3 Core Investment Ratios To Understand

With the financials of a company, you can determine whether the company has amazing potentials for investment success or whether it is a disaster in the making.

With investing, there is so much to consider and it goes beyond when you will get your projected or expected gains. Different elements work together to either increase the chances of your success or guarantee a complete loss.

This entire investment ecosystem cuts across the entire economic terrain, the political space, market trends like demand and supply and so on. However, one of the easiest to assess is that of the company itself.

With the financials of a company, you can determine whether the company has amazing potentials for investment success or whether it is a disaster in the making. While there are so many ratios to use to assess a company, the following three (3) ratios serve as a great place to start.

Price To Earnings Ratio

The Price to Earnings Ratio popularly known as PE Ratio is simply a comparison of the share price of any stock in comparison with its earnings or net profit over a period of time.

The price to earnings ratio is an amazing tool for the growth investor who is interested in tracking the growth of the company in terms of increased profit. It shows how much stock investors are willing to pay for each naira of profit made by the company.

With this ratio, you will discover the general demand for the company’s share by other investors (which is generally as a result of anticipated gains over time) and it also shows if the market is overvaluing or undervaluing the investments.

After computing the ratio, a great method of comparison is to use industry averages and benchmarks – likes with likes.

Return on Equity

As an investor of any company, you’re a shareholder of the company. One of the company’s core goals is to create wealth for its shareholders and this ratio is a great way to determine how well they have been doing that over a period of time.

This ratio helps you determine how well the company uses investments made by shareholders to generate earnings and grow. It directly measures the return shareholders get from the company.

This ratio is calculated by dividing net income by shareholders' equity. Equity here is computed by subtracting the company’s total assets by its liabilities. As such, it can also be regarded as return on net assets.

Note that for growth investments, which is really the most preferred option, it is normal for the company to reinvest its earnings to generate higher returns.

Dividend Yield

If your goal for investing is to make passive income, that is income investing, then this ratio is your prime concern. Dividend yield is simply the amount of money a company pays shareholders and can be computed by dividing the dividend paid per share by its share price.

You can also visit the Yochaa explore app to see pre-computed ratios of companies listed on the NSE spanning 6 years. The higher the dividend yield, the higher the chances of earning from the company.

Also note that a low dividend yield doesn’t mean the company is doing badly; it simply means they focus on reinvesting their dividends for growth.

Written by Lawretta Egba