Understanding basics II.

- My favorite financial ratios

Previously I did a write up on the most basis numbers and ratios investors need to know HERE.

This time I would like to introduce you to my favorite ratios, which I don’t use only by itself, but also
as an instrument when comparing how the company is improving from QR to QR. If I see
improvements over the time I consider it as important factor when deciding if the stock is worth to
invest in. Another use is even before that, when comparing candidates from the same sector to select
the most promising one for further analysis.

These ratios are:

1] Current Ratio

This ratio tells as how much current assets company has against current liabilities, telling us how
financially strong in the short term the company is. Even more simplified explanation is how much
cash on hand they have and how much they will need to pay in a short term.

Example: you have cash RM 1000, but you will need to pay your utility bills of RM 300 and house rent
1200, your current ratio will be: 1000 / (300 + 1200) = 0.66… Since I use this simplified explanation I
don’t have to explain, you will be in a serious financial trouble in a short term.

Formula: Current Assets / Current Liabilities

Number above 1 is a must, anything over that - the more the better, ratio of 2 is already good.

2] Debt to Assets (or Borrowings to Assets)

For this one I use little bit non-conventional formula, inspired by (if I remember correctly) Peter Lynch.
Because traditionally is used formula with total all debt and assets, my formula using just short term
and long term borrowings, because other items under liabilities are not exactly “loan” which Im after
here. It means even when we calculate this formula you need to read it together with full financial
report and consider all items as for example receivables and inventories too. Every sector and even
company has different levels which can be considered acceptable or not, and its not so straightforward.

Formula: (Short Term Debt + Long Term Debt) / Total Assets

Interpretation of this ratio is not so straightforward, more useful for comparison between QRs and other
companies within the same sector. The smaller the number the better. Optimal below 0.5 or less.

3] Equity to Assets

Equity to Assets ratio in contrast to Debt to Assets is easy to read and interpret. It means – when I again
simplify it – how much of company assets is "owned" by shareholders.
Formula: Equity (total shareholder equity) / Total Assets

The higher the number the better. Low ratio usually means the company is not exactly financially stable
in the long term, most probably issues with high leverage / debt. High ratio close to 100% means
company is financed more with stock. Generally should be above 0.5, but it again depends on
individual stock and sector and it also helps with comparison against other stocks.

As a good example of well improving ratios see TOMEI

For more see my blog: http://miloshtrading.blogspot.com