Wednesday, August 31, 2011

Industry Ratios: Financial Analysis of stock

A year’s Balance sheet, Profit & Loss account records the historical facts of business and analyzes industry ratios. Such calculated industry ratios allows investors to predict the future of a particular stock. In order to financially analyze stock of a company, the balance sheet and profit and loss account is the biggest tool an investor can have as a data base for calculating industry ratios.

The single most important parameter that can be gazed from a balance sheet and profit and loss account is ‘Return on Equity’. This is most important parameter available for an investor because it gives a measure of return on invested capital.

Industry ratios (1): Return on Equity

return on equity

Value investing asks for thorough financial analysis of a companies business and financial conditions. Several financial industry ratios has been developed which facilitates in quick analysis of stocks. Another great industry ratios to be carefully watched is called as current ratio

Industry ratios (2): Current Ratio

Optimum level of current ratio is from 1 to 2. One (1) means a company is generating just enough cash to pay all its immediate liabilities. If the ratio is more than two (2) means cash is not being put to work (re-invested etc) by the financial managers. It’s a crime to keep the cash idling in the bank account.

Industry ratios (3): Inventory Turnover Ratio

inventory turnover ratio

Inventory turnover ratios is another great industry ratio and a quick tool to judge the managerial effectiveness of a company. A very high inventory turnover ratio means the produced product is sold very fast. Ideally a finished product should not be allowed to lie idle even for a single day in the manufacturers place.

But generally finished product takes time to be dispatched and sold. It is totally managers efficiency that decides the speed at which an inventory is converted into cash. A perfect manager does all his home work before a finish material is ready so that it is immediately sold to the customer and the product turns into cash.

Industry ratios (4): Net Profit Margin

profit margin

Net Profit margin is again the most important industry ratios that must be tracked by all investors. Why? because the profit margins speaks a lot about the companies dominance in doing their business. In case of less business competition, companies can sell their products like a monopoly. They can afford to raise the profit margins without affecting their sales.

This is very crucial, Oil companies of Middle East, Microsoft etc are like monopoly business. They claim substantial benefits just because they do not have many competitors who can match their product, services and prices.
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