Some of the most common growth rate metrics investors and analysts consider in evaluating a company's future prospects and suitability as an investment are revenues and earnings, the price-to-earnings (P/E) ratio, the price-to-earnings-to-growth (PEG) ratio, and return on equity (ROE).
Revenues and Earnings
The initial figures for investors to consider include revenue and earnings. It is difficult for a company to be sustaining growth on any front if it is not at least seeing growth in revenue – a consistent increase in the amount of money its business activities are generating in sales. Beyond the basic revenue amount, the next area to look for growth is in earnings, the amount of revenue the company retains after paying all its expenses.
The earnings of a company are determined by a number of factors, such as operating costs, financing, assets and liabilities. Earnings per share (EPS) is one of the basic profitability metrics where analysts look for consistent increases.
Price Earnings Ratios
The P/E ratio is one of the most widely used equity valuation metrics. It presents a measure of a company's performance, and it provides an indication of the market's estimation of the company's future growth prospects. A higher P/E ratio indicates price action in the market is anticipating continued growth in a company's earnings.
A more refined analysis of stock P/E is provided by the PEG ratio. The PEG ratio offers a more complete picture of earnings and growth by dividing a company's P/E ratio by its preceding 12-month growth rate. Like the P/E ratio, the PEG ratio can be calculated on either a trailing or a forward basis, using either historical growth figures or projected growth figures. (For related reading, see "Can Investors Trust the P/E Ratio?")
Return on Equity
The ROE ratio is considered to be one of the best metrics for evaluating a company's ability to efficiently generate profits from its existing financial resources. The ROE looks at earnings in comparison to shareholders' equity. This metric can be extremely helpful to investors because it considers revenues, profit margin, leverage and the company's success at returning value to shareholders. Consistent increases in the ROE ratio indicate a company is steadily increasing in value and successfully translating that value increase into profits for investors.
Use Different Measures and Compare to Competitors
To evaluate potential equity investments, analysts and investors review the financial statements of companies and look at equity evaluation metrics designed to indicate the company's profitability and growth rate. It's important to analyze a company from more than one perspective, so it's helpful to consider several different valuation measures. Any analysis of a company should also include a comparative analysis of the company with its closest competitors and with the market as a whole.
(For related reading, see "Burn Rate Key Factor in Company's Sustainability.")