Price-to-earnings ratio (P/E)
= Market price per share/Normalized Earnings per share (EPS)
As a general rule one should avoid buying a stock when it's P/E is greater than it's normalized earnings growth rate. It should be noted that market capitalization and thus price per share do not take into account debt. As such many investors favour EV as it considers the over-all capital structure of a company. Normalized earnings should be adjusted to account for non-recurring items, any interest expenses owed on convertible bonds and fluctuations present in the business cycle.
Median by Sector
Sector P/E Ratio (Long-term Median)
Consumer Discretionary 19.9x
Consumer Staples 24.9x
Information Technology 29.9x
= Market price per share/ Revenue per share(TTM)
P/S is useful for valuing early-stage, cyclical and turn-around companies where earnings may not be present. A P/S of < 1 indicates a company is selling for less than it's (TTM) revenue.
Median by Sector
Sector P/S Ratio (Long-term Median)
Consumer Discretionary 1.0x
Consumer Staples 1.3x
Information Technology 2.4x
= Enterprise Value(EV)/Earnings before interest and taxes
Buffett's rule of thumb is reputed to be < 10 x pre-tax earnings when buying companies though this should not be a fixed assumption. From an examination of Buffett's writings and speeches the author concludes that primary focus is to attain a >10% rate of return on investment.
Median by Sector
Sector EV/Long-term Median EBIT
Consumer discretionary 14x
Consumer Staples 17.4x
Information Technology 22.1x
Price-to-earnings to growth(PEG) ratio
= P/E ratio/Annual net income growth
"The P/E ratio of any company that's fairly priced will equal its growth rate" - Peter Lynch. Thus a fairly valued company will have a PEG = 1
Median by Sector
Sector PEG Ratio (Long-term Median)
Consumer discretionary 1.1x
Consumer Staples 1.8x
Information Technology 1.1x
= Market price per share/Cash flow per share
Price-to-book value ratio(P/B)
= Price per share/Book value per share
The P/B ratio can be distorted by share buy-backs and excessive debt and if tangible book value is used this ratio may not capture the value of intangible assets.
Median by Sector
Sector P/B Ratio (Long-term Median)
Consumer Discretionary 2.0x
Consumer Staples 2.7x
Information Technology 3.2x
= Earnings per share (EPS)/Price per share
This is the inverse of the P/E ratio. EPS figures can be distorted by share buy-backs and thus this should be considered when using both P/E and it's inverse Earnings yield. Aggregate figures such as Net Income and EBIT can be substituted to avoid these distortions.
Dividend yield ratio
= Dividend per share/Price per share
Ben Graham advised one should insist upon > 2/3 AAA bond yield (5 & 10 year recommended). In modern markets bonds and equities have become dislocated and thus this rule is no longer relevant.
Price-to-Free cash flow ratio(P/FCF)
= Market price per share/Free cash flow per share
P/FCF subtracts capital expenditures from operating cash flow to obtain a stricter measure for valuation. This is done as CAPEX is required to maintain and expand a company's asset base which in turn maintains or expands it's free cash flow.
= Enterprise value/Earnings before interest, taxes, depreciation and amortization
This ratio is useful for comparing companies which have differing debt servicing costs, tax obligations and rates of depreciation/amortization.
Median by Sector
Sector EV/Long-term Median EBITDA
Consumer discretionary 9.4x
Consumer Staples 12.5x
Information Technology 16.0x
Price-to-Operating Cash Flow
= Market price per share/Operating Cash flow per share
Median by Sector
Sector P/OCF (Long-term Median)
Consumer discretionary 9.5x
Consumer Staples 13.2x
Information Technology 19.5x
Magic Formula Yield (Inverse of EV/EBIT)
This is a relative valuation used for comparison but >10% should be considered a minimum benchmark.
Price-to-growth flow ratio (Useful for companies with large R+D spending)
= Market price/(Net Income + Fwd 1 yr R+D costs)
x 5 : Cheap
x 10-12 : Normal
x >15-20 : Expensive
Modified PEG ratio
= (P/E ratio)/(Dividend yield + Growth rate) x 100
The original PEG ratio doesn't take into account dividends and as such may not be suitable for companies where a large part of their earnings are distributed to shareholders in the form of dividend payments .
Profitability & Efficiency Ratios
Return on Equity ratio (ROE)
= Net Income/Shareholder's Equity
ROE can be distorted by write-downs, share buy-backs and excessive debt and thus this should be considered when using this ratio.
Return on Assets ratio (ROA)
= Net Income/Total Assets
Return on Capital Employed ratio (ROCE)
= Earnings before interest and tax(EBIT)/Capital employed(Total assets - Current Liabilities)
Return on Invested Capital ratio (ROIC)
= (Net Income - Dividends)/Total Capital
Free Cash Flow-to-Sales ratio (FCF/Sales)
= Free Cash Flow(FCF)/Sales
If one is looking for companies which may possess some type of economic moat one should look for companies that consistently achieve > 10%. This could be an indicator that a moat is present.
Return on Sales ratio (ROS)
= Net Income (Before Income and Tax)/Sales
Return on sales is a useful measure of value for loss making companies such as turn-arounds and start-ups where earnings are absent due to temporary problems or capital expenditure for growth.
Cash Conversion Cycle
= Days Inventory Outstanding + Day Sales Outstanding - Days Payables Outstanding
This is a relative figure, not an absolute. As such it should be used for comparison with historical and industrial averages.
Accounts Receivable Turnover
= Annual Sales/Accounts Receivable
Cash Return on Invested Capital (CROIC)
= Free Cash Flow/Invested Capital (Shareholder's Equity + Interest Bearing Debt + Short Term Debt + Long-term Debt)
Jae Jun of Oldschoolvalue.com likes to see a figure growing or consistently above 13%. He suggests that > 13% is a sign that a company may possess some type of economic moat.
= Total Annual Sales/Cost of Inventory
= Cost of Goods Sold/Average Cost of Inventory
The second method of calculating inventory turnover is more useful for comparison for two reasons. Firstly using COGS compensates for the fact that companies may have differing mark-up rates to sale price leading to an overstating of actual inventory turnover. Secondly using the average cost of inventory compensates for the fact that the sales of certain companies may be seasonal in nature.
Liquidity & Financial Strength Ratios
Debt/Equity ratio (D/E)
= Total liabilities/Shareholder's equity
Contrarian investor David Dreman thinks that <20% is a prudent figure.
Total Debt/Capitalization ratio
= (Short-term debt + Long-term debt)/(Short-term debt + Long-term debt + Shareholder's equity)
This ratio is more comprehensive than the standard D/E ratio as it considers the overall capital structure of a company.
= Current assets/Current liabilities
Companies with a current ratio < 1 have a negative working capital position. As a general rule I consider a current ratio of > 1.5 as a minimum requirement for desired liquidity though exceptions may be made for wide moat companies which consistently generate large amounts of free cash flow.
Operating Cash Flow ratio (OCF)
= Cash flow from operations/Current liabilities
This is a relative figure and so should be used for comparison.
Interest Coverage ratio
= Earnings before interest and taxes/Interest expenses
< 1.5 suggests concern shold be given to a company's ability to meet its interest expenses
= (Current assets - Inventory)/Current liabilities
This ratio is a stricter measure of liquidity than the current ratio as it focuses solely on the most liquid assets, namely cash and those assets which can be quickly converted into cash. For this reason it omits inventory since this can sit idle if a company's sales stagnate.
Cash Flow to Debt ratio
= Operating cash flow/Total debt
Cash Interest Coverage ratio
= Cash flow from operations + interest paid + taxes paid/Interest paid
< 1 signals immediate risk of default
Cash current debt coverage ratio
= Operating cash-flow - Cash dividends/Current Debt
This ratio considers management's dividend distribution policy and it's consequent effect on cash balance available for current debt obligations.
Funds flow coverage (FFC) ratio
EBITDA/(Interest + Tax-adjusted debt repayment + Tax-adjusted preferred dividends)
This ratio assesses the coverage of unavoidable expenditures. In order to adjust for taxes one must divide by the complement of the tax rate.
Sir John Templeton Leverage Ratios*
*Total Debt/(TTM) EBITDA (Templeton considered a ratio of < 3 to be a conservative benchmark).
*EBITDA Coverage ratio = Earnings + Interest expense + Taxes + Depreciation/Interest expense. (Templeton considered > 6 to be a conservative bench mark).
*Free cash flow-to-Short-term debt ratio
= FCF/Short-term debt
If the figure is < 1 the company doesn't generate enough FCF to cover it's short-term debt obligations.
= cash & equivalents / Short-term debt
This ratio expresses a company's ability to repay it's short-term creditors out of it's total cash. If the value is > 1.00 it means the short-term debt obligations are covered.
= (Assets Past Due 90 Days or More + Non-accrual Assets + OREO) / (Common Equity - Preferred Stock - Intangible Assets + Loan Loss Allowance)
This ratio was developed by Gerald Cassidy at RBC Capital Markets to measure the credit problems of banks. Cassidy noted that banks tend to fail when a ratio of 1 : 1 (100%) is reached.
Non-performing Asset (NPA) ratio
= Net Non-performing assets/Loans given
A higher ratio reflects a greater proportion of poor quality loans.
= (Incurred Losses + Expenses)/Earned Premiums
A combined ratio < 100% represents an underwriting profit for an insurance company. Conversely a ratio > 100% represents an underwriting loss.
Total Free Cash (TFC) ratio
= (Net Income + Accrued and capitalized interest + Depreciation and amortization + Operating lease and rental expense - Declared dividends - Capital expenditures)/(Accrued and capitalized interest expense + Operating lease and rental expense + Current portion of long-term debt + Current portion of capitalized lease obligations)
This ratio was developed by the First Interstate Bank of Nevada. It's usefulness lies in the fact that it takes into account off-balance sheet financing in the form of operating leases and rental payments.
Cash Flow Adequacy (CFA) ratio
= (EBITDA - Taxes paid - Interest paid - Capital expenditures)/(Average annual debt maturities scheduled over next 5 yrs)
The CFA ratio determines a company's credit quality. It mitigates the cyclical distortions present in the standard CAPEX ratio and accounts for the effects of balloon payments. Companies with strong FCF relative to their upcoming debt obligations are deemed a safer credit risk than those which must seek capital externally, ergo the higher the CFA ratio the higher the credit quality of the company.
= Net income - operating cash flow - Cash flow from investments/Total assets
= Enterprise value/ debt adjusted cash flow
This ratio is superior to the standard P/CF ratio which can be distorted by debt and leverage.
= Enterprise value/Barrels of oil equivalent per day(BOE/D)
This is a key ratio used by Oil & Gas analysts and should be used on a relative basis. If the multiple is high compared to a company's peers it is trading at a premium, if it is lower it is trading at a discount.
= Enterprise value/Proven + probable reserves
This ratio allows Oil & Gas analysts to calculate how well a company's resources can support its operations. Analysts tend to refer to proven reserves as P90 (those having a 90% probability of being produced), probable reserves as P50 (those having a 50% probability of being produced). A lesser used variation of this formula known at the EV/P3 ratio also takes into account possible reserves, known as P10 (those with a 10% probability of being produced)
= ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization / Total Liabilities] x 0.6) + ([Sales / Total Assets] x 1.0)
The Z-score is a statistical tool used to measure the likelihood that a company will go bankrupt. It is tailored toward manufacturing companies and functions as a gauge of credit strength. In general, the lower the score the higher the chance of bankruptcy.
Z > 2.9 is in the safe zone,
Z > 1.23 < 2.9 is in the grey zone
Z < 1.23 is in the distress zone
The Z-score can be modified for non-manufacturing firms by removing the last component, namely (sales / total assets), as Altman wanted to remove the intensive asset turnover found in manufacturing firms.