Next video:
Loading the player...

Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know.

The working capital ratio reveals how easily a company can turn assets into cash to pay short-term obligations. It’s current assets divided by current liabilities. If two companies have a 2-to-1 working capital ratio –current assets are twice the current liabilities – the one with more cash among its assets is better able to pay off its debts.

The quick ratio is like the working capital ratio, but it subtracts inventories from current assets before dividing by liabilities. It shows whether a company’s cash -- along with items that can be quickly converted to cash – is sufficient to cover short-term obligations. Most companies prefer at least a 1-to-1 ratio; firms with smaller ratios need to turn over their inventories faster.

The price-to-earnings ratio reflects investors’ assessments of future earnings. It’s the current share price divided by the earnings per share. If a share cost $46.51 at the end of a session, and its earnings per share over the previous 12 months averaged $4.90, its PE ratio would 9.49, meaning investors would pay $9.49 for every dollar of annual earnings.

The debt-to-equity ratio reveals if a company is borrowing too much. It’s outstanding debt divided by shareholders’ equity. The ratio must be compared among companies within the same industry to be useful.

And the return-on-equity ratio shows investors how profitable their capital is in their investments. It’s a firm’s net earnings after taxes, subtracted by preferred dividends, and then divided by common equity dollars in the company. The higher the ROE, the better a company is at generating profits.

  1. No results found.
Related Articles
  1. Investing

    6 Basic Financial Ratios And What They Reveal

    Here's a brief introduction to six financial ratios every investor should be familiar with.
  2. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  3. Investing

    Ratio Analysis

    Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ...
  4. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  5. Investing

    Do Your Investments Have Short-Term Health?

    If a company is strong enough to survive tough times, it is more likely to provide long-term value.
  6. Investing

    Useful Balance Sheet Metrics

    These metrics can help you better understand the information found on balance sheets.
  7. Investing

    4 Simple Investing Ratios You Need To Know

    Dissecting a company’s financial statements to uncover ways to make money is a challenging endeavor. Here are four ratios that can help.
  8. Investing

    Analyze Investments Quickly With Ratios

    There are four categories of financial ratios: profitability, liquidity, solvency and valuation.
  9. Investing

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
Hot Definitions
  1. Blue Chip

    A blue chip is a nationally recognized, well-established, and financially sound company.
  2. Payback Period

    The length of time required to recover the cost of an investment. The payback period of a given investment or project is ...
  3. Collateral Value

    The estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal ...
  4. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  5. Current Account

    The difference between a nation’s savings and its investment. The current account is defined as the sum of goods and services ...
  6. Liability

    Liabilities are defined as a company's legal debts or obligations that arise during the course of business operations.
Trading Center