For a long time, key figures such as the price-earnings ratio or the price-sales ratio were considered important indicators of a company’s financial health. Investors who invest in growth stocks should also keep an eye on the net retention rate.
• Net retention rate provides information about growth
• Economic classification possible
• Correct interpretation is important
Price-to-earnings ratio and price-to-sales ratio
Many investors swear by the price-to-earnings ratio (P/E) when choosing a stock. To calculate the key figure, the current share price of a stock is divided by the company’s most recent earnings per share. The latter consists of the company’s profit divided by all of the company’s shares. A low ratio shows that the stock is cheaply valued – and possibly particularly promising. However, if the ratio is high, it does not automatically mean that the share certificate is too expensive. Furthermore, there are no clearly defined areas of the P/E ratio in which stocks are considered cheap or expensive.
However, the price-to-sales ratio (P/S) is now considered to be more meaningful, especially for young companies, as startups and unicorns often do not yet generate profits. Here, the stock market price of a share is divided by the company’s sales per share to obtain the key figure.
Net retention rate determines customer loyalty
To date, the Net Retention Rate (NRR), also known as Net Revenue Retention, Net Dollar Retention or customer retention rate, has received less attention. According to the investment advisor Pyfore Capital, the key figure is made up of the following formula:
(Sales at the beginning of the period + sales increase within the period – sales declines within the period – sales churn within the period) / sales at the beginning of the period
The sales of a company or product at the beginning of a period are considered. In addition, the additional sales generated within the period are added, but declines and churn are deducted. This adjusted sales is then divided by the sales at the beginning of the period – resulting in the customer retention rate as a percentage.
Relevance to growth stocks
Vincent Uhr from “Aktienwelt360” attests that the key figure is extremely important, especially with regard to growth stocks, as it provides information about how much more money existing customers are willing to spend on a product or service. According to Pyfore Capital, a customer retention rate of 100 percent means that all defections have been compensated for by existing customers. If the rate is more than 100 percent, it can be deduced that the product has experienced internal growth. However, if the key figure is below the 100 percent mark, a decline in growth is obvious.
Examination of economic sensitivity
In addition, the customer retention rate can also be used to check the economic sensitivity of a product or service. If this is often below 100 percent in growth companies, this could also be a sign that the product portfolio is less important. In economically uncertain times, customers may initially forego these products. However, if the value is above 100 percent even in an environment of economic challenges, the goods and services offered would not only prove to be crisis-proof, but could also help customers overcome difficult times, according to Uhr.
Increasing importance
Even if the strategist believes that the key figure is of enormous importance, it should only be used if it can be placed in the overall context of the company. According to Uhr, investors who are betting on growth stocks should learn how to use the net retention rate because the data “tells a lot about the product or service and its value.” And the experts at Pyfore Capital are also of the opinion that the NRR will become more informative and will stand alongside traditional key figures such as sales growth or gross margin.
Editorial team finanzen.net