Depreciation & Amortisation/Sales (%)Companies operating in the same industries should generate similar levels of depreciation and amortisation (D&A) relative to sales. We penalise those companies where depreciation is extremely low relative to its peer group as it suggests they are under-depreciating their assets in order to inflate profits. We also penalise companies where there has been a significant fall in (D&A) relative to sales.
Clearly, there is a large variance in depreciation to sales across industries, as shown in Figure 73. Asset heavy industries, such as Oil & Gas and Electric Utilities, report a high level of (D&A) relative to sales, in excess of 7%. Meanwhile, asset light companies report a low level of D&A, below 2% of sales.
Most ratios trigger a red flag because they are large and/or rising; for example, when receivable days exceed the 80th percentile relative to industry peers. However, for D&A/sales we are concerned when it is small and falling (i.e. below the 20th percentile). As such, for scoring purposes we reverse the percentile. What originally might be a ratio in the 20th percentile becomes the 80th, and so on.
Our accounting screen is set to trigger a red flag when D&A/Sales exceeds the 80th percentile (reversed) relative to its GICS industry peers, and/or when there is an abnormally large increase relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the increase in D&A/Sales exceeds the 80th percentile relative to the change experienced by GICS industry peers between 2010 and 2015.