Short Guide to Stock Ratios

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by zmuzum

This is a simple composite of my what I think are the most useful financial ratios and my preferred values for them.

LIQUIDITY

  • Current Ratio
    • This is the most useful ratio for determining a company’s short term financial health. A value at or over 1 indicates that the company has the capital available to meet its short term obligations. Generally aim for a value of 1.50 or greater.
  • Quick Ratio
    • This measures a company’s ability to meet its short-term obligations with its most liquid assets. Generally aim for a value of 1.00 or greater.
  • Total Debt to Current Assets
    • This measures a company’s ability to meet all its obligations with its current assets. Generally aim for a value of 1.1 or less.

SOLVENCY

  • Long Term Debt to Total Assets
    • This measures the percent of a companies total assets it would need to liquidate to pay off its long-term debt. It’s an excellent measure of long term financial health. Values of 0.4 or lower are ideal.
  • Long term Debt to Equity
    • The value represents the ratio of capital financing derived from debt to that derived from shareholder equity. Examining this in conjunction with the previous ratio provides good picture of a company’s long term financial health. Values of 2.0 or lower are best.
  • Times Interest Earned
    • This measures the ability of a company to meet its debt payments. The higher the value the better, and anything at or over 1 indicates a company can meet its interest payments.

PROFITABILITY

All profitability metrics should be compared to a peer group and or industry average.

  • Net Margin
    • This measures a company’s post-tax profitability.
  • Return on Assets
    • This measures how efficiently a company can use its assets to generate profit. Higher values are better.
  • Return on Equity
    • This measures how efficiently shareholder’s equity is used to generate returns. The higher the better.
  • Return on Invested Capital
    • This measures the ability of a company to use shareholder’s funds to generate earnings. I would argue that this is one of the most important drivers of valuation.
  • Positive EPS Growth
    • Find companies with positive EPS growth and generally avoid companies with earnings deficits in the last five years.

VALUATION

All valuation metrics should be compared to a peer group and or industry average.

  • Price To Free Cash Flow
    • Self explanatory. This is a personal favorite because free cash flow is very difficult to manipulate because it is based on cash accounting, unlike ratios like P/E which is based on accrual accounting.
  • EV to EBITDA
    • Compares a company’s cash flow to its economic value instead of its market value. More difficult to manipulate and provides a fuller picture than ratios such as P/E.
  • Price to Book Value
    • This works best when valuing banks and capital-intensive companies because their assets are the core driver of their earnings.
  • Price to Earnings
    • Fairly self explanatory. Despite my prior criticisms you should still include this in your analysis to help get the full picture.

ACTIVE RATIOS

These are often overlooked as they aren’t terribly important but they are useful for measuring the operational efficiency of a company.

All active ratios should be compared to a peer group and or industry average.

  • Inventory Turnover
    • This measures the speed at which a company can sell inventory and it works best with retailers. Low turnover ratios may imply weak sales or surplus inventory, while higher ratios indicate strong sales or lacking inventory.
  • Accounts Receivables Turnover
    • The higher this ratio the more efficient a company is at collecting receivables owed by customers.
  • Total Assets Turnover Ratio
    • This measures how proficient a company is at using its assets to make a sale.

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.

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