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8 Simple Investing Ratios You Need To Know

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Financial Ratios

There is a lot to be said for valuing a company — it is no easy task. If you have yet to discover this goldmine, the satisfaction one gets from tearing apart a company's financial statements and analyzing it on a whole different level is great — especially if you make or save yourself money for your efforts.

1. Earnings Per Share

Before you can understand many of these ratios, it is important to learn what earnings per share (EPS) is. EPS is basically the profit that a company has made over the last year divided by how many shares are on the market. It gets a little more complicated because you don't include preferred shares when calculating — only common shares. 

Also, the number of shares outstanding could change throughout the year. But don't worry, this number will be given to you on any financial website.

2. Price To Earnings Ratio

The price/earnings ratio (P/E) is the best known of the investment valuation indicators. The P/E ratio — though it has its imperfections — is the most widely reported and used valuation by investment professionals and the investing public. A high P/E ratio means investors are paying more for today's earnings in anticipation of future earnings growth.

The basic formula for calculating the P/E ratio is fairly standard. There is never a problem with the numerator — an investor can obtain a current stock price from various sources, and they'll all generate the same dollar figure (which, of course, is a per-share number).

However, there are a number of variations in the numbers used for the EPS figure in the denominator. The most commonly used EPS dollar figures include the following:

Basic earnings per share: based on the past 12 months
Estimated basic earnings per share: based on a forward 12-month projection

3. Price to Sales Ratio

A stock's price/sales ratio (P/S ratio) is another stock valuation indicator similar to the P/E ratio. The P/S ratio measures the price of a company's stock against its annual sales, instead of earnings. Like the P/E ratio, the P/S reflects how many times investors are paying for every dollar of a company's sales.

In this example, the price of a share is divided by the sales ($3,286) which is adjusted for average share outstanding throughout the year (3,286/247.1). This results in a calculated P/S of 5.1, which means investors are paying $5.10 for every dollar of sales.

4. Debt To Equity Ratio

The debt-equity ratio is a leverage ratio that compares a company's total liabilities to its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committed. A lower number means that a company is using less leverage and has a stronger equity position.

This ratio is not a pure measurement of a company's debt because it includes operational liabilities in the calculation of total liabilities. Nevertheless, this easy-to-calculate ratio provides a general indication of a company's equity-liability relationship.

 

5. Dividend Yield

A stock's dividend yield is expressed as an annual percentage and is calculated as the company's annual cash dividend per share divided by the current price of the stock. The dividend yield is often found in the display of stock quotes for dividend-paying companies. Investors should note that stock quotes record the per share dollar amount of a company's latest quarterly declared dividend.

In this example, the $1 dividend and $67.44 share price creates a 1.48 percent yield.

6. Price To Book Ratio

The price-to-book ratio (P/B) compares a stock's per-share price (market value) to its book value (shareholders' equity). The price-to-book value ratio, expressed as a multiple (i.e. how many times a company's stock is trading per share compared to the company's book value per share), is an indication of how much shareholders are paying for the net assets of a company.

"Price-to-book", provides investors a way to compare the market value —or what they are paying for each share — to a conservative measure of the value of the firm.

In this example, the share price is divided by the book value (adjusted into a per share number).

7. Payout Ratio

The dividend payout ratio tells you how much profit goes out in dividends. This ratio identifies the percentage of earnings (net income) per common share allocated to paying cash dividends to shareholders. The dividend payout ratio is an indicator of how well earnings support the dividend payment.

Dividends are paid at the discretion of management, if the percentage is too high (over about 75%), then the dividend could be cut. If the result is low, then the dividend payment could continue into the future.

8. Current Ratio

The current ratio is a popular financial ratio used to test a company's liquidity — also referred to as its current or working capital position — by deriving the proportion of current assets available to cover current liabilities. The concept behind this ratio is to ascertain whether a company's short-term assets (cash, cash equivalents, marketable securities, receivables, and inventory) are readily available to pay off its short-term liabilities (notes payable, current portion of term debt, payables, accrued expenses, and taxes). In theory, the higher the current ratio, the better.

In this example, current assets are valued well over 2 times the current liabilities.

 

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