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V. STOCKS L. RATIO ANALYSIS 1. Ratios That Measure Liquidity (the firm’s ability to convert assets into cash) a. Current Ratio = Current Assets Current Liabilities The higher the current ratio, the greater the firm’s liquidity and its ability to continue operations L. RATIO ANALYSIS (CONTINUED) b. Quick (Acid Test) Ratio: Current Assets - Inventory Current Liabilities The Quick Ratio measures whether a firm has sufficient assets that either are or can be readily converted into cash to pay current liabilities 2. Ratios That Measure Activity – Provide a gauge of the firm’s operations and operating efficiency L. RATIO ANALYSIS (CONTINUED) a. Inventory Turnover = Net Sales Inventory Higher turnover is generally better, but turnover rates vary by industry b. Average Collection Period = Accounts Receivable Annual Credit Sales per 360 Days The longer the collection period, the more likely it is that a firm will not be able to collect on all of its accounts receivable L. RATIO ANALYSIS (CONTINUED) c. Fixed Assets Turnover = Net Sales Net Fixed Assets A measure of efficiency in the use of plant capacity. d. Total Assets Turnover = Net Sales Total Assets Sales volume as a percentage of assets – a measure of operating leverage, the quantity of sales that are produced from the firm’s investment in assets L. RATIO ANALYSIS (CONTINUED) 3. Ratios that Measure Profitability a. Operating Profit Margin = Net Operating Profit Net Sales Higher = Better, but must compare with industry averages for consistency b. Net Profit Margin = Net Income Net Sales Results of operations, financing, investing, and taxes L. RATIO ANALYSIS (CONTINUED) c. Return on Equity = Net Income Stockholders’ Equity Measures efficiency of use of corporate (shareholders’) capital. 4. Ratios Measuring Capitalization (Use of Leverage) a. Debt to Total Assets = Total Liabilities Total Assets Indicates the portion of corporate assets financed by debt. L. RATIO ANALYSIS (CONTINUED) b. Long Term Debt to Total Capitalization = Long Term Debt Long Term Debt & Shareholders’ Equity Indicates balance of permanent financing. c. Debt to Equity = Total Liabilities Total Stockholders’ Equity An indicator of debt used to finance assets and operations. L. RATIO ANALYSIS (CONTINUED) d. Times Interest Earned = Earnings Before Interest, Taxes, and Depreciation (EBITD) Long Term Debt & Shareholders’ Equity A measure of the firm’s ability to service debt. e. Fixed Charge Coverage = Earnings Before Interest, Taxes, and Depreciation (EBITD) Interest Charges & Lease Payments A measure of the firm’s ability to service debt and other fixed expenses. L. RATIO ANALYSIS (CONTINUED) 5. Ratios That Measure Stock Value a. Price-Earnings Ratio = Market Price of Common Shares Earnings per Common Share Shows the multiple of earnings per share of stock price. b. Price to Book Ratio = Market Price of Common Shares Book Value per Share Book value per share = total assets minus intangible assets minus total liabilities minus preferred shares outstanding – Measures the multiple of book value per share of common stock L. RATIO ANALYSIS (CONTINUED) c. Dividend Payout Ratio = Dividends Per Common Share Earnings Per Common Share An indicator of a firm’s ability to continue to make dividend payments.