Key financial metrics to consider before you invest in stocks
Go beyond the basics when you evaluate a potential investment’s financial information. Learn about using financial ratios to measure market value.
Toronto Stock Exchange
Before you take the plunge and invest, you need to know which financial metrics may help you make informed decisions.
There are hundreds of company metrics to examine, but first, you should understand the basics.
Total revenue: the value of goods and services sold by a company
Capital expenditure: How much money is spent by a business or organization on buying or maintaining assets, such as land, buildings and equipment
Total assets: Capital items that are owned (paid for)
Total liabilities: The total amount of debts and financial obligations
Cash and cash equivalents: The value of a company's assets that are cash or can be converted
Beyond these basic financial metrics, there are other factors investors should examine.
Price-to-earnings ratio (P/E ratio)
The P/E ratio is a measure of the market value of a stock compared to the company's earnings. It tells you what other investors (the market) are willing to purchase a stock for right now. If the P/E is high, this could indicate the price of the stock is overvalued, and therefore not a good investment at this time. And the reverse may be true. However, don’t forget to investigate how a particular company is valued compared to other firms within the same sector. The big picture matters.
Price-to-book ratio (P/B ratio)
The P/B ratio is another way to measure whether a stock is potentially overvalued or undervalued. It’s determined by comparing a company’s net assets to the price of all the outstanding shares. Simply put, it’s the ratio of the market value of a company's stock (what investors are willing to pay right now) and its book value (a more conservative measure of a company's worth). Some investors like to invest in companies with a low market value in comparison to the book value. In these cases, they believe stock is undervalued and its market value is therefore likely to increase.
Debt-to-equity ratio (D/E ratio)
The D/E ratio tells investors about how much a company has borrowed to finance its business. Too much debt is obviously risky, but the D/E ratio can vary from sector to sector. A high D/E doesn’t indicate in every case whether a company is well-run or not. Debt is definitely sometimes required when a company expands or seeks to enter existing or additional markets with new products or services.
Free cash flow (FCF)
FCF is a measure of how much cash a company generates from its business. It tells us whether a company has the cash, after paying operational and capital expenses, to pay its shareholders. If a company’s FCF is rising, its sales could be rising or its costs are diminishing, or both. If a stock price seems low and free cash flow is on the rise, many investors see this as an indication that the stock value will increase.
Handle with care: Evaluating companies that haven’t turned a profit yet
Determining the potential investment opportunity for firms that haven’t made a profit is very different from evaluating firms that are already making money.
There are other financial metrics to look at for companies that haven’t yet turned a profit, but potential investors should also do their best to evaluate "softer" metrics:
The capability of company management: Do the firm’s leaders have a proven track record? Are their leaders invested in the future of the company as material shareholders?
The target market for the company’s products or services: What factors are affecting the market now and which ones might affect it in the future?
Whether the company has a competitive advantage: What sets it apart and makes it hard for other firms to compete with it? Some competitive advantages include a firm’s business model, level of innovation, ownership of patents and distribution model.
By understanding these and other financial metrics, both new and experienced investors can make the wisest decisions possible. For current market, index and company information for Toronto Stock Exchange and TSX Venture Exchange and US markets, and to help make data discovery easier, use TMX Money.com Opens in a new window..