We will go through three financial statistics that can help you analyze firms by looking at their stock price, profitability, and risk in the future, using basic examples.
Consider living in a city that is a miniature replica of a financial market. You have set your sights on two companies in which to invest. Anne’s bakery is one, while Pierre’s ice cream parlor is the other. To raise money, they each sell stock in their company. Anne wants to build a café and a pastry shop for her store, while Pierre intends to invest in new perfumes and kiosks in numerous swimming pools.
Anne has divided her “Chez Anne” bakery into 1,000 shares, each costing $43. She kept 250 and sold the other 750. There are constant lines to buy her croissants because they are so good. As a result, word got out among investors that the company would make money. As a result, she could sell the 750 shares not just a few months ago, but they are now worth $65.
Pierre, for one, has opted to sell 1,500 shares of his ice cream store “Gelato & Co” for $38 apiece. Because the weather forecast predicts elevated temperatures this summer, investors expect that consumers will eat a lot of ice cream and that the business will thrive. As a result, the glacier’s acts increased to $48.
When comparing the two companies, the P/E ratio can be helpful. You need to know the company’s earnings per share or net earnings for the last 12 months (earnings after expenses and taxes).
Last year, Anna made a profit of $21,500. She paid taxes of $1,070, manufacturing costs of $4,300, and dividends of $6,400. As a result, the net result is $9,600, resulting in a profit per share of $10. On the other hand, Pierre made $8,040, or $5 per share. The P/E ratio is calculated using the following formula:
The P/E ratio for Anne’s bakery is 6.6 (60/9), while it is 9 (45/5) for the ice cream parlor. The bakery’s lower P/E ratio could indicate one of two things: either the company is inexpensive or a better investment or investors anticipate it will lose value. A more excellent P/E ratio, on the other hand, could indicate that the company is overvalued or that investors anticipate more considerable earnings in the future. As a result, they are willing to pay higher costs presently.
More data should be examined to determine which company will perform better in the future. For the time being, we can compare their results. According to our records, Anne paid out $6,400 in dividends or $6 per share. Pierre gave out somewhat fewer shares, only $4 per share.
The “Chez Anne” bakery would take ten years of dividends to return your investment, whereas Gelato & Co. would take nine years. As a result, you will be able to recoup your funds more rapidly with Pierre. However, we presume that payouts remain constant yearly, which is only possible with bonds.
Divide debt or liability by equity, the total worth of all assets minus all liabilities. The debt ratio is used to calculate a company’s financial leverage. The balance sheet of the company contains this information. We described liabilities and balance sheets in this article if you do not recall them.
Businesses take out loans to expand. It can be a risky bet if its ratio is too high. However, if the ratio is too low, the company’s management may be overly cautious, and you may not earn a high return by not taking chances.
The “Chez Anne” bakery owes $12,000 to the bank. Her equity is $42,000, which is equivalent to the worth of her equipment, building, and everything she owns, less her obligations.
As a result, the debt ratio is 11,500/39,900, or 0.29. This indicates that debt accounts for only a minor portion of the company’s founding. It could take out more loans as a capital-intensive business, such as opening a second location or purchasing more ovens. Anne did an excellent job.
Gelato & Co has a 2.3 debt-to-equity ratio. The danger is substantially greater in Pierre’s case. Debt accounts for over two-thirds of its funding.