Before you can begin investing in individual stocks, you need to learn how to calculate financial ratios. Even if you decide to get your financial ratios from your broker or financial site, you still need to know what they represent. Otherwise, you may make a mistake and buy into a company with too much debt, not enough cash to survive, or low profitability. This guide to financial ratios will explain how to calculate the most important financial ratios, and, more importantly, what they mean.
You can't calculate financial ratios without the financial statements! This guide to financial statements provides step-by-step instructions for how to read a balance sheet, income statement, and other important accounting documents.
All financial ratios are divided into one of five categories. By learning the five categories, you'll be able to understand what it is you are after when you look at a company's financial statements
to calculate the ratios.
Some investors prefer to focus on a financial ratio known the price to cash flow ratio instead of the more famous price to earnings ratio (or p/e ratio for short). Sit back, relax, and grab a cup of coffee because you're about to learn everything you ever wanted to know about this often overlooked stock valuation tool.
The price to earnings ratio, also known as the p/e ratio, is probably the most famous financial ratio in the world. It is used as a quick and dirty way to determine how "cheap" or "expensive" a stock is. The best way to think of it is how much you are willing to pay for every $1 in earnings a company generates. Learn how to calculate it, and much more.
The price-to-earnings ratio (or p/e ratio for short) is the most popular way to measure the relative valuation of two stocks. The PEG ratio
, however, goes one step further. It stands for the price-to-earnings-to-growth ratio. It factors in a company's growth.
The asset turnover financial ratio calculates the total sales for each dollar of asset a company owns. It measures a company's efficiency in using its assets.
The current ratio is one of the most famous of all financial ratios. It serves as a test of a company's financial strength and relative efficiency. For instance, you can tell if a company has too much, or too little, cash on hand.
The debt to equity ratio is important because investors like to compare the total equity (net worth) of a company to the debt it has. For instance, if you own $100 million worth of hotels and have $30 million in debt, you are going to be less concerned than if you have the same $30 million in debt with only $40 million worth of real estate. Learn how to calculate the debt to equity ratio and why it is important.
The gross profit margin lets you know how much profit is available as a percentage of sales to pay payroll costs, advertising, sales expenses, office bills, etc. It's one of the most important financial ratios you can learn.
The interest coverage ratio is an important financial ratio for firms that use a lot of debt. It lets you know how much money is available to cover all of the interest expense a company incurs on the money it owes each year.