best decision.

One of my favorite shareholder letters is from Chris Bloomstran of Semper Augustus. He uses common size analysis to compare his fund’s performance against the S&P 500, and it is a great analysis. It helps see how his fund is performing relative to important metrics and gives you a sense of the direction the fund is going relative to the market. Let’s dive in and learn more about common size analysis.

What is Common Size Analysis?

Common size analysis according to CorporateFinanceInstitute is:

Common size analysis, also referred as vertical analysis, is a tool that financial managers use to analyze financial statements. It evaluates financial statements by expressing each line item as a percentage of the base amount for that period. The analysis helps to understand the impact of each item in the financial statement and its contribution to the resulting figure.”

Creating common size financial statements allows investors to make it easier to analyze Visa (V) over time and compare it to Mastercard (MA). Using common size financials helps point out trends we might not see when looking at raw financial statements. Common size analysis allows the use of all three major financial statements in this format:

  • Income statement.
  • Balance sheet.
  • Cash flow statement.

The easiest way to do this is by using spreadsheets that can easily convert the statements into percentages based on each separate line item or the ones you want to analyze. 

The two most common uses of common-size analysis are on the income statement and balance sheet. For example, when comparing line items on the income statement, it is most common to compare them to the company’s revenue. Likewise, it is common to compare them to assets, liabilities, or shareholder’s equity on the balance sheet.

How Do You Calculate Common Size Analysis?

To calculate a common size analysis, we need to convert the income statement’s financial data, for example, into percentages. The way we do this is simple:

To put that into practice, let’s use the latest quarterly report for Visa:

  •  Revenue – $5,687.
  •  Gross Profit – $4,533.

Percentage of Base = $4,533 / $5,687 x 100 = 79.71%. Pretty simple, huh? Common size analysis can be done in several ways:

  •  Vertical analysis.
  •  Horizontal analysis.

Vertical analysis is analyzing specific line items to a base item within the same financial period. For example, one can compare when looking at the gross margin, operating margin, and net income margin of the first quarter of 2020 for Visa.

Gross Margin

80.82%

Operating Margin

67.17%

Net Income Margin

52.68%

The horizontal analysis takes the same line items and looks at the results over a longer period, such as multiple years or quarters. Below is an example of looking at Visa’s profit margins over five years.

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Disclosure: Intrinsic Value Formula is published as an information service. It includes opinions as to buying, selling and holding various stocks and other securities. However, the publishers of ...

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