Lippmann-Mears Ratios (LMR)

Lippmann-Mears Ratios (LMR) are a powerful set of financial metrics designed to cut through accounting noise and reveal a company's true ability to generate cash and create economic value. Developed by French financial analysts François-Marie Lippmann and Jean-Charles Mears, these ratios offer a refreshing, cash-focused alternative to traditional earnings-based metrics like the P/E Ratio or EPS. For the discerning value investor, LMR is like having a pair of X-ray goggles; it helps you look past the often-manicured facade of the Income Statement and see the real, cash-pumping heart of a business. Instead of asking, “How much profit did the company report?”, LMR asks a more fundamental question: “How much cold, hard cash did the company actually generate?” This focus on cash flow provides a more robust and honest assessment of a company's operational health and long-term potential, making it an invaluable tool for identifying high-quality, durable businesses.

The driving force behind the LMR framework is a healthy skepticism of conventional accrual accounting. While reported profits are important, they can be influenced by non-cash items (like Depreciation) and various accounting choices that can obscure a company's true performance. Cash, on the other hand, doesn't lie. A company can't pay its employees, reinvest in its business, or return money to shareholders with accounting profits; it needs real cash. LMR strips away these accounting layers to focus on the core operational cash-generating power of a business. This aligns perfectly with the value investing ethos championed by figures like Warren Buffett, which emphasizes understanding a business as an economic engine. By using LMR, an investor can better assess a company's quality, efficiency, and resilience, making more informed decisions based on economic reality rather than accounting artistry.

While there are several ratios in the LMR family, three stand out as particularly insightful for investors. They work together to paint a comprehensive picture of a company's cash-generating prowess.

This is the flagship LMR metric, measuring how efficiently a company uses its total pool of capital to generate cash from its core operations. It’s a cash-based version of the popular ROCE (Return on Capital Employed).

• The Formula: (Net Cash Flow from Operations) / (Total Capital Employed)
• What It Tells You: A consistently high LMR1 (say, above 15-20%) indicates that the company has a strong competitive advantage, or Moat, allowing it to generate heaps of cash from the money invested in the business. It’s a hallmark of a high-quality, value-creating enterprise.

This ratio is essentially a cash-based profit margin. It reveals how much operating cash a company generates for every dollar of revenue.

• The Formula: (Net Cash Flow from Operations) / (Revenue)
• What It Tells You: LMR2 shows how effectively a company converts sales into cash. A business might boast impressive revenue growth, but if that growth doesn't translate into a healthy stream of cash (i.e., a high LMR2), it could be a sign of trouble, such as overly generous credit terms to customers or an inefficient business model.

Think of this ratio as an “accounting lie detector.” It directly compares the cash generated by operations to the profits reported on the income statement.

• The Formula: (Net Cash Flow from Operations) / (Net Profit + Depreciation & Amortization)
• What It Tells You: An ideal LMR3 is around 1 or higher, which means every dollar of reported profit is backed by at least a dollar of real cash. A ratio consistently below 1 can be a major red flag. It might suggest that the company is using aggressive accounting techniques to inflate its earnings or is struggling with Working Capital management (e.g., inventory is piling up or customers aren't paying their bills).

LMR isn't just an academic exercise; it's a practical toolkit for making better investment decisions.

• Screening for Quality: Investors can use LMRs to filter a universe of stocks to find elite, cash-generative businesses that are often wonderful long-term compounders.
• Detecting Red Flags: A sudden drop in LMR, especially LMR3, can signal deteriorating business fundamentals long before the problems show up in reported earnings. It serves as an early warning system.
• Comparing Companies: LMR provides a more standardized way to compare the underlying economic performance of companies in the same industry, as cash flow is less susceptible to the differing accounting policies that can distort earnings-based comparisons.

While incredibly useful, LMR should not be used in isolation. Always remember:

• Holistic Analysis: LMR is one piece of the puzzle. It should be used alongside an analysis of the balance sheet, debt levels, competitive landscape, and management quality.
• Industry Context: Cash flow profiles can vary dramatically between industries. A software company will have a very different LMR from a capital-intensive manufacturing firm. Always compare peers within the same sector.
• Look for Trends: A single year's data point can be misleading. The real insight comes from analyzing LMR trends over multiple years (e.g., 5-10 years) to understand the consistency and direction of a company's performance.