Stock market success: Investors should use these ratios

success in the stock market
Investors should take advantage of these metrics

A guest post by Michael Bormann

When evaluating stocks, the price-to-earnings ratio and the dividend yield are certainly the most popular and common. However, other key figures can improve the assessment noticeably. Read here what they are.

Rising interest rates and fears of a recession: There are a number of metrics that provide additional insight when valuing stocks and that are not difficult to determine. Investors should take advantage of:

1. equity share

Tax expert Michael Bormann

(Photo: Michael Bormann)

Inflation is at a record high, and so are interest rates. Because it is nothing but the price of borrowing money. Of course, the companies also feel this. The more debt you have, the greater the interest burden. In the current environment, it therefore makes sense not to have too much debt on the balance sheet. This means, conversely, that it is an advantage if the solidity is high. This is calculated by dividing equity by total assets. Investors can find both of these on company balance sheets.

2. Payment conditions

In principle, there is nothing wrong with the dividend yield. However, a high value can sometimes be misleading. The quotient of dividend and share price gives a high dividend, even if the share price has fallen sharply. In these cases, investors should act even more cautiously than usual.

The dividend yield also depends on how much of the profit a company earns as dividends to shareholders. In Europe, a payout ratio of 30 to around 50 percent is considered appropriate. Telecom stocks in particular tend to pay out significantly higher dividends. However, this often means that the management lacks ideas on how to invest the existing capital in a meaningful way.

It becomes worrying when the dividend is higher than earnings per share. share, i.e. the payout percentage exceeds 100 percent. This is exactly what happens over and over again, especially in the United States. In the corresponding cases, the companies pay part of the profit from the substance, i.e. of the savings, so to speak. Or worse, they get into debt for it. This kind of thing happens more often with takeovers from financial investors. From time to time, they encourage the acquired company to pay out the highest possible dividend so that they can use it to finance the purchase price.

3. Free cash flow

Free cash flows are funds that are not used for either operations or investments. Free cash flow thus indicates how much money is available to repay debt or pay dividends. The key figure thus reflects a company’s financial strength. While the dividend is often expressed as a percentage of earnings per share, it is paid out of free cash flow. The free cash flow can be found in the company’s cash flow statement.

4. Book-to-bill ratio

More and more economists assume that Europe is headed for a recession, which means that the economy will shrink in the coming quarters. Of course, this does not mean that every company will experience a drop in sales. Whether a company will grow or shrink in the future can be seen relatively reliably from the book-to-bill ratio. It compares the incoming orders (book) for a specific period ie. a quarter, half year or financial year, with the sales (bill) achieved in the same period.

When orders exceed sales, the book-to-invoice ratio is greater than one. For example, a value of 1.1 means that a company received 10 percent more new orders than sales in a given period. A book-to-bill ratio greater than one indicates growth, while a value less than one indicates a decrease in revenue.

5. ratio between price and book

Investors who trust the substance of a public company like to use the price-to-book (P/BV) ratio. This is calculated based on the ratio between the price of a share and the corresponding equity (book value) per A value below one means that the corresponding share is quoted lower than the equity attributable to it. So the stock is trading below the asset value attributable to it. The easiest way to calculate P/B is to divide market capitalization by equity. The lower the value, the cheaper a share is valued.

However, KBV has a weakness. It only takes into account the equity shown in the balance sheet. Hidden reserves or burdens are omitted.

6. Net asset value

This key figure is particularly widespread among real estate companies, who also regularly publish it with their quarterly results. The net asset value (NAV) is derived from the value of the property held less the debt. If the NAV per share exceeds the share price, the valuation is considered cheap. If it is lower, this indicates a fairly high rating.

7. Cash on hand at market value

Especially within the biotechnology sector, there are today a large number of companies that are worth less on the stock exchange than their liquidity reserves. In short, investors can buy such companies for less money than they have in their bank account. However, most of these companies are still making losses and burning through some of their cash.

P/E and dividend yield are easy to calculate and meaningful. Nevertheless, investors should consult other ratios to get a clearer picture of the valuation.

dr Michael Bormann is a tax expert and has been the founder of bdp Bormann Demant & Partner since 1992. In addition to taxes, his activities focus on the areas of financing advice and restructuring and crisis management for medium-sized companies.

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