When evaluating stocks, the price/earnings ratio and the dividend yield are certainly the most popular and common. However, other key figures can noticeably improve the assessment. Read here what they are.
Rising interest rates and fears of a recession: There are a number of metrics that provide additional insight when evaluating stocks and are not difficult to determine. Investors should take advantage of:
1. Equity Ratio
Inflation is at a record high and so are interest rates. Because these are nothing other than the price for 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. Conversely, this means that it is an advantage if the equity ratio is high. This is calculated by dividing equity by total assets. Investors can find both of these on a company’s balance sheet.
2. Payout Ratio
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 results in a high dividend yield even if the share price has fallen sharply. In these cases, investors should act even more cautiously than usual.
Also, the dividend yield depends on how much of the profits a company earns as a dividend to shareholders. In Europe, a payout ratio of 30 to around 50 percent is considered appropriate. Telecommunications stocks in particular tend to pay out significantly higher quotas. However, this often means that the management lacks ideas on how to invest the existing capital in a sensible way.
It becomes worrying when the dividend is higher than earnings per share, i.e. the payout ratio exceeds the 100 percent mark. This is exactly what happens again and again, especially in the USA. In the corresponding cases, the companies pay part of the dividend from the substance, i.e. from the savings, so to speak. Or worse, they go into debt for it. Something like this happens more often with takeovers by financial investors. From time to time they urge the acquired company to pay out the highest possible dividend so that they can use it to finance the purchase price.
3. Free Cashflow
Free cash inflows are funds that are not used for either operations or investments. Free cash flow thus indicates how much money is available to pay off debt or pay dividends. The key figure thus reflects the financial strength of a company. While the dividend is often expressed as a percentage of earnings per share, it is paid out of free cash flows. The free cash flow can be found in the company’s cash flow statement.
4. Book-to-Bill-Ratio
More and more economists are assuming that Europe is headed for a recession, meaning that the economy will shrink in the coming quarters. That doesn’t mean, of course, 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) of a certain period, i.e. a quarter, half-year or fiscal year, to the sales (bill) achieved in the same period.
When orders exceed sales, the book-to-bill 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 decline in business.
5. Price to book ratio
Investors who rely on the substance of a public company like to use the price-to-book ratio (P/BV). This is calculated from the ratio of the price of a share and the corresponding equity (book value) per share. A value below one means that the corresponding share is listed 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, the KBV has a weakness. It only takes into account the equity shown in the balance sheet. Hidden reserves or burdens are left out.
6. Net Asset Value
This key figure is particularly widespread among real estate companies, which also regularly announce it with the quarterly results. The net asset value (NAV) results 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 rather high rating.
7. Cash to Market Cap
In the biotechnology sector in particular, there are currently a large number of companies that are worth less on the stock exchange than their cash reserves. Put simply, investors can buy such companies for less money than they have in the bank account. However, most of these companies are still making a loss, burning some of their cash.
P/E and dividend yield are easy to calculate and meaningful. Nevertheless, investors should consult other key figures in order to get a clearer picture of the assessment.
dr Michael Bormann is a tax expert and has been a founding partner of bdp Bormann Demant since 1992