Monday, 30 November 2009

Doing Your Homework: Basic Financial Metrics and Ratios Analysis

Ratios Analysis

Ratios are widely used not only to evaluate a company, but to compare a company's financial position with other companies'.  The data used to calculate ratios are readily available in each company's annual and quarterly reports.  You can concentrate your analysis in the following two areas.

Building Block One:  Basic Financial Metrics

These are formulas that allow you to view any company's results on a per share basis.  Once financial data are reduced to the shareholder level you can easily compare companies that might be very different in size or in different industries.

For example, trying to compare the annual sales of General Motors with the annual sales of a much smaller car company like Porshe might not tell you much, but by comparing sales per share (divide each company's sales by the number of shares outstanding), you have a more meaningful measurementGenerally, the company generating higher sales per share is going to be the better value. 

Some useful basic financial metrics you can use for your analysis are:

Sales per share
= Sales/Shares outstanding  (Source: IS; BS)

Earnings per share
=Earnings/Shares outstanding (Source: IS; BS)

Dividends per share
=Dividends/Shares outstanding (Source: RE; BS)

Cash flow per share
= (Net Income + Depreciation)/Shares (Source: IS, BS)

= Dividend per share/Price per share (Source: DPS; newspaper)

Building Block Two:  Ratio Analysis

Ratio analysis allow you to analyse a company's financial performance
  • against other companies in the same industry,
  • against all stocks in the market, or
  • against industry standards, which are sometimes known as "rules of thumb." 

Although there are a great number of ratios that you can use to analyse a company, below is a short list of ratios that will give you the information you need to pick good dividend-paying stocks.

Liquidity Ratio
Quick Ratio
= (Current Assets - Inventory) / Current Liabilities (Source:  BS)

Debt Coverage Ratio
Short-term Debt Coverage Ratio
= Operating Income/Short-term debt (Current Liabilities)  (Source: IS; BS)

Valuation Ratios
Price-to-Sales ratio
 = Stock price/Sales per share (Source: Newspaper; Sales per share)
Price-to-Earnings ratio
= Stock price/Earnings per share (Source:  Newspaper; Earnings per share)

Dividend Ratios
Payout ratio =
Dividend per share/Earnings per share (Source:  Basic metric formulas)
Dividend coverage ratio =
Cash flow per share/Dividend per share (Source:  Basic metric formulas)

Growth Ratios:
Revenue growth rate ratio
= Year over Year percent change in revenues (Source: IS)
Earnings growth rate ratio
= Year over Year percent change in earnings (Source: IS)

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