Being an investor it is more important to bring out the information required for a company’s financial statements. Knowing each and every small bit of information and later combine it, interpret them and then come to a result. It is more an art than science. Undoubtedly, it is the most significant way of performing well while investing in a company. The three most important financial statements are the income statement, balance sheet and cash flow statement.
Ratios are categorized into different segments. Here there are 15 ratios that need to discuss and investors must aware while entering for investing in a company.
Price ratios are used to get an idea of whether a stock’s price is reasonable or not. This is useful only when comparing one company’s ratio to another company’s ratio, a company’s ratio to itself over time, or a company’s ratio to a benchmark. 6 types of ratios that we generally prefer to calculate in this categories that are:
1) Price-to-Earnings Ratio (P/E) :
P/E Ratio = Price per Share / Earnings Per Share
P/E Ratio is the relationship between a company’s stock prices and earning per share. It gives the better sense to the value of the company.
2) PEG Ratio
PEG Ratio = (P/E Ratio) / Projected Annual Growth in Earnings per Share
PEG ratio uses the basic formula of the P/E ratio for a numerator and then divides by the potential growth for EPS, which you’ll have to estimate. It gives an estimate for future value growth and a ratio below 1.0 is considered as best good value.
3) Price-to-Sales Ratio
Price-to-Sales Ratio = Price per Share / Annual Sales Per Share
The P/S ratio is a great tool as sales figures are considered to be relatively reliable while other income statement items, like earnings, can be easily manipulated by using different accounting rules. If you are comparing two different firms and you see that one firm’s P/S ratio is 2x and the other is 4x, it makes sense to figure out why investors are willing to pay more for the company with a P/S of 4x.
4) Price-to-Book Ratio (P/B)
P/B Ratio = Price per Share / Book Value per Share
P/B Ratio is used to compare a company’s current market price to its book value. It is also known as Market to book value.
5) Dividend Yield
Dividend Yield = Dividend per Share / Price per Share
Dividends are the main way companies return money to their shareholders. If a firm pays a dividend, it will be listed on the balance sheet, right above the bottom line. The dividend yield is used to compare different dividend-paying stocks. Some people prefer to invest in companies with a steady dividend, even if the dividend yield is low, while others prefer to invest in stocks with a high dividend yield.
6) Dividend Payout Ratio
Dividend Payout Ratio = Dividend / Net Income
The percentage of profits distributed as a dividend is called the dividend payout ratio. Some companies maintain a steady payout ratio, while others try to maintain a steady number of dollars paid out each year (which means the payout ratio will fluctuate). Each company sets its own dividend policy according to what it thinks is in the best interest of its shareholders. Income investors should keep an especially close eye on changes in dividend policy.
Profitability ratios tell you how good a company is at converting business operations into profits. Profit is a key driver of stock price, and it is undoubtedly one of the most closely followed metrics in business, finance and investing.
7) Return on Assets (ROA):
Return on Assets = Net Income / Average Total Assets
A company buys assets (factories, equipment, etc.) in order to conduct its business. ROA tells you how good the company is at using its assets to make money. For example, if Company A reported $10,000 of net income and owns $100,000 in assets, its ROA is 10%. Forever $1 of assets it owns, it can generate $0.10 in profits each year. With ROA, higher is better.
8) Return on Equity (ROE)
Return on Equity = Net Income / Average Stockholder Equity
Equity is another word for ownership. ROE tells you how good a company is at rewarding its shareholders for their investment. For example, if Company B reported $10,000 of net income and its shareholders have $200,000 in equity, its ROE is 5%. For every $1 of equity shareholders own, the company generates $0.05 in profits each year. As with ROA, higher is better.
9) Profit Margin
Profit Margin = Net Income / Sales
Profit margin calculates how much of a company’s total sales flow through to the bottom line. As you can probably tell, higher profits are better for shareholders, as is a high (and/or increasing) profit margin.
Liquidity Ratios indicate how capable a business is of meeting its short-term obligations. Liquidity is important to a company because when situations are difficult, a company without enough liquidity to pay its short-term debts could be forced to make unfavourable decisions in order to raise money (sell assets at a low price, borrow at high-interest rates, sell part of the company to a vulture investor, etc).
10) Current Ratio
Current Ratio = Current Assets / Current Liabilities
The current ratio measures a company’s ability to pay its short-term liabilities with its short-term assets. If the ratio is over 1.0, the firm has more short-term assets than short-term debts. But if the current ratio is less than 1.0, the opposite is true and the company could be vulnerable to unexpected bumps in the economy or business climate.
11) Quick Ratio
Quick Ratio = (Current Assets – Inventory) / Current Liabilities
The quick ratio (or acid-test ratio) is similar to the quick ratio in that it’s a measure of how well a company can meet its short-term financial liabilities. However, it takes the concept one step further. The quick ratio backs out inventory because it assumes that selling inventory would take several weeks or months. The quick ratio only takes into account those assets that could be used to pay short-term debts today.
Debt Ratios concentrate on the long-term health of a business, particularly the effect of the capital and finance structure on the business:
12) Debt to Equity Ratio
Debt-to-Equity Ratio = Total Liabilities / Total Shareholder Equity
Total liabilities and total shareholder equity are both found on the balance sheet. The debt-to-equity ratio measures the relationship between the amount of capital that has been borrowed (i.e. debt) and the amount of capital contributed by shareholders (i.e. equity). Generally speaking, as a firm’s debt-to-equity ratio increases, it becomes riskier because if it becomes unable to meet its debt obligations, it will be forced into bankruptcy.
13) Interest Coverage Ratio
Interest Coverage Ratio = EBIT / Interest Expense
Both EBIT (or, operating income) and interest expense are found on the income statement. The interest coverage ratio, also denote as times interest earned (TIE), is a measure of how well a company can meet its interest payment obligations. If a company can’t make enough to make interest payments, it will be forced into bankruptcy. Anything lower than 1.0 is always a creates a difficulty.
Efficiency Ratios give investors insight into how efficiently a business is employing resources invested in fixed assets and working capital. It is to know the reflection of how effective a company’s management is.
14) Asset Turnover Ratio
Asset Turnover Ratio = Sales / Average Total Assets
Like return on assets (ROA), the asset turnover ratio tells you how good the company is at using its assets to make products to sell. For example, if Company A reported $50,000 of sales and owns $25,000 in assets, its asset turnover ratio is 2x. Forever $1 of assets it owns, it can generate $2 in sales each year.
15) Inventory Turnover Ratio
Inventory Turnover Ratio = Costs of Goods Sold / Average Inventory
If the company you’re analyzing holds has inventory, you want that company to be selling it as fast as possible, not stockpiling it. The inventory turnover ratio measures this efficiency in cycling inventory. By dividing costs of goods sold (COGS) by the average amount of inventory the company held during the period, you can discern how fast the company has to replenish its shelves. Generally, a high inventory turnover ratio reflects that the firm is selling inventory (thereby having to spend money to make a new inventory) relatively quickly.
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