Price-to-Earnings Ratio
When it comes to indicators, the P/E ratio is very popular with investors. It relates the current stock price to earnings per share relative to what is expected by market investors of a company’s future profitability. In general, every time the P/E ratio is greater than 20, it means there are high expectations for the company in terms of growth from the market. Historically, technology companies such as Amazon (AMZN) have traded above 50 price-to-earnings multiples. Banking companies are in the 10-15 P/E range, reflecting an expectation for more modest earnings growth.
If a company has a stock price of 100 yuan and the earnings per share is 5 yuan, this would translate to a P/E ratio of 20, meaning investors are willing to pay 20 RMB for every 1 RMB in future earnings. If the industry average P/E ratio is 25, and the company’s P/E is only 15, it could indicate that the market thinks very little about its future prospects or that the company may be undervalued.
Earnings Per Share
EPS (earnings per share) is a widely used metric that refers to a company’s profitability in the simplest terms. Apple Inc. (AAPL) earned $6.11 per share in the 2023 fiscal year, meaning that for every stock of Apple, shareholders received $6.11. Companies with high EPS tend to earn a lot of money, which attracts more investors to invest in these companies.
If a firm had 4 yuan of EPS last year and now has 5 yuan, that means earning power is up by 25%. The growth trend in EPS over recent years often helps investors evaluate how the company’s earnings may grow in the future. Consistency in EPS indicates stable operations and that the company is making money without much volatility.
Dividend Yield
The dividend yield is an important metric for investors to consider when evaluating the return on investment. In 2023, Johnson & Johnson (JNJ) had a dividend yield of 2.7%, meaning investors would receive $2.7 in annual dividends for every $100 invested. This makes such businesses particularly appealing to income-focused investors, especially in a low-interest environment where dividends become an important source of income.
However, a high dividend yield is not always a good sign. For example, if a company has a dividend yield as high as 8%, as seen in some energy companies, but the stock price continues to fall, the high yield could signal financial distress. Falling stock prices could erode the benefits investors earn from dividends. Therefore, investors need to balance the dividend yield with the company’s growth potential.
Price-to-Book Ratio
The price-to-book ratio (P/B ratio) compares a stock’s market value to its book assets. By 2023, Goldman Sachs (GS) had a P/B ratio of 1.2, indicating the company’s market value exceeded its book value. The P/B ratio is an important valuation metric for financial firms or asset-heavy industries.
A P/B ratio of less than 1 can indicate that the market value is lower than the company’s net assets, which could signal that the company might be undervalued. During market turmoil or declines in certain sectors, stocks like oil and coal may have a P/B ratio lower than 1. A low P/B ratio may also suggest financial difficulties or a lack of market confidence in the company’s future growth.
Free Cash Flow
Free cash flow is an essential measure of a company’s financial well-being. Alphabet, Google’s parent company, reported $60 billion in free cash flow in 2023, reflecting the firm’s ability to generate cash that can be returned to shareholders via stock buybacks or dividends, as well as put toward strategic investments and acquisitions. One key attribute to watch for is stable and growing free cash flow.
Some fast-growing companies, like Tesla (TSLA), may show negative free cash flow in their early stages when they are heavily investing in research and capital expenditures. Although these companies may not yet be free cash flow positive, they have the potential to provide long-term growth and increased market share. When analyzing free cash flow, it is important to consider the company’s development stage and the phase its industry is going through.
Debt-to-Equity Ratio
The debt-to-equity ratio calculates the relative weight of shareholder equity and financing from debt. By 2023, Microsoft (MSFT) had a debt-to-equity ratio of less than 0.6, indicating a stable financial structure that relies more on equity than on borrowing. In contrast, airlines like United Airlines (UAL) had a debt-to-equity ratio greater than 1.5, indicating a higher level of debt.
A high debt-to-equity ratio generally means that a company could face financial challenges during economic uncertainty or rising interest rates, as the company’s heavy debt load could become unsustainable. On the other hand, a lower debt-to-equity ratio means that the company has more financial flexibility to handle market fluctuations.
Return on Assets and Return on Equity
Return on assets (ROA) and return on equity (ROE) are important management efficiency metrics. In 2023, Apple Inc. posted an ROA of 12% and an ROE of almost 150%, signaling the company’s ability to efficiently use its assets to generate profits and return a larger portion of those profits to shareholders through equity. High ROE generally indicates a company’s strong profitability and effective capital utilization.
