Accounting Ratios Important to Stock Investors - dummies

Accounting Ratios Important to Stock Investors

By Paul Mladjenovic

Stock investors need to pick up some rudimentary knowledge of accounting to round out their stock-picking prowess and to be sure that they’re getting a good value for their investment dollars. Ratios are helpful numerical tools that you can use to find out the relationship between two or more figures found in a company’s financial data. Ratios can add meaning to a number or put it in perspective.

Say that you’re considering a stock investment and the company you’re looking at has earnings of $1 million this year. You may think that’s a nice profit, but in order for this amount to be meaningful, you have to compare it to something.

What if you find out that the other companies in the industry (of similar size and scope) had earnings of $500 million? Does that change your thinking? Or what if the same company had earnings of $75 million in the prior period? Does that change your mind?

Two key ratios to be aware of are

  • Price-to-earnings (P/E) ratio

  • Price to sales ratio (PSR)

Every investor wants to find stocks that have a 20 percent average growth rate over the past five years and have a low P/E ratio. Use stock screening tools to do your research. A stock screening tool lets you plug in numbers, such as sales or earnings, and ratios, such as the P/E ratio or the debt to equity ratio, and then click! — up come stocks that fit your criteria.

These tools are a good starting point for serious investors. Many brokers have them at their websites (such as Charles Schwab and E*TRADE). Some excellent stock screening tools can also be found at Yahoo! Finance, Bloomberg, Nasdaq, and MarketWatch.