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Q Ratio Analysis of the Top 250

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For the last seven years, this report has offered an analysis of the Q ratios of publicly traded Top 250 retailers. The Q ratios for this year are a bit lower than last year owing to the weakness in the global economy in 2011 and the consequent impact on equity prices. Once again, the star performers were located in some of the major emerging markets, where Q ratios tended to be better than those in more affluent markets.

Before examining the results of our analysis, it is worth taking a moment to understand what the Q ratio is intended to measure.

In the current and anticipated business environment, the world’s leading retailers will face intense competition, slow growth in major developed markets, rising input prices (yet consumer resistance to higher retail prices) and excess retail capacity in many developed markets. All of this implies that, in order for retailers to succeed, they will have to find ways to distinguish themselves from competitors. That means having strong brand identity, offering consumers a superior shopping experience and being clearly differentiated from competitors. The latter can entail unique merchandise offerings (including private brands) and store formats and designs, as well as unusual customer experiences. The goal is to have a sufficiently unique position in the market to generate pricing power and, consequently, strong profitability. If a publicly traded retailer has these characteristics, the financial markets are likely to reward such a retailer. That is where the Q ratio comes in.

The Q ratio is the relationship between a publicly traded company’s market capitalization and the value of its tangible assets. If this ratio is greater than one, it means that financial market participants believe that part of a company’s value comes from its non-tangible assets. These can include such things as brand equity, differentiation, innovation, customer experience, market dominance, customer loyalty and skillful execution. The higher the Q ratio, the greater share of a company’s value that stems from such non-tangibles. A Q ratio of less than one, on the other hand, indicates failure to generate value on the basis of non-tangible assets. It indicates that the financial markets view a retailer’s strategy as unable to generate a sufficient return on physical assets; indeed, it suggests an arbitrage opportunity. Theoretically, at least, a company with a Q ratio of less than one could be purchased through equity markets and the tangible assets subsequently sold at a profit.

Which companies have high Qs?
This year we analyzed the financial results of 157 publicly traded companies on the Top 250 list, up from the 144 analyzed last year. The composite Q ratio for all companies was 1.06. This was slightly off from 2011, when the composite Q was 1.144, but far better than the extremely low 0.75 recorded in 2009. It remains far below the 1.57 recorded in 2008, just before the start of the global economic crisis. The company with the highest Q ratio was Coach, the U.S.-based luxury fashion retailer. For the second year in a row the second company on the list was BIM, the Turkish hard discount retailer. Third on the list was Hennes & Mauritz, which has been either first or second on the list in all previous years that this analysis was conducted.

As mentioned, emerging-market retailers did particularly well for the year covered in this report. The composite Q ratio for emerging retailers was 1.22, far lower than last year’s 1.932. The emerging retailers compared quite favorably to Western European retailers (0.85) but fared poorly in comparison to U.S.-based retailers (1.47). Among countries with two or more retailers on the list, Sweden performed best: its two retailers had a composite Q ratio of 5.21. The countries with the lowest composite Q ratios were Japan and Germany. When measured according to dominant format, the retailers with the highest composite Q ratio were electronics stores and apparel specialty stores, while the lowest were convenience and department stores. When measured according to dominant merchandise category, the top retailers were those selling hardline and leisure goods, while the lowest were diversified retailers, those for which there was no dominant category.