No matter how long you’ve been investing, there will inevitably come a time when you ask yourself if there’s a financial metric that is better than the others. What financial metrics can do is to help you to put a number on the value of a company.
So the question is, how do you find the best financial metric for your taste? If it’s already popular by other investors, you should also be able to use them, right?
Here are my 10 preferred financial metrics (listen in no particular order):
- The Price to earnings (P/E) ratio. This is a classic when it comes to valuation. What you do is that you take the current market price of the stock and divide by the earnings per share. What you end up with is a number that tells you how much you are paying for the stock. The lower the number the cheaper the stock.
- The Price to average earnings ratio. This is an alternative to the normal P/E ratio. What you do is that you take the current market price of the stock and then you divide the average over a given number of earnings. What I prefer to do is to look at the three years, but at least in theory, any number would do.
- The Price to trailing earnings ratio. This is when you follow the stock in detail and know the exact each quarter. Then you can calculate a trailing P/E ratio even in, let’s say, the second, third and fourth quarter without estimates.
- The Price to forward earnings ratio. This metric is similar to the one above but the difference is that instead of calculating the full four quarters earnings, you estimate next quarters’ earnings. I somehow prefer this metric to the one above.
- The CPI-adjusted Price to earnings ratio. This deep value ratio can come in handy if you have a period of intense inflation that distorts the real value of the average. What we are doing here is that we are adjusting every earning with the CPI. What that gives us is a number that is adjusted for inflation. The problem with this kind of metric is that the business is likely to change during the ten years that we are looking at. I therefore prefer to only look at five years back.
- The Price to book ratio. This is where you take the current price of your stock of choice and you divide with the book value. Now, the book value is calculated by taking the company’s total assets and subtracting its total liabilities and also the intangible assets that the company might have. If you are an observant reader, you will recognize that total assets minus total liabilities is what is called Shareholders’ equity.
- The Free cash flow yield. The free cash flow is an important metric for calculating how much comes in and out of the company in given year. The metric is defined by taking the operational cash flow and then subtracting the costs that company infers for maintaining its asset base. The free cash flow yield then comes from taking the price of the stock and then divide by the free cash flow per share
- Current assets to current liabilities. This metric tells you how much more current liabilities that there are in the company. The numbers for this can be either be found in the balance sheet of the company’s quarterly or annual report.
- Debt to equity. This is where you compare the total liabilities that the company has to its equity. The number tells you something about if the debt load is high or low. The numbers for this can also be found in the balance sheets of the quarterly or the annual reports.
- Return on equity. This profitability metric tells you how much profit the company makes in relation to the equity. The number tells you how good the company is at reinvest its capital. Personally, I prefer to see a ROE above 17 per cent in order to be happy.
Today I’ve been talking about my favourite financial metrics. Have I missed any? Leave your comments below!