Stocks Part 2 – Understanding the Numbers and Ratios (less basic)
In the previous installment I went over a glossary of stock terms, let’s continue our definitions. These terms are not usually the first numbers you see on a stock, but can tell you important information about how a company is doing.
Inst. Own – This is short for “institution ownership”, it tells you how much the company owns of its own stock.
Employees – Yes, you guess it, how many employees work for the company.
Operating margin – This ratio is found where you divide “operating income” by “revenues”. It tells you how much a company makes on each $1.00 of sales before interest and taxes. “Operating income” is calculated as “gross income – operating expenses – deprecation” (or how much profit is left after you take you operating expenses, but not interest and taxes).
Net profit margin – This is a ratio where you divide “net income” by “revenues”. It tells you how much of every $1.00 of sales the company keeps in earnings. If a company is losing money, then this number will be negative. It tells you also about how good the company is at controlling costs; this is particularly useful if you’re looking at two competing companies in the same industry. This is important because sometimes a company’s earnings could be going up, but if their costs are going up even faster (as a percentage of total revenue) the company is not necessarily getting healthier or stronger. “Net income” is similar to “operating income” but you also take out interest, taxes and other expenses. This is the bottom line of a company’s income numbers. Because you have more of the earnings taken out, it means that “net profit margin” will always be lower than “operating margin”.
EBITD margin – Short for “earnings before interest, tax, and depreciation”. There is also EBITDA “earnings before interest, tax, depreciation and amortization”. These are similar to the ratios above, just with more of the earnings left into the calculation.
Return on average assets – First of all let’s define the term “average assets”. For big companies, the amount of assets they have will constantly change throughout the year as they buy and sell property and equipment. Because of this, to get a firm figure “average assets” takes the average value of a company’s assets over the course of a year. “Return on average assets” is calculated by taking the net income and dividing by the average value of the assets. It tells you how efficiently a company is using its assets.
Return on average equity – Similar to the about definition, this is found by dividing net income by average equity (which is assets minus liabilities). It gets more to the meat of how well a company is profiting on what they own.
Carbon disclosure rating – This is a newer term that often doesn’t have enough data to create, but it’s meant to tell investors about the carbon emissions of a company.
Price/book ratio (or P/B ratio) – This is another nuance of telling investors whether or not a stock is overpriced or underpriced. At times, stock price can have large movements in a short period of time. The stock price can double or get cut in half in a short amount of time. Logically, does this mean that the company suddenly became twice as big or twice as profitable (or half as big or profitable) in that very short period of time? Usually not. This is a ratio that divides the company’s “stock price” by its net worth (i.e. “total assets – intangible assets and liabilities”). A lower ratio can mean that it’s undervalued, or it can mean that there is something fundamentally wrong with the company.
It’s always important to look beyond the numbers of a company to see what else can be driving the stock price. For example, if an oil company has a big oil spill, that disaster probably won’t have an instant impact on their bottom line. However, investors may sell out of the stock and if you didn’t know about the spill, you may initially see very low P/E and P/B ratios and think that the stock is underpriced. However, what the market has factored into the stock is what investors believe about how the oil spill could affect future earnings. Unexpected costs of cleanup, lawsuits, etc. are things directly impacting the company’s bottom line, but they are costs that won’t show up immediately.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.