Should I Buy This Stock? Here’s How to Use Financial Ratios to Measure Stock Performance - Parthian Securities - Your Smart Brokerage Firm

Recently, you’ve been hearing a lot about a certain stock, and for some reason, you begin to feel a FOMO (fear of missing out) – which happens to most investors since we all are looking to maximize profit anyways. But how can you determine if a stock is doing well and it’s ok to buy? The answer: research the company.

How do you research a company or stock performance? Periodically, public companies disclose their financials to the public. These financial statements consist of three main documents – the balance sheet, profit-and loss-statement, and the cash flow statement.

Investors analyze how these companies are managed, their financial stability, and whether they are profitable or not by calculating several financial ratios. You may have come across any of these ratios and wondered what they mean. Let’s dive into a brief explanation of the 8 financial ratios used to analyze companies and their stock performance.

1. Price-to-earnings (P/E) ratio: P/E ratio assists in comparing the value of one stock in a sector with another, it measures a stock’s value by showing you how much you would have to spend to make $1 in profit. It’s a guide to determine if a company is currently overvalued or undervalued compared with its historical growth.
2. Debt-equity ratio (D/E): This measures a company’s debt against its assets and gives insight into how the company is performing relative to its competitors. A low ratio could mean that the company gets most of its funding from its shareholders. A ‘good’ or ‘bad’ ratio depends on the industry.
3. Return on equity (ROE): this shows you if a company is generating enough income by itself relative to the amount of shareholder investment. It measures a company’s profitability against its equity, expressed as a percentage.
4. Earnings yield: this measures earnings by dividing the most recent 12-month earnings per share by the current market price per share. The earnings yield (the inverse of the P/E ratio) represents a company’s earnings per share as a percentage. When calculating earnings yield, a company’s growth prospects are critical. Stocks with high growth potential are typically valued higher, and their earnings yield may be low even as their stock price rises.
5. Relative dividend yield: This measures a company’s dividend yield compared to that of the entire index. If you’re looking to buy stock, you should consider the relative dividend yield because it can show if stocks are overvalued or undervalued compared to competitor stocks
6. Current ratio: this is a liquidity ratio that measures a company’s ability to pay off debts within a year by comparing a company’s current assets to its current liabilities. It shows if liabilities can be adequately covered by the available assets. The lower the current ratio, the higher the likelihood that the stock price will continue to go down.
7. Price-earnings to growth (PEG) ratio: this is a measure of the P/E ratio compared to the percentage growth in annual EPS. If you are deciding on which stocks to pick, you should consider the PEG ratio because it could give you an indication of the stock’s fair value
8. Price-to-book (P/B) ratio: this is a measure of the current market price against a company’s book value. A ratio higher than one often indicates overvalued shares.