One Metric Makes Village Super Market, Inc. (VLGEA) Special: The Kroger Co. (KR), Kansas City Southern (KSU)

When evaluating a business, most investors concentrate on margins, ROE, ROIC, free cash flow, and a host of other metrics. While important, those measures of performance do not always reveal the true value-creating mechanism for a company.

Asset turnover is one metric that is often vital to a company’s performance but rarely scrutinized by investors.

Can a Grocery Store Be a Better Business than a Railroad?

Grocery stores are notorious for having razor-thin margins. When you combine loss leaders with products that cannot be marked up more than a few pennies, you will always have a small window of profitability.

On the other hand, railroads typically have much higher margins than grocery stores. In fact, most railroads consistently earn double-digit operating margins, whereas grocery stores invariably earn low-single-digit margins.

Many investors would take this information and determine that it’s better to be in the railroad business than the grocery store business, but it’s not that simple.

Although railroads earn higher margins, their assets are not as productive as those of grocery stores. In other words, grocery stores make more sales per dollar of assets than railroads — much more.

Sales per dollar of assets is referred to as asset turnover. If you multiply asset turnover by profit margin, you get return on assets.

Over the last decade, Village Super Market, Inc. (NASDAQ:VLGEA) had an average EBIT margin of just 3.06%. However, it turned over its assets 3.7x each year. 3.7 times 3.06% = a pre-tax, pre-interest return on assets of 11.42%. This is the same as saying that for every $1 in assets, Village Super Market earned $0.11 before interest and taxes.

Meanwhile, Kansas City Southern (NYSE:KSU) had an average EBIT margin of 12.08% and an asset turnover of 0.31x. 0.31 times 12.08% = 3.83% pre-tax, pre-interest return on assets.

So, while Kansas City Southern earns a much higher margin on its products and services, Village Super Market, Inc. (NASDAQ:VLGEA)’s superior asset turnover leads to a better unlevered return on the capital required to operate the business.