Feb 14 Important Accounting Ratios That Are Used To Analyze The Value Of A Stock
The stock market offers a very lucrative investment channel but you can easily be overwhelmed by the heavy financial jargon used there. Financial ratios are some of the most confusing language expressions in the stock market. You can peruse an entire stock report without finding a single paragraph to explain the many tabulated figures and ratios featured there. Surprisingly, the many ratios used in the stock market are quite elementary. They are sort of abbreviated fraction forms. In other words, instead of using full words to describe a ratio, the stock market like the rest of the financial world uses abbreviations to represent the mathematical relationship. There are countless ratios in the stock market but we will only look at the most important ones that are used to express the value of a stock. They are the following.
Price-To-Book Ratio (P/B)
Also called the price-equity ratio, the price-to-book ratio is the most basic stock description ratio. It compares the market value of a certain stock to its book value. Normally, the P/B ratio is the obtained by dividing the most recent closing price of a stock by its book value in the latest quarter. The book value or the book value per share is calculated by dividing the difference between the total assets and the total liabilities by the number of outstanding shares. The P/B ratio varies from industry to industry and a lower ratio could be due to undervalued stocks or a bad firm.
Price-To-Earnings Ratio (P/E)
This is one of the most useful ratios in the analysis of a stock’s value. The P/E ratio is calculated by dividing the current trading value of a stock by the earnings per share. As such, the P/E ratio indicates how long a stock investment will take to pay off the investor. As any professional accounting firm in Clifton will advise you, this ratio determines whether a surge in stock prices will be sustainable. Essentially, a high stock price cannot remain up there unless there are substantial earnings per share to back it up. It is only financially logical to compare the P/E ratios of companies in the same market and industry.
Price To Earnings Growth Ratio (PEG)
The PEG ratio is an extension of the P/E ratio to get a better and more accurate understanding of the company’s financial performance and standing. The PEG ratio looks at the historical growth rate of a firm’s earnings to project future growth. It is calculated by dividing the P/E ratio with the yearly growth rate of the company’s earnings. A lower PEG ratio indicates a bright future in terms of earnings per share for a specific company. The PEG ratio is also used to compare the value of a company’s stock against another’s stocks.
This is one of the most straightforward indicators of a company’s stocks value. The dividend yield trend helps to determine whether you will get a check in the near future, which is usually at the end of the year. Although the long-term investment goal in stocks is to reap financial rewards from the growing value of the company over time, dividends offer a short term financial reprieve especially during stagnant growth periods. Dividends are sort of interests paid on invested capital. The dividend yield is calculated by dividing the annual dividends by the stock’s price or share price.
As you can see, each of these ratios is deficient in one way o the other. As such, all these ratios should be considered together for a more accurate break down of a stock’s value.