2 crucial ratios to weigh up a company

Fsp Invest, 06 Nov. 2013

Tags: ratios, financial ratios, investing, net asset value, nav, return on equity, roe, what is net asset value, what is nav, what is roe, what is return on equity

Deciding on a company to invest in is no easy task. When it comes down to risking your cash in shares, you want to make sure that you’ve done all the necessary homework. There are two key ratios that can help you see through all the numbers and can indicate a company’s financial health and value. Let’s take a closer look at two crucial ratios to weigh up a company…

The following two ratios can give you a good idea of a company’s prospects and worth, Gareth Stokes in Fear, Greed and the Stock Market explains.

If both these figures are promising, then you may just have found a company worth investing in. You can then delve a little deeper.

Return on equity (ROE)

Return on equity (ROE) is a really important financial measure. It tells you how well the company is using the financial resources available to it.

In other words – what return is the company earning on your and other shareholders’ funds?

The simplest way to calculate ROE is to divide net income by total equity. You will find net income on the income statement and total equity on the balance sheet.

If the return on equity is insufficient for the risk associated with the business concerned, then you should seriously look for another avenue for your investment funds.

Net asset value (NAV)

The net asset value of a company is exactly that – what its assets are worth.

This is what the nuts and bolts of the company are worth once all liabilities are settled.

If the company had to cease operations today and sold off bit by bit – then the net asset value is what’s left.

A company usually gives its NAV on a per share basis. Companies include it in their financial statements.

You might be surprised to see the NAV of your favourite shares. This is because this number is way below the actual share price.

But remember, a company is worth much more as a going concern. The share price always reflects the future potential of the company rather than the sum value of all the individual parts.

So there you have it, two crucial ratios to weigh up a company.

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