5 Rockin’ Investing Ratios and Why I Like It

September 19, 2012 | Comments (5)

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Jae Jun

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investing ratios

Investing Ratios | Flickr: psd

Here are the investing ratios, in no particular order, that I like to check in order to get a good all round picture of a company.

 

Here are the 5 Rockin’ Investing Ratios

Price to Book Value (P/B)

Where would a value investor like me be without the P/B ratio. It is one of the most fundamental metrics and will tell you at what level a stock is trading in relation to its book value.

You may also want to compare P/B to its P/Tangible Book Value. This will let you see whether a company is building its assets through intangibles or solid assets.

Free Cash Flow to Sales (FCF/Sales)

I first came across this metric while reading the 5 Rules for Successful Stock Investing. This investing ratio concept is very simple and powerful.

How much of sales is converted to FCF? This metric will show you.

AAPL has a TTM FCF/Sales of 0.28 = 28%

Amazing.

Apple is able to convert 28% of its sales into FCF.

Compare that to a company like GMCR which has a TTM FCF/Sales ratio of -0.03. In other words, GMCR is dipping into its bank account to support sales.

Cash Return on Invested Capital (CROIC)

CROIC is a fantastic metric first popularized by Joe Ponzio of F Wall Street.

You may be more familiar with ROE or ROIC to measure business returns, but CROIC takes it a step further.

CROIC shows how much free cash flow per dollar the business generates from invested capital. I find this to be the ultimate performance metric as it shows so clearly how effective management is and the strength of the business.

CROIC = FCF/Invested Capital

The higher the CROIC, the more cash the company is generating and it also indicates that the business is a profitable one. Rarely do you see a high CROIC but low or negative FCF.

Enterprise Value to Free Cash Flow (EV/FCF)

A much better alternative to PE. Another variation that you see used widely is EV/EBITDA but I have already written about the negatives of EBITDA.

Enterprise Value will give you the total valuation of a company.  i.e. it includes debt and subtracts cash. This makes it easier to compare companies in the same industry and is not skewed towards cash rich companies.

Using FCF instead of Earnings, will show you how cheap a company is in relation to its cash generating ability. Another alternative is the P/FCF ratio

Total Debt/Equity, Long Term Debt/Equity & Short Term Debt/Equity

Some ratios are better analyzed together. If you just look at one, it could be mistaken easily.

You see total debt/equity quite often and if this ratio is high, you will get the impression that the company is highly leveraged.

However if you look at Long Term Debt/Equity and Short Term Debt/Equity together, it could paint a different picture.

Company A and B may both have a a Debt/Equity ratio of 2 but company A has a long term debt/equity ratio of 1.5 compared to company B whose short term debt/equity ratio is 1.5.

Two same debt/equity ratio’s but two very different pictures.

I’m just scratching the surface with the investing ratios I use and the combinations in which it should be looked. More hopefully soon.

About Jae Jun


Jae Jun is the founder of Old School Value. He is on a mission to provide practical and actionable value investing tools, tutorials and educational material to help empower the individual investor. Keep in touch with Jae via any of the methods linked below.

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  • http://www.oldschoolvalue.com/ Old School Value

    forgot to add the definition of invested capital.
    Invested Capital = BV + Total Liabilities – Current Liabilities – Excess Cash

  • Stable Investor

    One of major problems with P/BV is that it depends on Book value, which can ‘adjusted’ as per accounting practice. One should always be cautious when dealing with numbers which have some sort of subjectivity attached to them.
    Great post though.

  • http://twitter.com/DiegoStendardo Diego Stendardo

    Nice article. Are there any online screeners that enable you to use these metrics?

  • http://www.oldschoolvalue.com/ Old School Value

    Not that I know of. There metrics are usually performed by hand or through my spreadsheets.

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