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.
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