Analyzing Stocks – Market Cap, EPS, and Financial Ratios
Stock market analysts and investors may look at a variety of factors to indicate a stock’s probable future direction, up or down in price. Here’s a rundown on some of the most commonly viewed variables for stock analysis.
A stock’s market capitalization, or market cap, is the total value of all the outstanding shares of the stock. A higher market capitalization usually indicates a company that is more well-established and financially sound.
Publicly traded companies are required by exchange regulatory bodies to regularly provide earnings reports. These reports, issued quarterly and annually, are carefully watched by market analysts as a good indicator of how well a company’s business is doing. Among the key factors analyzed from earnings reports are the company’s earnings per share (EPS), which reflects the company’s profits as divided among all of its outstanding shares of stock.
Analysts and investors also frequently examine a number of financial ratios that are intended to indicate the financial stability, profitability, and growth potential of a publicly-traded company. The following are a few of the key financial ratios that investors and analysts consider:
Price to Earnings (P/E) Ratio: The ratio of a company’s stock price in relation to its EPS. A higher P/E ratio indicates that investors are willing to pay higher prices per share for the company’s stock because they expect the company to grow and the stock price to rise.
Debt to Equity Ratio: This is a fundamental metric of a company’s financial stability, as it shows what percentage of a company’s operations are being funded by debt compared to what percentage are being funded by equity investors. A lower debt to equity ratio, indicating primary funding from investors, is preferable.
Return on Equity (ROE) Ratio: The return on equity (ROE) ratio is considered a good indicator of a company’s growth potential, as it shows the company’s net income relative to the total equity investment in the company.
Profit Margin: There are several profit margin ratios that investors may consider, including operating profit margin and net profit margin. The advantage of looking at profit margin instead of just an absolute dollar profit figure is that it shows what a company’s percentage profitability is. For example, a company may show a profit of $2 million, but if that only translates to a 3% profit margin, then any significant decline in revenues may threaten the company’s profitability.
Other commonly used financial ratios include return on assets (ROA), dividend yield, price to book (P/B) ratio, current ratio, and the inventory turnover ratio.