Do not drown in financial detail

You may be given a vast amount of financial information, particularly if you work for a large company.

This could be because someone believes that it is useful or just because the system automatically provides it.

Remember the old saying about not being able to see the wood for trees.

Learn to concentrate on what is important and give little or no attention to the rest.

That way you will get the key financial information and still have time to do your job.

This is particularly important when things are tough and your time is at a premium.

Doing Your Homework: Rule of thumb

Basic Financial Metrics

Sales per share
Rule of thumb: The higher the better.


Dividends per share
Rule of thumb: The higher the better.


Cash Flow per share
Rule of thumb: The higher the better.


Yield
Rule of thumb:  The higher the better.

Quick Ratio:
Rule of thumb:  Greater than 1 and the higher the quick ratio the better.  If the ratio is less than 1, you would want to assure yourself that the company is generating enough cash flow from operations to cover both its normal expenses and any short-term debt obligations that come due.

Valuation Ratios

Price-to-Sales ratio: 
Rule of thumb:  ratios less than 2 indicate good value

Price to Earnings ratio (P/E):
Rule of thumb:  Historically, stocks are a good value when the ratio or multiple is around 14.  We will consider stocks that have a P/E of less than 20 a decent value based on this ratio - the lower the ratio the better.

Dividend Ratios

Dividend Coverage ratio: 
Rule of thumb:  Minimum of 120%

Dividend Payout ratio:
Rule of thumb:  The higher the better, so long as the ratio does not exceed 100%.   By maintaining a conservative payout ratio of 30%, this allows management to consider increasing dividends as earnings increase.

Growth Ratios

One-year revenue growth rate:
Rule of thumb:  greater than 10% increase in revenue

One-year earnings growth rate:
Rule of thumb:  greater than 10% increase in earnings


Trend Analysis

All preceding ratios
Rule of thumb:  Look for positive trend with an increasing growth in sales, earnings, cash flow, and dividends per share.  The quick, leverage, value and dividend ratios are all positive or well within acceptable ranges.



Caution:  A parting word about a standard rule of thumb
Although convenient, rules of thumb should not be adhered to in isolation. 

For example, electric utilities normally have current liabilities that exceed their current assets, yielding a quick ratio of less than 1.  However, investors are not concerned because utilities have strong cash flow from operations and their accounts receivables are from electricity users who must pay their bills if they want to continue to receive electricity.  If your rule of thumb were rigid, a low quick ratio would be a signal for you to avoid the company and discard promising stocks individually or even across an entire industry.

Ultimately, by integrating these ratios into a single analysis for any given company, you should be able to confidently select dividend-paying stocks that will help you to accomplish your investment goals and to build your wealth slowly over time through compounding dividends and price appreciation.

Doing Your Homework: Trend Analysis

The information in the financial statements (BS, IS or RE statement), the basic (per-share) financial metrics and the various ratios are snapshots of the company's financial condition at a point in time, but there are trends in motion that need to be identified so you can understand if the company's position is improving or deteriorating.

For example: 

http://spreadsheets.google.com/pub?key=tdTJEsOwTqdvL-tOgwfeb9A&output=html

• Company ABC's year-over-year trend analysis indicates a generally positive trend with an increasing growth in sales, earnings, cash flow, and dividends per share. 
• The leverage, value, and dividend ratios are all positive or well within acceptable ranges, with the exception of the quick ratio. 
• Based on analysis, the dividend looks to be secure and Company ABC would be a good buy.

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 measurement.  Generally, 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)

Yield
= 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)