Financial Ratio Analysis

Introduction

• Presenter: Brian Feroldi, a financial educator with 20+ years of experience.
• Objective: Learn 10 essential financial ratios to analyze businesses like a professional investor.
• Tool Mentioned: FinChat for analyzing ratios.

Balance Sheet Ratios

1. Current Ratio

• Formula: Current Assets / Current Liabilities
• Purpose: Indicates a company's ability to repay short-term obligations.
• Ideal Range: Above 1.5
• Example (Microsoft): Currently around 1.3, trending down from above 2.

2. Debt-to-Equity Ratio

• Formula: Total Liabilities / Shareholder’s Equity
• Purpose: Shows how a company is financed.
• Ideal Range: Below 1.0
• Example (Microsoft): 0.36, indicating more shareholder’s equity than debt.

Income Statement Ratios

3. Gross Margin

• Formula: Gross Profit / Revenue
• Purpose: Measures efficiency in converting revenue to gross profit.
• Ideal Range: Over 40%
• Example (Microsoft): 69.7%

4. Net Margin

• Formula: Net Income / Revenue
• Purpose: Efficiency in converting revenue to net income.
• Ideal Range: Above 10%
• Example (Microsoft): 36%

Capital Efficiency Ratios

5. Return on Equity (ROE)

• Formula: Net Income / Shareholder’s Equity
• Purpose: Efficiency in turning equity into profits.
• Ideal Range: Over 15%
• Example (Microsoft): Recent ROE around 37%

6. Return on Invested Capital (ROIC)

• Formula: NOPAT / Invested Capital
• Purpose: Efficiency in using total capital to generate profits.
• Ideal Range: Over 15%
• Example (Microsoft): 24%

Shareholder Return Ratios

7. Dividend Yield

• Formula: Total Dividend Payments / Market Capitalization
• Purpose: Shareholder's return from dividends.
• Ideal Range: Over 2%
• Example (Microsoft): 0.7%

8. Shareholder Yield

• Formula: (Dividend Payments + Net Buybacks + Net Debt Repayments) / Market Capitalization
• Purpose: Total return from dividends, buybacks, and debt repayments.
• Ideal Range: Over 3%
• Example (Microsoft): 0.7%

Valuation Ratios

9. Price-to-Earnings (P/E) Ratio

• Formula: Market Cap / Net Income or Share Price / Earnings per Share
• Purpose: Market value per $1 in earnings.
• Ideal Range: Below 20
• Example (Microsoft): 35

10. Price-to-Free Cash Flow (P/FCF) Ratio

• Formula: Market Cap / Free Cash Flow
• Purpose: Market value per $1 of free cash flow.
• Ideal Range: Below 20
• Example (Microsoft): 42

Conclusion

• These 10 ratios are crucial for evaluating a business’s investment potential.
• There are other ratios used by investors like Warren Buffett.
• Resource: PDF with Warren Buffett's financial ratios available at longtermmindset.co/buffett.