Why do metrics matter?
Stock metrics are one of the most valuable ways to analyze how a company is performing in different categories. Based on certain metrics, different conclusions can be drawn about a company. Some of these conclusions include whether or not the company represents a good buying opportunity, whether it is profitable or not, etc.
The value of metrics is that they can be easily compared across different companies to identify strengths and weaknesses, which can then inform investment decisions.
As useful as these metrics can be, it is important to keep in mind that a single metric does not tell the whole story. Metrics alone can be misleading and cause you to make investment mistakes, so it is important that metric analysis is paired with other forms of analysis as well.
Types of Stock Metrics
There are many different types of stock metrics. Knowing the type of metric is very important in identifying the correct conclusion to draw. Generally, these metrics are organized in the following categories: activity, solvency, profitability, and equity analysis. Each of the categories along with their most commonly used metrics is explained below.
Profitability ratios are some of the most commonly used metrics for evaluating a company's ability to generate profits. After all, companies are made to earn a profit. If a company is unprofitable it is generally seen as undesirable (with some exceptions of course).
A common metric that is used is the gross margin. This is where the revenue minus the cost of goods sold is divided by the total revenue. This metric essentially returns what the profit is per every $1 of revenue generated. Generally the higher the margin is, the more profitable the company is considered to be.
Gross margin = cost of goods sold/total revenue
The profit margin is very similar to the gross margin except that the net income is divided by the total revenue. The result is the profit the business earns per $1 of sales generated. Similar to the gross margin, the higher the number the more profitable the company is.
Return on Equity
The return on equity is a very useful metric used by great investors like Warren Buffet. To find the return on equity we divide the net income by the average total shareholder's equity. This number represents the rate of return on resources provided by investors.
Return on equity = net income/average shareholder's equity
Return on Assets
The last metric in this category is very similar to the previous one. The difference is that the net income is divided by the average total assets. The result is the rate of return for the assets being used.
Return on assets = net income/average total assets
Solvency ratios are used to assess a company's ability to meet its long-term obligations or pay off its liabilities. If a company is insolvent, the company is at risk of not being able to meet its obligations and go bankrupt, whereas if it's solvent, it can meet its obligations and continue to operate.
Debt to Equity ratio
As the name suggests in order to calculate this ratio all you need to do is divide the company's debt by the shareholder's equity. The resulting number tells you how much debt the company has relative to its equity. A company with a higher debt to equity ratio is seen as more risky and less solvent than a company with a lower one.
Debt to equity ratio = total liabilities/shareholder's equity
Net Debt as a Percentage of Total Capitalization
This ratio is calculated just like debt to equity except you divide the debt by the shareholder equity plus the debt. It is a useful metric because it shows you the proportion of the company's total financing represented by debt. The more leveraged or in debt the company is, the riskier it is considered.
Net Debt as a Percentage of Total Capitalization = total liabilities/(shareholder's equity + total liabilities)
This ratio is a classic measure of a company's ability to pay its interest expense from its earnings. The number is calculated by taking the EBITDA (earnings before interest, taxes, depreciation, and amortization) and dividing it by the interest expense. A higher ratio is better since it tells you that the business can cover more of its interest expenses than it currently incurs.
Interest coverage = EBITDA/interest expense
Cash Flows to Total Liabilities
This ratio is calculated by taking the cash flows from operating activities and dividing it by the total liabilities. The result of this number is the proportion of liabilities that can be covered with the business cash flow. The more it can cover, the more solvent the business is.
Cash Flows to total liabilities = cash flows from operating activities/total liabilities
Equity analysis ratios are the most common tool and they are important in helping you decide whether you should invest in a particular stock. These ratios are primarily used to assess shareholder returns. For most of these ratios, a higher number represents a higher quality company.
Earnings per Share (EPS)
This ratio tells investors how much money a company makes on a per-share basis. The formula is equal to the net income of the company divided by the number of shares outstanding. The more a company makes per share, the more profitable a company generally is. This number can be misleading because it is heavily reliant on the number of shares.
Earnings per share = net income/outstanding shares
PE ratio (Price to Earnings Ratio)
One of the most common metrics, the PE ratio, is a good indicator as to whether a stock is selling for a high price or low price. Low PE ratios are generally preferred, but premium companies that are worth investing in often have a high PE. It is also important to know that PE is a current measure and does not reflect the earnings growth of a company. The formula for this ratio is very simple – you take the price of the stock divided by the earnings per share.
Price to earnings ratio = stock price/earnings per share
The dividend yield is used to assess the attractiveness of a stock that pays dividends. The higher the yield (assuming the quality of the company remains the same), the more attractive the stock is. The dividend yield is calculated by taking the current dividend per share and dividing it by stock price. This number tells investors, "for every dollar you invest in the business, how much you are expected to make back in dividends".
Dividend yield = dividend per share/stock price
This metric is used to evaluate the sustainability of the current dividend payment. The formula is equal to the dividend per share divided by the earnings per share. A higher number represents a less sustainable dividend because it means that the business is forced to pay back a large portion of its income to shareholders instead of reinvesting into the business. Keep in mind certain company types (like REITs) are obligated to pay a large portion of their earnings to shareholders. You should be wary of those stocks paying a lot more in dividends than what they make.
Dividend payout = dividend per share/earnings per share
Net Free Cash Flow
The free cash flow tells you how much cash a company is left with after receiving its payout from operations and after it has paid for capital expenditures and dividends on preferred shares (if any). As the name suggests, the formula is equal to the cash flow from operating activities, minus net capital expenditures, minus dividends on preferred shares. The more free cash flow that a company has, the more it can grow by reinvesting or sharing the profits with its shareholders.
Net free cash flow = cash flow from operating activities – net capital expenditures – dividends on preferred shares
The last category is comprised of activity ratios. This set of ratios is used to assess how effectively a company manages its operations. More effective operation processes are usually reflected by these ratios. Note there are times where this is not the case because although in terms of efficiency a company might seem better, the absolute numbers in sales, income, etc might be better on a less efficient business.
Accounts Receivable Turnover
The formula for these metrics is equal to credit sales divided by the average accounts receivable. A higher number represents a faster period of collection. In other words, accounts receivable collection happens soon after the credit sale is made.
Accounts receivable turnover = credit sales/average accounts receivable
Average Collection Period
The formula for this ratio is 365 days divided by the accounts receivable turnover. The resulting number explains how long it takes to collect receivables from customers. The longer it takes the less efficient it is because a longer collection period can lead to liquidity issues.
Average collection period = 365/accounts receivable turnover
The inventory turnover ratio is very similar to the accounts receivable turnover except that the cost of goods sold is divided by the average inventory. The more efficient inventory is turned (i.e received and sold), the better the company operates.
Inventory turnover = cost of goods sold/average inventory
Days to Sell Inventory
This formula is 365 days divided by the inventory turnover to show you the number of days it takes to turn the company's inventory. Again, faster is generally better as there is less inventory stored which lowers costs and improves the business cash flow.
Days to sell inventory = 365/inventory turnover
Accounts Payable Turnover
The accounts payable turnover tracks how efficiently the account payables are handled. Account payables are short-term liabilities or debt the company has to pay to suppliers. The faster it is the better, but within reason. This is because paying suppliers too quickly can lead to cash flow issues. The formula for this ratio is credit purchases divided by average accounts payable
Accounts payable turnover = credit purchases/average accounts payable
Accounts Payable Payment Period
Lastly, the accounts payable payment period tells you how long it takes for the company to pay its suppliers. If it takes them too long, it can be a red flag because the supplier can stop supplying the company. It also may be a sign of cash flow issues. The formula is equal to 365 days divided by the accounts payable turnover.
Accounts payable payment period = 365/accounts payable turnover
Where can you find stock metrics?
Now that you know about all of these important metrics and why they matter, and how to calculate them, the last step is to find these metrics. Even though you can calculate all of these metrics on your own by looking at the company's financial statements, it can be very time consuming. They may have different accounting conventions and it becomes very complicated very fast.
For this reason, it is highly recommended that you use Wisesheets so you can get these metrics and a lot more on your spreadsheet instantly by simply entering the company's ticker.
The number of hours you will save and easily comparing metrics across different stocks at once is totally worth it.
Making investment decisions
Now that you know everything about these stock metrics, being a smart investor comes down to making good investment decisions. Being able to interpret these ratios well and making a stock investment decision based on important factors is critical and something you will learn through knowledge and experience.
We hope this guide helped you, and we wish you all the best in your stock investment journey.
To your investing success,
The Wisesheets Team