Before you invest, you need to understand what you’re putting your money into. For example, you wouldn’t buy an expensive appliance you’ll depend on without first reading some reviews, researching the brand and knowing if it’s a good price. In the same way, analyzing key Financial Metrics helps investors and analysts determine if a specific market security like a stock, bond or fund is worth investing in.
The stock market lists thousands of companies, which can be overwhelming. Looking at key Financial Metrics can help shed some light on business practices, overall earnings, available cash flow, etc., so you can determine if this is a company you think might be a good short- or long-term investment.
What Are Investment Metrics?
Investment metrics—also referred to as key Financial Metrics or stock metrics—are ratios, calculations and other information that help investors analyze a company’s fundamentals. These fundamentals highlight a company’s value, earnings, viability and potential for growth. However, different types of investors may prioritize different investment metrics when trying to understand a company.
For example, some people may look at valuation metrics over financial metric ratios to understand the sentiment and overall value of a company. In contrast, others may focus on financial metric ratios to easily compare companies against one another. Stock metrics can help people make better decisions about which companies in invest in as well as which to avoid.
What Are Valuation Metrics?
Let’s start with the basics: Valuation is the process of determining the current, as well as the projected, worth of company or asset by analyzing data. Investors use valuation metrics to fully understand a company’s market value in relation to its equity and earnings. Valuation metrics help you look at the price you are paying for some stream of earnings, revenue, cash flow or other financial metric and determine if the security is under- or overvalued. A few examples of valuation metrics include:
- Price-Earnings (P/E) Ratio: A P/E ratio is used to gauge market expectation and sentiment of future performance by relating a stock’s current share price to its earnings per share.
- Price-Earnings-to-Growth (PEG) Ratio: A PEG ratio is a valuation metric that is used to evaluate a company’s price-earnings ratio relative to its overall growth rate in earnings.
- Price-to-Book Ratio: Measures and compares a firm’s market capitalization to its book value.
- Price-to-Sales Ratio: Compares a company’s stock price to its total overall revenue. The price-to-sales ratio is an indicator of the value that is placed on each dollar of a company’s annual revenue.
- Price-to-Cash-Flow Ratio: Used to measure the value of a stock’s current price relative to its operating cash flow (OCF) per share. Specifically used for companies that report a positive cash flow but are not considered profitable.
- Price-to-Free-Cash-Flow Ratio: Is more precise than the price-to-cash-flow ratio and is used to compare a company’s market price per share to its amount of free cash flow per share.
Each valuation metric and ratio are puzzle pieces that together make up an entire company’s image. As an individual investor, you will need to choose which valuation metrics to use when determining if you want to purchase a company’s securities.
What Are Financial Metric Ratios?
Financial metric ratios can be invaluable tools for investors and analysts alike to help them make informed decisions about companies they want to invest in. Ratios—calculations that are made up of one variable divided by another—are utilized for understanding how companies are doing internally. Financial metric ratios are primarily used to easily compare one company to another.
There are four main types of financial metric ratios to look at:
- Activity ratios
- Liquidity ratios
- Solvency ratios
- Profitability ratios
The first set of financial metric ratios many investors look at are the activity ratios. Activity ratios measure how a company utilizes its resources to generate revenue. Investors want to know how a company is able to convert different accounts within the balance sheet such as capital and assets into a sale.
- Inventory turnover
- Receivables turnover
- Payables turnover
- Asset turnover
Liquidity ratios provide investors with an idea of a company’s operational efficiency and how well they can repay their debts with available, generated capital. A few examples of liquidity ratios include:
- Current ratio
- Cash ratio
- Quick ratio
Solvency ratios analyze how well a company can deal with its long-term financial obligations such as debt and interest. Overall, solvency ratios focus on how sufficient a company’s cash flow situation is and how long it can maintain that sufficiency. Examples of solvency ratios are:
- Debt-to-assets ratio
- Debt-to-equity ratio
- Interest coverage ratio
Lastly, profitability ratios seek to analyze how much profit a business generates and how that profit relates to other important information about the company. A few examples of profitability ratios include:
- Gross profit margin
- Net profit margin
- Operating profit margin
- Return on assets (ROA)
- Return on equity (ROE)
Overall, investors can use financial metric ratios to develop a feel for a company’s attractiveness based on its competitive position, financial strength and overall profitability. Using these four types of key financial metric ratios can help you decide whether or not a business is viable to invest in.
How to Find Financial Metrics for Companies
If you’re ready to start picking which stock metrics are important to you, you’ll want to know where to find them as well as how companies typically report their numbers. When researching a company’s Financial Metrics, you’ll want to look at three main pieces of information:
- Balance sheet: A summary of the total business assets, liabilities and equity;
- Income statement: A report of exactly how much revenue and earnings the company generated over a specific time period, such as quarterly or annually; and
- Cash flow statement: The total amount of money leaving and coming into the company through various activities.
Looking at these three main financial statements will help investors get the information they need to calculate financial metric ratios. Additionally, you’ll want to take into account industry trends and historical data, as well as a company’s business model, operational and management strategies and sustainable competitive advantages.
Depending on where your brokerage account is located, there may be different ways to find a company’s Financial Metrics. However, the American Association of Individual Investors (AAII) makes it easy to locate a company’s financial metric ratios by going to any stock ticker page on our website. There you will find valuation and growth metrics, financial ratios, grades, charts, earnings, filings, as well as industry trends/news.
Differences Between Value and Growth Investor Metrics
Different investors may analyze various investment metrics to fit what they’re looking for. For example, value investors use Financial Metrics and ratios to help discover stocks they believe to be undervalued and to weed out securities that may be overvalued.
Investors who focus on value investment metrics believe the market overreacts to news and trends, resulting in price fluctuations that do not match up with a company’s long-term fundamentals. By analyzing these long-term stock metrics, investors who focus on a company’s valuation try to find market securities that are undervalued but show promise and buy them at a low price.
In contrast, growth investors may focus on companies that exhibit signs of significant growth, even if the security’s share price may be expensive in terms of metrics such as the price-earnings ratio or the price-to-book ratio. Growth investors look at companies with the potential to achieve high earnings growth.
Using Financial Metrics to Choose Investments
Utilizing investment metrics and financial ratios helps investors predict the future of a company and develop a feel for its attractiveness as measured through factors such as its competitive position, financial strength and profitability.
Knowledge of Financial Metrics and ratios should also give investors a feel for how a company might react to shifts in industry, financial and economic environments.
As we mentioned above, AAII offers a long list of helpful educational tools, resources and stock metrics to help people invest their money wisely. Subscribing to our A+ Investor service provides members with customizable stock grades and screens as well as countless new enhancements updated quarterly. Members can search any company on our website to see specific stock metrics for different types of investor approaches.
You can use A+ Investor to vet various market securities like stocks, bonds, funds, etc., with key Financial Metrics, professional screens and power rankings. Start analyzing your stocks’ Financial Metrics and overall performance today with A+ Investor.
