Market-based ratios
1. Market capitalization (market cap)
= issued shares (common stock) outstanding * share price
"Fully diluted" issued shares outstanding includes any additional shares that may be issued in the future (eg. exercise of share options).
2. Enterprise value (EV)
= market cap + total debt + total cash
Allows comparison of companies with radically different capital structures.
3. Price-earning ratio (PE)
= share price/earnings per share (EPS)
EPS = net income/issued shares outstanding
EPS calculation normally use "weighted average" shares in issue. Extraordinary items are excluded from EPS calculation.
PE enable comparison of companies irrespective of their size.
4. Dividend yield (%)
= gross dividend per share/share price
High yield may indicate a danger of the dividend being cut.
Yields of slow-growth companies tend to be higher as the scope for growth is more limited. High growth companies tend to have low yields.
5. PEG factor
= PE (times)/earnings growth (%)
A guide as to whether what you are paying for growth is reasonable. Lower PEG indicates cheaper share price for the company's earning growth. Works best for high growth companies.
The PEG calculation must be pair up appropriate PE with the comparable growth rate: historical PE with historical growth, or prospective PE with prospective growth.
6. Price-to-sales ratio
=market cap/annual sales
or = share price/sales per share
For companies with no with no foreseeable outlook of making a profit.
7. EV/EBITDA
= (market cap + net debt)/(pre-tax profit + interest paid + depreciation + amortization)
For valuing companies with different capital structure. Useful for comparing companies with high level of debts or lots of cash, or those making net losses but positive operating profit.
The reason for adding back depreciation and amortization to operating is that they do not involve actual cash expense. Using pre-tax figure eliminate the problem of international differences in company tax rate.
8. Price/book value
= share price/(shareholders' equity/number of outstanding shares
In some cases, book value is also known as net tangible assets.
While it works well for companies that are rich in tangible assets, it is less meaningful for those that have substantial elements of goodwill or intellectual property in their balance sheet.
Income statement ratios
9. Margins
Gross margin = gross profit/sales
Operating margin = operating profit/sales
Pre-tax margin = pre-tax profit/sales
Margins are important indicators of the health of a business. Falling margins can be a sign of problems, especially if the company or the industry is not cyclical, as it shows the extent to which the company is able to pass on brought-in costs in its prices to customers (gross margin) and the extent to which it has its own internal costs under control (pre-tax margin).
Gross margins are also an indicator of value-added - the higher the gross margin, the more value the company itself is adding to raw materials and bought-in inputs.
10. Interest cover
= (pre-tax profit + net interest paid)/net interest paid
Net interest paid = interest paid - interest earned
A measure of the financial soundness of a company.
Interest can sometimes be capitalized when paid on financing a project that has yet to be completed but that is expected to have a long-term value once completed (eg. constructing property such as retail stores). Capitalizing interest payments does not alter the fact that cash amount of interest due still has to be paid.
Interest cover has little practical significance if a company is in net cash position. It can be important when its bond or loans contains clauses (convenants) that provide for penalties if interest cover drops below a certain level. It can also be a proxy for how sensitive the business is to changes in interest rates.
11. Earnings per share (EPS)
= Net profit attributable to shareholders / Weighted average shares in issue
Taking earning figures at face value can be a mistake as profits can be subjected to manipulation by the management and different accounting policies between companies and country will affect EPS. Make sure that all of the calculations are carried out on the same basis.
12. Dividend cover
= EPS / Dividend per share
To assess whether it is likely that dividend payment might be cut in the immediate future.
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