Business Ratios

Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

Business ratios are used with financial information to compare companies of different sizes within the same industry. The goal is to discover the best investment for return on your stock purchase. Business ratios essentially equalize different size companies within the same industry. A common mistake is to compare two different industries within the same economic sector.

Business ratios are strictly a function of the financial reports audited by Certified Public Accountants. There are five widely accepted categories of financial business ratios. Each category has no less than two different ratios.

1) Liquidity Ratios – measures the relationship between current assets and the corresponding current liabilities.
2) Activity Ratios – are used to compare balance sheet assets against the volume of sales or an income statement value.
3) Leverage Ratios – assist with evaluating the use of debt to capitalize a company.
4) Performance Ratios – designed to reveal income statement performance.
5) Valuation Ratios – market driven information customarily tied to the market share price, it is the only set of business ratios not internally generated.

The ratios accepted as outstanding in one industry are not applicable to a different industry even one within the same sector. Utilizing ratios for comparisons is restricted to comparing companies within the same industry.

Value Investing Episode 1 – Introduction and Membership Program

High Price to Book Ratios – Proper Interpretation and Evaluation
With stock investing, one of the valuation ratios used is the price to book ratio. It identifies the spread between book value and market value for a share of stock.
Valuation Ratios
Valuation ratios are the only group of business ratios that are externally and not internally driven. The market dictates valuation ratios.
Price to Sales Ratio: A Poor Indicator of Value
The price to sales ratio is a marginal valuation ratio at best. It is really an offshoot of an antiquated concept of valuing a business.
Performance Ratios
The most common thought among business owners, consultants, investors and students is the ‘bottom line’. The proper word is of course ‘PROFIT’.
Leverage Ratios
Leverage ratios refers to the use of borrowed funds to increase the profits of the company.
Price to Cash Flow
The price to cash flow ratio is a valuation tool used to assist buyers and sellers of stock in determining timing of purchases or the disposition of shares.
Activity Ratios
The majority of activity ratios measure the ability of the company to turn assets into earnings.
20 Private Industry Sectors
The gross domestic product comprises 20 private industry sectors and two government groups. All together 22 distinct sectors contribute to the gross domestic product (GDP).
Liquidity Ratios
Liquidity ratios are a group of ratios used to measure the ability of a business operation to meets its current obligations.
Return on Equity
Another performance ratio used in business is return on equity. It is similar to return on assets except return on equity uses one section of the bottom half of the balance sheet.