In the first part we looked at company financial reports, while it is true that the basic company financial statements have some extremely useful information and are well worth studying in their own right you will be able to better understand the information that these financial statements give you by applying some of the key ratio tools that we are going to cover in part two.
Earnings Per Share
The absolute earnings figure of a company is not a particularly useful indication of that company's value. The value of Earnings Per Share (EPS) is a much better indicator of how well the company is doing than just the earnings information itself. Earnings per share is worked out by dividing the total net earnings of the company by the total number of issued shares. Let's look at an example, if a company has net earnings of $100 million and one million issued shares the Earnings Per Share is equal to 10. The fact that the company has an Earnings Per Share of 10 is of no great value on its own, but if you wish to compare two companies in the same industry then the information becomes very useful indeed.
Price To Earnings Ratio
A Price To Earnings ratio (P/E) is calculated by taking the share price and dividing it by the earnings per share as calculated above. For example if the share price of the company is $25 and the Earnings Per Share equals 10 then the Price To Earnings Ratio equals 2.5. This tells you how much stock investors are prepared to pay to this particular companies earnings. You can interpreted this information in several ways, a high P/E would indicate that the company may be overpriced, on the other hand it could mean that investors think the company will continue to grow and produce better profits. Alternatively a low P/E may mean that investors are uncertain about the future of the company, but it could just indicate a company that many investors have failed to spot the potential of. Both Earnings Per Share and Price to Earnings Ratio should be treated with some caution and you will need to do further analysis to arrive at the true value of the stock you are considering for investment.
Price To Sales Ratio
Sometimes a company has no earnings, for instance companies that are new to the market, if this is the case there are other key ratio tools available to help you in your investment decisions. The Price To Sales Ratio (P/S) is very useful when considering investing in new companies. It is calculated by dividing the company's market capitalisation, that is to say the stock price multiplied by the number of issued shares, by the total income of the company. The Price To Sales Ratio gives an indication of the value the stock market places on the company's sales, the lower the price to sales ratio the better the value.
Price To Book Ratio
The book value of the company is established by deducting the company's liabilities from its assets. If a company is dynamic and growing the value of that company will always be more than is indicated by its book value because of the potential future growth in income. The Price To Book Ratio (P/B) is the value the stock market places on just the book value of the company, it is arrived at by dividing the present price per share, by the book value per share. If the company has a low Price To Book Ratio it is considered to be good value, such companies are considered to be particularly attractive by investors who are prepared to hold their investment for the longer term to allow the company develop its potential.
Dividend Yield
If you are a stock market investor who is interested in income then you would look for companies that pay a high dividend. The Dividend Yield is helpful in discovering such companies it is calculated by dividing the annual dividend per share by the current stock price of the company. Because of the nature of older well-established companies these are the companies that normally pay higher dividends and have a correspondingly higher Dividend Yield.
There are other key ratios that can be applied to company financial statements but the ones I've listed above are the most important and will the most helpful to you in your stock market investment decisions.
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