Transcript Common Cents Investment Group

Common Cents Investment
Group
Financial Ratios and Stock Screening
November 3rd, 2008
FINANCIAL RATIOS
Financial Ratios

Useful in comparing different elements of
a firm versus another firm or and industry
average

Are somewhat weak as a stand alone
metric
◦ Should be combined with other information

Four major types
Liquidity Ratios

Measure of the firm’s short-run ability to
pay its maturing obligations
◦ Readiness of assets to be converted into cash

Current Ratio:
◦ (Current Assets) / (Current Liabilities)
◦ Company’s ability to satisfy its short-term
liabilities—must be careful in how much of
your current assets are classified as what
Liquidity Ratios

Acid-test Ratio:
◦ (“Quick Assets”) / (Current Liabilities)
◦ Similar to the current ratio, except
inventories and prepaid items are excluded
from current assets
◦ Provides a more accurate description of
ability to meet short-term obligations
Solvency/Leverage Ratios

Investors and creditors are particularly
interested in a company’s long-term solvency
and stability
◦ The extent to which a firm relies on creditors to
finance operations rather than its owners

Debt-to-Equity Ratio:
◦ (Total Liabilities) / (Shareholder’s Equity)
◦ As this ratio increases, if the company were to
liquidate, less of the assets would be available to
the owners because they’d be claimed by
creditors
Solvency/Leverage Ratios

Times Interest Earned Ratio:
◦ (EBIT) / (Interest Expense)
◦ EBIT = Net Income before Interest and Taxes
◦ Indicates the margin of safety provided to
creditors
◦ The number of times a firm would be able to
pay its interest expense from financing before
running out of funds from operations
Efficiency Ratios

How quickly certain assets (namely
receivables and inventory) can be converted
into cash; also called activity ratios

Accounts Receivable Turnover:
◦ (Net Sales) / (Average Accts. Receivable)
◦ Measures how often their sales remain
uncollected
◦ If this number is low, it may say that the firm has
trouble collecting cash—especially if needed
Efficiency Ratios

Inventory Turnover:
◦ (Cost of goods sold) / (Average Inventory)
◦ Measures how quickly inventory is sold
◦ Provides information about whether obsolete
inventory exists
◦ Must be careful in analysis:
 A low number means they are sitting on a lot of
inventory which is costly to store
 A too high number may indicate they face potential
stock-out problems
Profitability Ratios

Measures how profitable a firm is based
on many dimensions

Profit Margin Ratio:
◦ (Net Income) / (Net Sales)
◦ After all expenses are included, how profitable
is the firm?
◦ May want to look at Operating Profit Margin
instead
Profitability Ratios

Return on Assets:
◦ (Net Income) / (Average Total Assets)
◦ Measures how well a company puts its assets
to use
◦ A lower ratio may indicate they aren’t
generating enough income to justify the cost
of their assets
Profitability Ratios

Return on Equity:
◦ (Net Income) / (Average Shareholder’s Equity)
◦ The higher the ratio the better
◦ Have to look at other ratios as well
 For example, if the company is heavily debtfinanced, this ratio (should) be higher
 However, this could be dangerous if they begin to
have trouble collecting cash and thus can’t pay their
current debt obligations
Book Value and Market Cap

Market Cap:
◦ (Current Share Price) * (# of common shares
of stock outstanding)
◦ If you wanted to completely purchase the
company today, how much would it cost?

Book Value:
◦ (Total Assets) – (Total Liabilities)
◦ Also known as…Shareholder’s Equity!
Interpretation

The accounts used in these ratios can
vary based on what you perceive them to
represent

Book Value example:
◦ Intangibles or goodwill need to be carefully
factored into Total Assets, if at all
◦ Compare to the firm’s market cap to see if it
is discounted
STOCK SCREENING
Stock Screening

ValueLine has a powerful component
known as Stock Screening

Allows you to see firms that meet specific
requirements
◦ E.g.: You are only interested in firms with a
P/E Ratio between 10 and 20, those who have
a Return on Equity above 15%, and those with
a Market Cap between $100 and $1000
million
Stock Screening

Check out the CCIG website for how to
initially access ValueLine

Click on “Standard Edition” on the lefthand side then “Stock Screening”

The combinations are nearly endless; play
around with it some to get a feel!