Frants Preis
INVESTING in shares can be daunting, especially for those who are new to it. With an array of companies, industries and market conditions to consider, how does one make sense of it all? The answer lies in mastering the art of equities analysis, and a crucial aspect of this skill is understanding key ratios and metrics. Financial ratios are like the vital signs of a business. They tell you how healthy or unhealthy a company is.
Imagine you are considering investing in two companies: A and B. At first glance, both seem promising, but digging deeper reveals a stark contrast. Company A boasts impressive revenue growth year over year, while Company B struggles to maintain profitability despite high sales. What’s the difference? It boils down to analysing the right ratios. Although the ratios alone are not necessarily enough to draw conclusions, they do help us identify the right questions to ask about a company.
One fundamental ratio every investor should know is the Price-to-Earnings (P/E) ratio. This metric compares a company’s current share price to its earnings per share (EPS). A high P/E ratio may indicate that investors expect strong future growth, while a low ratio could signal undervaluation. For example, a P/E ratio of 20 suggests investors are willing to pay R20 for every R1 of earnings. A PEG ratio is the P/E ratio relative to the earnings growth, where a ratio below 1 can indicate undervaluation.
Another critical ratio is the Debt-to-Equity (D/E) ratio, which assesses a company’s financial leverage. A high D/E ratio indicates that a company relies heavily on debt to finance its operations, potentially increasing financial risk. Conversely, a low ratio suggests a healthier balance between debt and equity. For instance, a D/E ratio of 0.5 means a company has R50 in debt for every R100 of equity.
Furthermore, the Return on Equity (ROE) ratio measures a company’s profitability relative to shareholders’ equity. A high ROE indicates efficient use of shareholder funds to generate profits, while a declining ROE may signal underlying issues. For instance, an ROE of 15% means the company generates R15 in profit for every R100 of shareholder equity. Related to this ratio is the Return on Investment (ROI), which is a performance measure that indicates the profit (or loss) of an investment relative to its cost. CAGR is the Compound Annual Growth Rate, which measures an investment’s annual growth rate over time, with the effect of compounding being taken into account.
Beyond these ratios, understanding metrics like the Dividend Yield, Dividend Growth, Price-to-Sales (P/S) ratio and Free Cash Flow (FCF) yield can provide valuable insights into a company’s financial health and growth prospects.
In conclusion, mastering key ratios and metrics is essential for making informed investment decisions. By analysing these indicators, investors can uncover valuable insights and identify promising opportunities in the equities market.
Frants Preis is the managing director at Preis Investments.
BUSINESS REPORT