Stock measurement

There are some common stock measurements that many individual investors use. You will not have to calculate most of them as they are available on newspaper, magazine and online. Of course, you can compute your own measurement by using data from financial statement of a company. Note that measurements of different publications sometimes do not match as they differ in reading and analyzing financial statement. So P/CF from Yahoo finance may not be the same as that of Google finance. Moreover, it is important to realize that stock measurements do not necessarily guarantee a good investment. Even if all your stock measurements give a green light, the stock may end up being a loss.

One of the common stock measurements is cash flow per share (CF/share). The idea is simple: Cash is always good. Cash flow is a stream of cash coming in and out of business. You will prefer it to be positive. Many businesses sell their goods/services on credit and most likely, those companies will report their financial statement based on accrual accounting. This means that a company will book its revenue on account receivable although cash has not been exchanged (or flowed in from company perspective). This is not necessarily bad or good thing as there are pros and cons for accrual/cash based accounting. One negative aspect of this method is if there are defaults, those receivables will be written off as bad debts. That is where CF/share kicks in as an important factor. Because if you solely rely on sales/earning based on financial statement, it can mislead you. Especially, earning is a subject to manipulation. In such case, a plenty of cash is very handy. If some unexpected events occur causing an expense, those cash comes in handy. In similarity, if there is a good opportunity to expand its business, cash can be very helpful. For instance, if a company A wants to acquire company B and B agrees to sell itself then A will have to come up with a bunch of payment options. It could be cash+stock. There is a plenty of reasons to reject it but cash only is a safe deal. CF/share is simply a company's cash flow divided by the number of shares outstanding. What it shows is the price you are paying for a share of the company's cash flow.

Current ratio is one of the key measurement to find a company's financial health. It reveals the company's ability to pay its short-term debts. Current ratio = Current Asset / Current Liabilities. For example, if company's CA is $4M and CL is $2M then current ratio will be 2 to 1. Current assets are company's assets that are used up and replenished frequently such as cash, inventory and account receivable. Current liabilities are liabilities that are due within one year or a business cycle. If current ratio is too small, a company might have hard time facing unexpected to expense, which can lead the company to insolvency problem. Note that it does not necessarily mean better when a company has higher current ratio. It is important that a company has enough assets and cash to meet its debt obligation but it is as much important to wisely utilize their assets and cash to increase the future earnings.

Dividend yield is company's annual cash dividend divided by current stock price. For instance, if a company's annual dividend is $1 and its stock price is  $25 then DY= 1/25 = 4%. This measurement tells whether the price you are paying is overvalued or not. For most companies, dividends remain constant over time. If there is a change in DY, it is most likely because of stock price change. If DY declines, that means denominator the stock price increased. As mentioned in the previous posting, investor can profit off the stock from dividends and capital appreciation. As an owner/shareholder of company, you share the profit of a company in form of dividend, If DY is too low, the stock may be overvalued.

Earning per share (EPS) is most commonly used measure for growth investors. EPS = Earning / number of shares outstanding. For instance, if a company earned $100,000 and the number of shares outstanding is 10,000 then EPS is 10. This number is quite big. Generally, EPS will fall within 1-5. It can also be negative if a company experiences loss. Obviously, stock is more attrack if EPS is high. But for growth investor, what is more important is probably EPS growth rate. If a company has higher EPS quarter after quarter or year after year, company is having earnings momentum. This is one of the ways to discover growing company. In addition, growth investor also pays attention to earning surprise, which is quarterly report from a company showing either higher or lower EPS than expected. Positive surprise usually causes a sharp increase in stock price whereas negative surprise does opposite.

Net profit margin (NPM) is another measure to evaluate a company's performance and how management does well on cutting expenses and keep most of its revenue. NPM = Net income / Sales. For instance, if net income = $100,000 and sales = $1M then NPM = 10%. Indeed, sales volume and total earnings are very importact factor in financial analysis. But at the same time, margin is equally important because it shows management ability to control business cost. If company A and B make the same sales but B keeps more of its sales than the A does, it is obvious that B is superior to A and should be a better investment (all other things being equal).

Price to Book ratio (P/B) compares a stock's market price to company's book value. P/B = Ps/Pb or total MV / total BV. Book value is the dollar value you get when a company is liquadated. For instance, if a company fails and sell all its factories, equipments, inventory then it gets $500,000. That is the total book value of a company. Say there are 100,000 shares of stock oustanding, then Pb=$5. If Ps = $5 then P/B = 1. This means even if a company goes bankrupt, investor will be able recoup his initial investment. So if P/B is less than 1, you can say stock is undervalued and purchase it since you have nothing to lose. Actually, you have a "margin of safety" in this case. Since price you are paying for is lower than the book value, you have some buffer to withstand when the stock price goes down until P/B hits 1. Note that P/B is more suitable risk-aversive investor because it measures market price in relation to liquadation value, which is probably the most worst scenario for all the companies out there. Note that book value does not accomodate intangible assets such as brand power and good will. Think about Coca Cola or McDonald. The values of those brand go beyond their equipments, factories, and any tangible assets.

Price to earning ratio (P/E) = Ps/EPS or Total MV / Total earning. This is the number one measure of value investors. If price of stock = $100 and EPS =5 then P/E = 20. This means you are paying $20 for every dollar earned by a company. Trailing P/E uses earnings from last 12 months whereas forward P.E uses next year's projected earnings. Generally, companies with low P/E usually operate in slow-growth or matured industry. Most young companies have high P/E over 20.

Price to sales (P/S) = total market value of stock / total sales or price of stock / sales per share. For instance, if a company's stock price = $50 and sales per share = 10 then P/S = 5. This means you are paying $5 for every dollar sale. If another company also has stock price = $50 and sales per share = 25 then P/S = 2. In other words, you are only paying $2 for every dollar sale. In this case, latter is a more bargain than the first one. Note that sales and earnings are not mutually exclusive. If you look at P/S then you should also pay attention P/E and EPS to make comparison among stocks.

Return on equity (ROE) is one significant measure. This shows the rate of return to sharesholders, which is ultimate measure of investment value. ROE = Net income / Total shareholders' equity. If NI = $1M and TE = 100,000 then ROE = 10%. Since ROE tells how much a company is making off the investments that shareholders provide, a larger % is always better.