Every individual should perform a rigorous fundamental analysis of related potential investments before pouring any further effort into trading or a long-term investment. With the season of final annual balances upon us, we have put together ten must-know key performance indicators for assessing the viability of any trades and/or investments. We suggest putting together a comprehensive spreadsheet to measure, track and compare all your data so that you know exactly which opportunities are worth your time and money.
Price-to-Earnings (P/E) Ratio
The price-to-earnings ratio (P/E ratio) is a measure of a company’s current share value relative to its earnings per share. It can also be used as a tool for comparing companies against their own historical performance or against aggregate, comparative markets. Investors will determine a P/E ratio based on either a past, trailing estimate or a forward-looking projection and then compare metrics with the industry and comparative historical performance of competitors and peers within the industry.
Price-to-Earnings Growth (PEG) Ratio
As a measure largely accepted to indicate a stock’s true value, a low PEG ratio reflects an undervalued stock, whereas a higher PEG ratio typically shows overpriced shares. The EPS growth is obtained from analyst forecasts or an advanced investor/trader’s own technical analytics. The more accurate the growth rate used in the calculation, the more accurate the derivation obtained from the PEG ratio.
Price-to-Book (P/B) Ratio
The price-to-book ratio (P/B ratio) compares a firm’s market capitalization to its book value. It is calculated by dividing the company’s stock price per share by its book value per share (BVPS), and the BVPS is determined by deducting the company’s total liabilities from its total assets and then dividing this total by the number of total shares outstanding. A low P/B ratio as compared to industry peers is either showing that the shares are undervalued, or the business is suffering from an underlying fundamental problem.
Debt-to-Equity (D/E) Ratio
The Debt-to-Equity Ratio indicates the proportion of company equity to debt used to finance assets. You’ll find the Total Shareholder Equity and Total Liabilities needed to calculate the D/E Ratio for the company in question on its balance sheet. To gain accurate insight, comparing the D/E Ratios of close competitors in the industry is necessary. However, as a general rule of thumb, debt-to-equity of roughly 2 to 2.5 is considered to be a hallmark of a potentially good stock investment.
Free Cash Flow (FCF)
Free Cash Flow is a fantastic measure of a company’s financial health, reflecting its capability and efficiency to generate cash as the total cash available to repay credits and pay out investors in the form of interest and dividends. Potential investors should look to the FCF to determine how likely it is for the company to pay its expected dividends and interest.
The best place to locate the metrics needed for the calculation is the current cash flow from operating activities found on the statement of cash flows. However, if this isn’t available, simply add the EBIT and the non-cash Expenses (Depreciation, Amortisation, etc.) from the income sheet and deduct change derived from the current assets less the current liabilities from the balance sheet added to the capital expenditures (CAPEX) which includes property, plant and equipment from the balance sheet.
Payout Ratio (Dividend Payout Ratio)
Potential shareholders should look to the payout ratio to measure a company’s maturity and its likelihood of stock value growing rapidly. Most companies who have reached the point of paying a dividend are past their initial phase of growth. The higher the payout ratio, the less likely of rapid momentum seizing shares and carrying prices higher. In most cases, a 100% payout ratio means that it is paying out more money to shareholders than it is making, which is typically not sustainable. It is best to evaluate historical payout ratio trends to gauge whether or not the business is growing healthily or spiking erratically into volatile areas or stages of business.
Return On Equity (ROE)
Return on equity (ROE) indicates the company’s profit relative to the total equity of all shareholders. It does not factor in debt financing. Most investors who opt to use ROE to gauge the viability of investment compare their results to the Return On Capital KPI in order to identify exemplary candidates. Potential investors calculate the ROE of a company at various periods in order to compare performance and see whether the company is stagnant, improving or declining.
Return On Capital (ROC)
Return on capital (ROC) shows the company’s profits relative to the shareholder’s equity while factoring in debt. ROC is often termed return on invested capital (ROIC) instead, and the metric is used chronologically in the same way as ROE while also being used as a sign of confirmation of a good investment when the stock has both favourable ROC and ROE performance.
Price-To-Book (P/B) Ratio
The Price-to-Book ratio reflects whether a company’s current trading price accurately measures its true market worth. The market price per share is obtained from the current trading price of company stock, while the book value per share is derived by dividing the number of shares still to be issued by the sum of the total assets minus the total liabilities. Lower P/B ratios typically indicate an undervalued share price, while higher values show the adverse. One must always compare the P/B ratio to the industry and close competitors before relying on any assessment as a part of your evaluation.
The Earnings Per Share KPI is a reliable indicator of profitability. To calculate a company’s EPS, divide the net profits by the number of shares outstanding. The higher the EPS, the more profitable the potential investment. Comparative EPS metrics from companies from the same sector or industry give a good comparison of profitability. Traders can also chart the EPS of a single company over time to help gauge the current trend from quarter to quarter.
Note: Please do not invest money or assets in the financial markets that you cannot afford to lose. This article should not be construed to be investment advice and is for information purposes only