Portfolio Management - Ratio Analysis

Once a fundamental analyst decodes a company's financial statements, certain measurement formulas are used to interpret them. Specifically, fundamental analysts determine a company's:

  • Liquidity
  • Risk of bankruptcy
  • Efficient use of assets
  • Profitability
  • Asset coverage and safety of income
  • Earnings per share
  • Competitiveness


Exam Tips and Tricks
You should memorize the following formulas. Not all of them will be on the exam, but some of them certainly will and it is impossible to know which ones you will need:


See the Ratio Analysis tutorial, which discusses everything from where to find data to how to calculate each one:


LIQUIDITY
Working capital Current assets - current liabilities
Current ratio Current assets / current liabilities
Quick ratio (Cash + marketable securities + accounts receivable) / current liabilities
Acid test ratio (Current assets - accounts receivable - inventory) / current liabilities
RISK OF BANKRUPTCY
Debt-to-equity ratio Total debt / total equity
EFFICIENT USE OF ASSETS
Inventory turnover ratio Cost of goods sold / inventory
Cash flow Net profit + depreciation + depletion + amortization
PROFITABILITY
Gross margin EBIT / revenues
Net profit ratio Net profit / revenues
ASSET COVERAGE AND SAFETY OF INCOME
Bond interest coverage EBIT / interest expense
Book value per share Shareholders\' equity/ number of shares
EARNINGS PER SHARE
Earnings per common share (EPS) Net profit / number of common shares outstanding
Fully diluted EPS Net profit / (number of common shares outstanding + number of shares represented by securities convertible into common stock)
Price-earnings ratio Market price of share / EPS
Dividend payout ratio Dividend per share / EPS
Current yield Dividend per share / market price of share
COMPETITIVENESS
Return on common equity (EPS - dividend per preferred share) / market price of common share
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