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Understanding Financial Analysis in Investing

Friday September 09, 2016,

3 min Read

Investment is a roller coaster ride when you don't understand financial analysis. Terms like ROE, P/E Ratio and many others play a critical part in where and how investments take place. Understanding these terms gives you the ability to create our own judgements of the market rather than completely relying on someone else's. Thus, your financial investment decisions are in your own hands. Let's take a look at some of the major aspects that fall under financial analysis:

Market Analysis

The market price (or stock price) per share of a publicly traded company needs to be analyzed in order to make sure that the company is not over or undervalued. This can be done in 2 ways:

Price to Earnings Ratio (P/E Ratio): This ratio is created by comparing the stock price against the earnings per share (EPS). If the ratio is above the industry average then the company is overvalued. In simpler terms, this means that the investors are paying more for $1 of the company's earnings. If the ratio is lesser than the industry average then the company is undervalued and might be a good one to invest in.

Price To Book Ratio (P/B Ratio): The book price of a share is the actual accounting value of each share. When compared with the stock price of the share, you can figure how the shares are valued. Shareholders will be concerned with this ratio if the company is facing bankruptcy as they will be compensated the book price instead of the stock price.

Returns Analysis

ROI or Return on Investment dictates how much the investors generate by investing in a particular company. This criteria lets investors' know how the company is using the money invested in it.

ROE (Return on Equity) is one of the most common criteria of financial analysis. It shows the amount of net income generated for every $1 of the investors' money.

Profitability Analysis

The profit margin is the most popular way to measure a company's profitability. It shows how much profit a company is able to make for every $1 of sales.

Liquidity Analysis

This shows whether the company is able to pay it's debts back. Liquid assets (mostly cash) is a major decider in this category. Goods are partially liquid whereas assets like property, plant etc are not liquid as they are hard to convert to cash. As part of this analysis, debt-to-capital ratio is calculated along with the current ratio.

There are many other criterion that are to considered when performing a financial analysis of a firm. The many areas of financial analysis can be complicated to learn. Consider getting the help of a professional if you are confused or unsure.