You receive a lot of guidance when you decide to become an investor in stock markets. Study the trends, don’t be bullish on just a few selected stocks, listen to your broker and etc. Many of these ideas are sound enough to be followed. However, as a new investor there are a few ratios which can help you determine the worth of a company’s stock when you make the investment decision. These ratios independently help you in making a decision uninfluenced by your relationship with the various parties offering advice.
Current ratio = Current Assets / Current Liabilities
This ratio helps to understand the liquidity situation of the company. If the ratio is more than 1 then the company has more short-term assets available at their disposal for liquidation if contracting a financially unstable situation. If below 1 then the company has more debts to pay.
Debt-to-Equity ratio = Total liabilities / Shareholder’s Equity
This ratio determines the ratio of the debt taken by the company to the shares in the market. A company is financed by a combination of debt and equity (shares in the market). A low ratio means that company has a strong equity position, which is any day favorable.
Dividend payout ratio = Dividends per common share / Earnings per share
This one indicates the dividend distributed as cash among shareholders. A higher ratio is in favor of the shareholders, but doesn’t always indicates sound conduct of business on the company’s part. Companies generally have personal policies when deciding on distribution of dividend.
Earnings per share = (Net Income- Dividends on the preferred stock) / Average outstanding shares
You can easily asses the profitability of the company with this ratio. The figures can be easily discerned from the audited balance sheet published in the financial newspapers and then calculated to arrive at earnings per share. Higher the resulting number more profitable is the company.
Price to earnings ratio = Price per share / Earnings per share
This is the most commonly used ratio among investors. It helps you to determine the amount of investment needed to be made to gain one dollar of the company’s earnings. If a company has a P/E ratio of 25 then that means for making 1 dollar on every share you need to shell out $25 to purchase it in the first place. A higher P/E ratio means companies are highly valued and their stock is very worthy. For example, companies like Apple and Google have a high P/E ratio. However, a lower P/E ratio is not always bad and could just mean that a company is undervalued.
The above is a very concise list, providing a gist of the initial ratios to size up the company for investment. All the figures are explicitly mentioned on the balance sheet, often published in the newspapers. If you are already a shareholder then yearly mailers will contain them. Knowing these ratios is akin to doing your homework before you approach a broker, which shouts that you are serious about your investments.