Finance

Don’t buy shares without learning about these ratios


The Nigerian equity market has been one of the top-performing markets this year as its All-Share Index (ASI) is positive Year-to-Date (YtD) 20.28%. Interestingly, the Nigerian exchange has not traded at this level since September 2008, over 13 years ago.

The Nigerian stock exchange has seen significant growth, especially in 2020, when it recorded over 50% growth in ASI. In 2021, the exchange ended the year marginally bullish by 5.89%, despite a strong appeal for U.S.-dominated stocks. However, its performance in 2021 is relatively small, compared to the parabolic performance in 2020.

So far, in 2022, the ASI Year-to-Date (YtD) performance is bullish, with the Nigerian market being one of the top-performing emerging markets in Africa. This is because in YtD performance, the NGX is doing better than its peers like the Ghanaian Exchange which is down 10.53% YtD, and the Johannesburg Stock Exchange which is down 10.85% YtD and Nairobi Securities Exchange, which is also down 28.74% YtD.

The growth of the NGX in 2022 has been majorly a result of the improved financial performance of listed companies on the exchange. Although many argue that these improved financial performances is as a result of the double-digit inflation rate the country is facing, we still cannot ignore the fact that the market has been getting more traction, especially from local investors in recent times.

The market has also seen astronomical growth in its equity market capitalization since September 2008, when it recorded N9.83 trillion. Compared to the latest market capitalization of approximately 26 trillion, this represents a growth of 164.50% in over 13 years. This is a testament to the growth and increased participation in the market, through capital injection, by both foreign and local investors.

Financial Ratios and why they are significant

Financial ratios are created with the use of numerical values taken from financial statements to gain meaningful information about a company. The numbers found on a company’s financial statements, balance sheet, income statement, and cash flow statement, are used to perform quantitative analysis and assess a company’s liquidity, leverage, growth, margins, profitability, rates of return, valuation, and more.

Being that a major factor to the growth is improved financial performance by listed companies, it becomes difficult to actually know which financial ratios/indicators are very important, going beyond just the top line items of a company’s financials.

A major benefit of financial ratios is that they help track the changes in the values of companies over time and in turn, helps spot trends that may be developing in a company. For example, an increasing debt-to-asset ratio may indicate that a company is overburdened with debt and may eventually be facing default risk.

Another major benefit of Ratios is that they help comparative judgments regarding company performance. With ratios, it becomes easier to compare financial ratios with that of major competitors and this will help identify whether a company is performing better or worse than the industry average. For example, comparing the return on assets between companies helps an analyst or investor to determine which company is making the most efficient use of its assets.

Here is a look at some ratios to check for before buying a stock:

Price to Earnings Ratio (P/E)

P/E ratio is a type of valuation ratio. Valuation ratios generally rely on a company’s current share price and reveal whether the stock is an attractive investment option at the time. The P/E ratio is one of the most commonly used financial ratios among investors to determine whether the company is undervalued or overvalued. The ratio indicates what the market is willing to pay today for a stock based on its past or future earnings. It is gotten by dividing the price per share by the earnings per share.

Price-to-Book Ratio (P/B)

The price-to-book ratio compares a company’s market value to its book value. The market value of a company is its share price multiplied by the number of outstanding shares. The book value is the net assets of a company. It is used to compare a firm’s market capitalization to its book value. It is gotten by dividing the market value per share by the book value per share.

Current ratio

This is a type of liquidity ratio. Liquidity ratios help measure a company’s ability to repay both short- and long-term obligations. The current ratio measures a company’s ability to pay off short-term liabilities with current assets. It is calculated by dividing the current assets by the current liabilities.

Operating cash flow ratio

The operating cash flow ratio is a measure of the number of times a company can pay off current liabilities with the cash generated in a given period. It is gotten by dividing operating cash flow by current liabilities.

Debt ratio

This is a type of leverage ratio that measures the amount of capital that comes from debt. The debt ratio measures the relative amount of a company’s assets that are provided from debt. It is calculated by dividing the total liabilities of a company by the total assets.

Debt to equity ratio

The debt-to-equity ratio calculates the weight of total debt and financial liabilities against shareholders’ equity. It is calculated by dividing the total liabilities of the company by the shareholder’s equity.

Debt service coverage ratio

The debt service coverage ratio helps reveal how easily a company can pay its debt obligations. It is gotten by dividing the operating income by the total debt service.

Asset turnover ratio

This is a type of efficiency ratio. Efficiency ratios help measure how well a company is utilizing its assets and resources. The asset turnover ratio in question helps measure a company’s ability to generate sales from assets. It is gotten by dividing net sales by average total assets.

Inventory turnover ratio

The inventory turnover ratio measures how many times a company’s inventory is sold and replaced over a given period. It is gotten by dividing the cost of goods sold by the average inventory.

Gross margin ratio

This is a type of profitability ratio that measures a company’s ability to generate income relative to revenue, balance sheet assets, operating costs, and equity. The gross margin ratio compares the gross profit of a company to its net sales to show how much profit a company makes after paying its cost of goods sold. It is gotten by dividing gross profit by net sales.

Operating margin ratio

The operating margin ratio compares the operating income of a company to its net sales to determine operating efficiency. It is gotten by dividing the operating income by net sales.

Return on equity ratio

The return on equity ratio measures how efficiently a company is using its equity to generate profit. It is gotten by dividing net income by shareholder’s equity.



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