MOST IMPORTANT Financial Ratios For Stock Market - YouTube

Quick ratio, return on equity, return on investment, price per earnings.

Do these say anything to you?

In this video I will show you 10 important financial ratios and what they mean!

Whats up guys welcome to the episode four of investing in the stock market for beginners

series!

If you haven’t seen the first three episodes, a playlist can be found in the description.

If this is your first time here, take care of your finances by clicking the subscribe

button!

In this video I will show 10 important financial ratios and what they mean.

Financial ratios are relative magnitudes of two selected numerical values taken from a

company’s financial statements.

They show us information like how profitable, liquid, efficient and how much debt the company

is using as a leverage.

All this information helps you to know if the stock is worth buying, and is the share

price correctly valued.

Before we get started comment down below what financial ratios do you use the most to invest?

Also let me know if you think I didn’t mention some financial ratio that you think is very

important!

Let’s get started with number one, Gross margin percentage.

Gross margin is a company’s net sales revenue minus the cost of goods sold.

This shows the amount of sales revenue that the company keeps from sales, after the direct

costs associated with the product has been removed.

Direct costs means things like material and labour needed to produce the product.

The higher the gross margin percentage is, the more the company keeps on each dollar

of sales made.

Gross margin is calculated by the formula Gross margin = Net sales revenue - direct

costs Gross margin percentage is calculated by dividing

the gross margin with the net sales revenue and multiplying the answer with 100.

Let’s say that our company Orange sells Phones $100 each, and the direct costs of

the phone are $60 each.

If we sell 10 phones our net sales revenue is $1,000.

The direct costs are $600.

So the gross margin is $1,000 - $600 = $400.

The gross margin percentage is $400 divided by $1,000 which equals to 0.4.

0.4 multiplied with 100 equals 40%.

So every dollar we get from our sales, we keep 40 cents.

Financial ratio #2: Net profit margin Net profit margin shows the percentage of

sales that has turned into profits.

It shows company’s bottom line after all other expenses have been included.

So in this one you don’t only count the direct costs, you count every expense from

taxes to salaries.

So let’s imagine that we are selling the phones again.

First we make $100.

Then we deduct the direct costs, which were $60.

The $40 left is a gross margin.

Now we pay indirect costs, meaning things like researching, marketing and so on.

Let’s say the indirect costs are $20 so now we minus $20 from $40, which equals $20.

This is an operating margin.

Now we pay $5 interest on our debt, and the $15 left is the pre-tax margin.

After we pay our taxes, which are $5, we are left with the net margin, which is $10.

Now to calculate the net profit margin we divide the net income with our sales revenue.

$10 divided by $100 is 0.1.

This multiplied with 100 is 10%.

So the net profit margin for our company is 10%.

Financial ratio #3: Quick Ratio

The quick ratio tells how well the company is able to pay its short term obligations.

Because it’s used for a short term, it uses only liquid assets, meaning assets that can

be easily converted into cash.

These assets are cash and cash equivalents, marketable securities and accounts receivable.

When we divide these assets with Current Liabilities, we get the Quick Ratio.

If the Quick ratio is over 1, it is a good sign, the company is able to pay its current

liabilities.

So if our company’s cash liquid assets are worth $1,000,000 and current liabilities are

worth $1,200,000, our Quick ratio is 0.8333.

This means that we are not able to pay back our current liabilities, which usually is

a bad thing.

Financial ratio #4.

Current Ratio

The current ratio also tells us how well a company is able to pay its obligations.

The formula for this one is different than what it was for quick ratio.

Current ratio is calculated by dividing current assets with current liabilities.

This means that we also include those assets that are not easily converted to cash.

The higher the current ratio is, the better.

There is no single number to be looking for, the current ratios vary from industry to industry.

If the number is less than 1, it means that the company is not able to pay its short-term

obligations well.

So if our company’s current assets are $1,500,000 and current liabilities are $1,000,000, our

current ratio is 1.5.

This is over 1 which means that we should be able to pay our short-term obligations

without problems.

Financial ratio #5.

Debt-To-Equity Ratio

The Debt-to-Equity Ratio shows us how much leverage a company uses.

It shows us how much of the company’s operations is financed with debt, and how much is financed

with owned funds.

The ratio is calculated by dividing total liabilities with total assets.

For example if our company has $1,000,000 worth of assets and $500,000 worth of liabilities,

the ratio would be 0.5.

This multiplied with 100 gives us 50%.

This means that our debt ratio is 50%, which means that half of our assets are financed

through debt.

If the ratio is less than 50%, more of the assets are financed through equity, if it’s

more than 50%, most of the assets are financed through debt.

Financial ratio #6.

Return on equity

Return on equity is a financial ratio that tells us how effectively company’s assets

are used to create profits.

You should compare the Return on equity with other companies.

For example S&P500 average long-term Return on equity is 14%, so if a company’s Return

on equity is 10 it is pretty bad.

If it’s over 20% it’s very good.

The formula for calculating this is dividing net income with equity.

If our company’s net income is $1,000,000 and the equity is $10,000,000, the return

on equity is 0.1 aka 10%.

So it’s less than S&P500’s average.

Financial ratio #7.

Return on investment

Return on investment shows us how efficiently an investment is doing compared to how efficiently

other different investments are doing.

So with this financial ratio you can compare whether or not you want to invest, and if

other investment possibilities are better.

The Formula for this ratio is the net profit divided by the cost of investment.

Let’s say that our company Orange has a net income of $1,000,000 and the investment

is $10,000,000.

The return on investment is 0.1 aka 10%.

Now our competitor Banana has a net income of $1,500,000 and the investment is $10,000,000.

The return on investment is 0.15 aka 15%.

So which company do you think is better to invest in?

Tiktaktiktak bananaaaa.

That’s correct!

Well done.

Financial ratio #8.

Return on assets

This financial ratio shows how profitable a company is relative to its total assets.

It tells us how efficiently the company’s assets are generating earnings.

The formula for return on assets is the Net income divided by the average total assets.

This ratio is useful for comparing companies in the same industry, and it also varies across

different industries.

So in this example our company Orange has a net income of $1,000,000 and average total

assets of $10,000,000.

This means that the return on assets is 0.1 aka 10%.

Financial ratio #9.

Earnings Per Share

Earnings per share shows a company’s profit divided by the amount of shares of common

stock.

The higher the company’s Earnings per share is, the more profitable it is considered.

There are many different formulas For EPS, but the basic formula is net income minus

preferred dividends divided by the weighted average common shares.

Weighted average means that you take the amount of shares this year plus the amount of shares

last year, and divide that by 2.

So if our company Orange had 110 shares last year, and this year we only have 90 shares,

the weighted average is 110 plus 90 divided by 2 equals 100.

If the net income is $1,000 and preferred dividends are $500, the earnings per share

would be $1,000 minus $500 divided by 100 shares, which equals $5 earnings per share.

Financial ratio #10.

Price-to-earnings ratio This financial ratio is used for valuing the

company.

It shows if the share price accurately represents the projected earnings per share.

Good thing that you now know what Earnings per share means, because the formula for price-to-earnings

is Market value per share divided by earnings per share.

So if our company Orange is publicly traded company, and the price of a share is $10,

and our earnings per share is $1, the price-to-earnings ratio is $10 divided by $1, which equals 10.

This means that you are investing $10 for every dollar of earnings.

This financial ratio also tells that how long it should take to get your investment back.

In our example it would take 10 years to get the $10 investment back.

The lower the P/E ratio is, the faster you will get your investment back.

Congratulations, now you know how to calculate ten different financial ratios for the stock

market!

There are dozens more, but I only included these 10 for now.

Comment down below if you watched this far and feel free to ask any questions, I will

answer all of them.

The good thing about financial ratios is that you don’t have to remember all these formulas,

because many websites calculate these ratios for you.

For example the website investing.com has a lot of different financial ratios for stocks

calculated, so you can check the link in the description if you want to see how your favorite

companies are doing.

While you don’t have to calculate everything by yourself, it is still important that you

understand what all these ratios mean, and how they are calculated.

Next week’s episode will be the last of this series, and it will help you to make

your first investment.

While you wait for that, you might want to check out my recent book summary on what Robert

Kiyosaki teaches about becoming an ultimate investor in his book Rich Dad’s Guide to

Investing.

Smash that subscribe button so you don’t miss out next week’s episode!

Have a nice day and I’ll see you later!