Introduction To Financial Ratios
Financial ratios are a set of
"tools" that you can add to your available resources to assist in analyzing a
stock for possible purchase. The purpose of using the various financial ratios is to
enhance your evaluation of a company's performance. Ratios are used in conjunction with
the Income Statement and the Balance Sheet as shown in the annual report. Below are ratio categories with specific types of ratios in each category listed. Each category title is a bookmark that will take you to an explanation of the various ratios in the category. |
![]() Price/Earnings (PE) Ratio PE to Growth (PEG) Ratio Price/Sales Ratio Dividend Yield
|
Price to Earnings - or the P/E is the ratio of a company's share price to its per-share earnings. For example, a P/E ratio of 10 means that the company has $1 of annual, per-share earnings for every $10 in share price. Earnings by definition are after all taxes etc. P/E ratios help you think
about the value of a company, not just the share price. The P/E relates the stock price to
the earnings of the company. You want to buy when the present P/E is at or below the
average P/E ratio, which is the 5 yr. P/E ratio. Dividend Yield = Dividend Per Share / Price Per Share X 100 (percent) Investors who want or need income producing investments use this ratio. There is a trade-off between having a high current dividend yield and having future dividend growth. The dividend pay out ratio (the fraction of current earnings that are paid as dividends) is an indicator of both safety (assurance that the dividend will not be cut in the future) and potential future dividend growth. Maximum suggested pay out ratios seem to vary from 50% for companies with moderate growth, up to 90% for companies such as utilities that have low growth and stable income. Current Ratio Current Ratio = Current Assets / Current Liabilities Is a
basic test of short term liquidity. Generally the higher the ratio, the stronger the
financial strength of the company. You are looking for 1.2 :1 or better.
Leverage ratios measure the extent that a company is relying on debt to fund its operations. Long-term debt may not have to be paid off for many years. However, interest on the debt is a fixed expense that must be paid every year. High interest payments increase the risk that a company may not earn enough to pay the interest if there is an unexpected reduction in sales and profit during a bad year. You are looking for low values . You find the data on the Balance Sheet - current assets, plant, property, equipment, etc. Then look for the components under Total Liabilities such as current liabilities, long term debt, other liabilities. Long Term Debt To Equity Ratio = Long Term Debt / Equity Long Term Debt To Capital Ratio= Long
Term Debt / Capital Total Debt To Equity Ratio =
Total Debt / Equity Debt to Equity Ratio = Total Liabilities / Shareholder's Equity Measures how much the creditors/lenders
have put into the company versus the shareholders.The lower the %, the greater the
company's financial safety and operating freedom.
Turnover Ratios are indicators of how well company management is using available assets to generate sales and cash. It is desirable for these ratios to have high values. Receivables Turnover Ratio = Sales / Receivables This is an indicator of how much time elapses before payment is received for a credit sale. In general it is considered desirable for a company to have a high Receivables Turnover Ratio. However, the time it takes to collect receivables varies greatly for different industries. Inventory Turnover Ratio = cost of sales / 365 days = sales per day average inventory / sales per day = inventory
turnover
Operating Margin - Earnings before depreciation, depletion, amortization, interest and income tax as a percentage of sales. Net Profit Margin - Net income before nonrecurring gains and losses as a percentage of sales. Financial Strength - A relative measure of financial strength of the companies reviewed by Value Line. The relative ratings range from A++ (strongest) down to C (weakest), in nine steps. It is located in the bottom right corner of the Value Line report. You are looking for at least a B+
|