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Common Cents Investment Group

Common Cents Investment Group. Financial Ratios and Stock Screening November 3 rd , 2008. Financial ratios. Financial Ratios. Useful in comparing different elements of a firm versus another firm or and industry average Are somewhat weak as a stand alone metric

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Common Cents Investment Group

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  1. Common Cents Investment Group Financial Ratios and Stock Screening November 3rd, 2008

  2. Financial ratios

  3. Financial Ratios • Useful in comparing different elements of a firm versus another firm or and industry average • Are somewhat weak as a stand alone metric • Should be combined with other information • Four major types

  4. Liquidity Ratios • Measure of the firm’s short-run ability to pay its maturing obligations • Readiness of assets to be converted into cash • Current Ratio: • (Current Assets) / (Current Liabilities) • Company’s ability to satisfy its short-term liabilities—must be careful in how much of your current assets are classified as what

  5. Liquidity Ratios • Acid-test Ratio: • (“Quick Assets”) / (Current Liabilities) • Similar to the current ratio, except inventories and prepaid items are excluded from current assets • Provides a more accurate description of ability to meet short-term obligations

  6. Solvency/Leverage Ratios • Investors and creditors are particularly interested in a company’s long-term solvency and stability • The extent to which a firm relies on creditors to finance operations rather than its owners • Debt-to-Equity Ratio: • (Total Liabilities) / (Shareholder’s Equity) • As this ratio increases, if the company were to liquidate, less of the assets would be available to the owners because they’d be claimed by creditors

  7. Solvency/Leverage Ratios • Times Interest Earned Ratio: • (EBIT) / (Interest Expense) • EBIT = Net Income before Interest and Taxes • Indicates the margin of safety provided to creditors • The number of times a firm would be able to pay its interest expense from financing before running out of funds from operations

  8. Efficiency Ratios • How quickly certain assets (namely receivables and inventory) can be converted into cash; also called activity ratios • Accounts Receivable Turnover: • (Net Sales) / (Average Accts. Receivable) • Measures how often their sales remain uncollected • If this number is low, it may say that the firm has trouble collecting cash—especially if needed

  9. Efficiency Ratios • Inventory Turnover: • (Cost of goods sold) / (Average Inventory) • Measures how quickly inventory is sold • Provides information about whether obsolete inventory exists • Must be careful in analysis: • A low number means they are sitting on a lot of inventory which is costly to store • A too high number may indicate they face potential stock-out problems

  10. Profitability Ratios • Measures how profitable a firm is based on many dimensions • Profit Margin Ratio: • (Net Income) / (Net Sales) • After all expenses are included, how profitable is the firm? • May want to look at Operating Profit Margin instead

  11. Profitability Ratios • Return on Assets: • (Net Income) / (Average Total Assets) • Measures how well a company puts its assets to use • A lower ratio may indicate they aren’t generating enough income to justify the cost of their assets

  12. Profitability Ratios • Return on Equity: • (Net Income) / (Average Shareholder’s Equity) • The higher the ratio the better • Have to look at other ratios as well • For example, if the company is heavily debt-financed, this ratio (should) be higher • However, this could be dangerous if they begin to have trouble collecting cash and thus can’t pay their current debt obligations

  13. Book Value and Market Cap • Market Cap: • (Current Share Price) * (# of common shares of stock outstanding) • If you wanted to completely purchase the company today, how much would it cost? • Book Value: • (Total Assets) – (Total Liabilities) • Also known as…Shareholder’s Equity!

  14. Interpretation • The accounts used in these ratios can vary based on what you perceive them to represent • Book Value example: • Intangibles or goodwill need to be carefully factored into Total Assets, if at all • Compare to the firm’s market cap to see if it is discounted

  15. Stock Screening

  16. Stock Screening • ValueLine has a powerful component known as Stock Screening • Allows you to see firms that meet specific requirements • E.g.: You are only interested in firms with a P/E Ratio between 10 and 20, those who have a Return on Equity above 15%, and those with a Market Cap between $100 and $1000 million

  17. Stock Screening • Check out the CCIG website for how to initially access ValueLine • Click on “Standard Edition” on the left-hand side then “Stock Screening” • The combinations are nearly endless; play around with it some to get a feel!

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