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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.

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