Financial Ratios Below lists some of the more commonly used financial ratios in fundamental analysis for determining the health and affordability of a company. Instead of going thru all the possible ratios available, below should be enough to determine the fundamentals of a company.
Gross Profit Margin (%) = [(Revenue - Cost of goods sold) / Revenue] x 100
Cost of goods sold includes costs directly linked with producing the goods and services sold by a company, such as material and labor. It does not include indirect fixed costs like office expenses, rent, administrative costs, etc.
This number represents the proportion of each dollar of revenue that the company retains as gross profit. For example, if a company's gross margin for the most recent quarter was 35%, it would retain $0.35 from each dollar of revenue generated, to be put towards paying off selling, general and administrative expenses, interest expenses and distributions to shareholders. The higher the percentage, the more profitable the business is.
Operating Margin (%) = [Operating Income / Revenue] x 100
EBIT (Earnings before Interest and Taxes) = Operating Revenue – Operating Expenses (OPEX) + Non-operating Income
Operating Income = Operating Revenue – Operating Expenses (excludes non-operating income)
Operating margin gives analysts an idea of how much a company makes (before interest and taxes) on each dollar of sales. . If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.
Net Margin (%) = [Net Profit / Revenue] x 100
It shows how much of each dollar earned by the company is translated into profits. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss.
It is not very meaningful to compare the gross/operating/net margin between companies of different industry. When looking at margins to determine the quality of a company, it is best to look at the change in margins over time and to compare the company's yearly or quarterly figures to those of its competitors. When there is a gradual or sudden drop in these margins, do find out the reason as the company may be affected by some cost increase and does not manage it well.
PE(Price to Earnings) Ratio = Share Price per share / Annual Earnings per share
The price per share is the market price of a single share of the stock. The earnings per share is the net income of the company for the most recent 12 month period, divided by number of shares outstanding. The earnings per share(EPS) used can also be the "diluted EPS" or the "comprehensive EPS".
EPS is usually from the last four quarters (trailing PE), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward PE). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.
In layman terms, it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (PE) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.
In general, a high PE suggests that investors are expecting higher earnings growth in the future compared to companies with a lower PE. Investors can use the PE ratio to compare the value of stocks: if one stock has a PE twice that of another stock, all things being equal, it is a less attractive investment.
PB (Price to Book) ratio = Share Price per share / Book Value per share
The price per share is the market price of a single share of the stock. A company's book value is its total assets minus intangible assets and liabilities. In the United Kingdom, the term net asset value may refer to the book value of a company.
In general, a lower PB ratio could mean that the stock is undervalued. This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately.
It varies a fair amount by industry. Industries that require more infrastructure capital (for each dollar of profit) will usually trade at PB ratios much lower than of, for example, consulting firms.
It is also known as the market-to-book ratio and the price-to-equity ratio
PE and PB Ratios are 2 of the most commonly used ratios to provide a quick and rough estimation of "how low is the current share price". As a general guide, a PE below 10 and a PB below 3 is fine. SGX's average PE is currently at around 14. Generally, if a blue chip is trading below a PE of 10, you can say that it is at a bargain, and if any good growth company is trading at a low PE of 5-7 and less than PB of 2, it should be considered cheap. However, these 2 ratios should not be used as the only guide as it only covers only a portion of the story. I personally will not go for a company trading at a forward PE of > 20.
Return on Equity (ROE) (%) = [Net Income / Shareholder's Equity] x 100
Shareholder's Equity = Total Assets - Total Liabilities OR
Share Capital + Retained Earnings - Treasury Shares
Treasury Shares = Stock that has been repurchased by the issuing company (Share Buyback)
Shareholder's Equity comes from two main sources. The first and original source is the money that was originally invested in the company, along with any additional investments made thereafter. The second comes from retained earnings that the company is able to accumulate over time through its operations.
ROE is a measure of a corporation's profitability that reveals how much profit a company generates with the money shareholders have invested. The higher, the better.
Return on Assets (ROA) (%) = [Net Income / Total Assets] x 100
The assets of the company are comprised of both debt and equity. Both of these types of financing are used to fund the operations of the company. The ROA figure gives investors an idea of how effectively the company is converting the money it has to invest into net income. The higher the ROA number, the better, because the company is earning more money on less investment.R
Return on assets gives an indication of the capital intensity of the company, which will depend on the industry; companies that require large initial investments will generally have lower return on assets
Both ROA and ROE are important indicators of the company's efficiency and management competency. Anybody can make a profit by throwing a ton of money at a problem, but very few managers excel at making large profits with little investment. It is usually more accurate to compare ROA/ROE of related industries (e.g capital intensive companies). I personally think that ROA is a better measure than ROE, as it includes the total assets that a company has to generate the return. In general, I will try to look for a company with ROA > 20% to invest in, though this is highly industry dependent.
Current Ratio = Current Assets / Current Liabilities
It measures whether or not a firm has enough resources to pay its debts over the next 12 months. It is used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables).
The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign.
Quick Ratio = (Current Assets - Inventories) / Current Liabilities
The quick ratio is more conservative than the current ratio, a more well-known liquidity measure, because it excludes inventory from current assets. Inventory is excluded because some companies have difficulty turning their inventory into cash. In the event that short-term obligations need to be paid off immediately, there are situations in which the current ratio would overestimate a company's short-term financial strength.
The higher the ratio, the better. Generally, the quick ratio (or known as acid test ratio) should be 1:1 or better, however this varies widely by industry
Debt/Equity Ratio = Total Liabilities / Shareholder's Equity
Note: Sometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation.
It indicates what proportion of equity and debt the company is using to finance its assets. A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt, which can generate more returns, however this also mean that the company is taking a higher risk, and may result in bankruptcy if the returns is less than the cost of the debt.
The debt/equity ratio depends on the industry in which the company operates, and will be higher for a capital intensive industry.
Debt Ratio = Total Liabilities / Total Assets
Debt Ratio is a financial ratio that indicates the percentage of a company's assets that are provided via debt. A company with a high debt ratio (highly leveraged) could be in danger if creditors start to demand repayment of debt.
In general, I will go for a company that have a current ratio of > 2, a quick ratio of > 1, a debt ratio of around 0.5-0.8, and a debt to equity ratio of around 1, especially in a bear market where business is brisk, and a company may easily go into bankruptcy due to inability to service their debts or refinance their debt. However, do compare these ratios with competitors as it varies between industry.
