What are financial ratios?

Financial ratios are ratios that give you an idea of how under- or over-valued a stock may be in terms of its earnings and cash flow, as well as how sound its balance sheet is and so on. Using financial ratios can’t tell you everything about a stock, but they well help you determine which stocks are worth taking a closer look at. A few examples of financial ratios are: Price-earnings ratios (or P/E ratio): The p/e is the ratio of a stock’s market price to its per-share earnings. As a general rule, the lower the p/e, the better, and generally a p/e of less than 10 represents value. Price-to-book-value ratios: The book value per share of a company is the value that the company’s books place on its assets, less all liabilities, divided by the number of shares outstanding. Book value per share gives you a rough idea of the stock’s asset value. Price-cash flow ratios: Simply put, it’s earnings without taking into account non-cash charges such as depreciation, depletion and the write-off of intangible assets over time. It’s actually a better measure of a company’s performance than earnings. Debt-to-equity: When a company loses money, it still has to pay the interest and eventually repay the debt. Generally it does so by dipping into shareholders’ equity. A high ratio of debt to equity increases the risk that the company (that is, the shareholders’ equity in the company) won’t survive a business slump. Once we’ve found a company that looks attractive using the financial ratios detailed above, we look to see if it has a solid business in an attractive industry, with a history of rising sales and earnings, if not dividends. Even a stock whose financial ratios look good can stagnate if the company or its industry is in a difficult period. But if it’s a high-quality company, it’s likely to hold up better than other alternatives. Better still, it may be first to move up when conditions improve. We often receive questions about planning and enjoying a successful retirement. Our answers to those questions, based on decades of investment experience, are all located in this FREE report: 12 Steps to the Retirement You Want.