|
 |
|
Stocks
Making Sense of Ratios |
Ratios. They look boring. Even
confusing. But they are one of the most useful ways to analyze and compare stocks of
different companies. Ratios will allow you to see whether a stock is fairly valued or not.
And by using balance sheet numbers, ratios might reveal if a company is experiencing
financial difficulties. Ratios are not a means to an end -- but they are a great place to
start your analysis.
Here are a few key ratios that might help you evaluate a potential stock:
- Price/Earnings Ratio (P/E Ratio).
The price per share of a stock divided by its earnings per share over the last twelve
months. This is one of the most widely used ways to determine a stock's valuation. You
should compare a stock's P/E ratio with historical P/Es (the same stock) or with P/Es of
similar industries. Future projections of the company's earnings (or growth rate) should
also be considered. P/E ratios are often published in the stock tables of many newspapers.
Example: XYZ stock is currently trading at $10 and its
earning per share (EPS) for the trailing 12 months is $0.50. It's P/E ratio is 20
($10 divided by $0.50 = 20).
- Price-to-Book Value. The price per share of a stock divided by its net
assets per share. This ratio will help you determine a stock's valuation based on the
company's assets (what it owns).
- Current Ratio. The current liquid assets of a company (inventory, cash,
etc.) divided by its current liabilities (expenses, payments due within a year). This
ratio identifies how well a company can respond to unforeseen circumstances -- cash
crunches, low sales or other potential crisis. A low current ratio may signal a company's
inability to deal with near-term obligations.
Quick Ratio. Similar to current ratio except liquid assets include only
cash or cash equivalents. Quick ratios are a better way of determining a company's ability
to respond to a crisis.
Debt-To-Equity Ratio.
Long-term debt divided by shareholder equity. A low debt-to-equity ratio usually means a
company is financially sound. Generally -- the lower the debt, the better. If you avoid
companies with long-term debt, this ratio becomes unimportant.
Tip: Some stocks have higher debt-to-equity ratios than others.
A utility company, for instance, might have large amount of debt -- normal for a company
that produces a steady and predictable stream of income.
Return On Equity Ratio (ROE).
Net income divided by total stockholders' equity. This ratio identifies how profitable a
company has been using investors' money. A high ratio over time indicates a company is
maintaining or increasing its bottom line.
Stock Calculators:
-------------------
• What is my return if I sell now?
• Should I sell before or
after one year?
• What future return makes selling now
worthwhile?
• What selling price provides my desired
return?
|
