9. Introduction to ratio analysis

Ratios

Useful in assessing a firm's profitability, liquidity, risk, and highlighting competitive advantages.

Time series analysis

A method to compare a firm's ratios at different points in time.

Cross-sectional analysis

A method to compare a firm's ratios against other firms in the industry.

Return on Equity (ROE)

Ratio of net income to average shareholders’ equity, measuring investment return.

Drivers of ROE

Primary drivers are operating performance and financial leverage.

Return on Assets (ROA)

Measures operating performance, represented by the company's return generated from assets.

Financial Leverage Ratio (FLR)

Ratio of average assets to average shareholder’s equity, indicating debt usage.

Tax shield

The tax deduction from interest obligations that helps reduce a firm's tax liability.

Common Size Financial Statements

Financial statements expressed as a fraction of total assets or total sales to aid comparison.

Operating Income

Income generated from core business operations, calculated before interest and taxes.

Liquidity Ratios

Measures a firm's ability to cover short-term obligations with its most liquid assets.

Current Ratio

Ratio of current assets to current liabilities, indicating short-term financial health.

Quick Ratio

Measures a firm's ability to meet short-term obligations without relying on inventory.

Profit Margin

Indicates the percentage of revenue that has turned into profit, reflecting efficiency.

Gross Profit Margin

The percentage of revenue that exceeds the cost of goods sold (COGS).

Net Profit Margin

The percentage of revenue left after all expenses, including taxes, have been deducted.

Operating Margin

Percentage of revenue remaining after covering operating expenses but before interest and tax.

Debt-to-Equity Ratio

Compares a company's total debt to shareholders' equity, indicating financial leverage.

Earnings per Share (EPS)

Indicates the portion of a company's profit allocated to each outstanding share of common stock.

Market Capitalization

The total market value of a company's outstanding shares, calculated as share price times total shares.

Dividend Yield

Indicates how much a company pays out in dividends each year relative to its share price.

Price-to-Earnings (P/E) Ratio

Measures a company's current share price relative to its earnings per share, indicating valuation.

Return on Investment (ROI)

Measures the gain or loss generated relative to the amount invested, expressed as a percentage.

Cash Flow Statement

A financial statement showing the inflows and outflows of cash within a company over a period.

Working Capital

The difference between current assets and current liabilities, indicating short-term financial health.

Economic Value Added (EVA)

A measure of a company's financial performance that shows net profit after deducting cost of capital.

Value at Risk (VaR)

A statistical method used to assess the risk of investment losses, indicating potential worst-case scenario.

Discounted Cash Flow (DCF)

A valuation method used to estimate the value of an investment based on its expected future cash flows.

Beta

A measure of a stock's volatility in relation to the overall market; a beta greater than 1 indicates higher risk.

Capital Asset Pricing Model (CAPM)

A model used to determine the expected return on an asset, accounting for its risk relative to the market.