Ratios
Here’s a brief explanation of key ratios that investors use to assess the company’s financial health:
1. Profitability Ratios
a. Gross Profit Margin
- Shows how efficiently a company produces goods/services relative to its revenue.
- Indicates operational efficiency and pricing power.
b. Net Profit Margin
- The percentage of revenue that remains as profit after all expenses.
- Reflects overall profitability and cost management.
c. Return on Equity (ROE)
- Indicates how effectively the company generates returns on shareholder investment.
- Measures profitability and management efficiency.
d. Return on Assets (ROA)
- Shows how efficiently the company uses its assets to generate profit.
- Evaluates overall asset utilisation.
2. Liquidity Ratios
a. Current Ratio
- A company’s ability to pay short-term obligations with short-term assets.
- Indicates short-term financial stability (ideal: >1).
b. Quick Ratio (Acid-Test)
- Ability to meet short-term obligations without relying on inventory.
- Provides a stricter test of liquidity than the Current Ratio.
3. Solvency Ratios
a. Debt-to-Equity Ratio (D/E)
- The proportion of debt used to finance assets relative to equity.
- Indicates financial risk; higher values signal greater leverage.
b. Interest Coverage Ratio
- Displays how easily a company can cover its interest payments.
- Indicates solvency and the ability to manage debt.
4. Efficiency Ratios
a. Asset Turnover Ratio
- Signifies how efficiently a company uses assets to generate revenue.
- Reflects operational efficiency.
b. Inventory Turnover Ratio
- Shows how quickly a company sells and replaces its inventory.
- Indicates inventory management effectiveness.
5. Valuation Ratios
a. Price-to-Earnings Ratio (P/E)
- Shows how much investors are willing to pay per dollar of earnings.
- Indicates whether a stock is overvalued or undervalued.
b. Price-to-Book Ratio (P/B)
- Compares market value to the net assets of the company.
- Measures valuation relative to tangible assets.
c. EV/EBITDA
- Compares a company’s total value to its operating earnings.
- Useful for comparing companies across industries.
6. Market Performance Ratios
a. Dividend Yield
- The return on investment from dividends alone.
- Indicates income potential for dividend-focused investors.
b. Earnings Per Share (EPS)
- The profit earned per share of stock.
- A key metric for profitability and valuation.
7. Cash Flow Ratios
a. Free Cash Flow (FCF)
- Cash available after maintaining operations and assets.
- Indicates the ability to invest, reduce debt, or return value to shareholders.
b. Cash Flow-to-Debt Ratio
- Ability to pay off debt using operating cash flow.
- Reflects financial flexibility.
Ratios are useful for:
- Time series comparison: Look at multi-year trends to identify growth or decline.
- Benchmark Against Peers: Compare with competitors or industry averages.
By studying these ratios, investors can make informed investment decisions about the company and its growth potential.