An Introduction to Stock Trading Part 5 - Metrics

The Next Topic I am going to look at is Metrics - basically a few ways to look at a company and try and decide if they are going to be a good investment. It is worth pointing out that no metric can predict the future so they are mostly concerned with looking at the past but it is always important to do your own research so that you are happy with how you think the future is going to go. Never invest your money unless you are happy with where it is going.

Follow these links for earlier posts on Terms, Dividends, Corporate Actions and Types of Accounts

Earnings Per Share

The most basic measure of a companies performance is the earnings per share, this is simply the profit earned divided by the numbers of shares in circulation so for a company with 1,000,000 shares and £1,000,000 in profit then the EPS would be £1

Price Earnings or PE Ratio

PE Ratio is calculated as Market Price of the Share divided by the annual earnings per share (You can also predict a future PE by looking at the forecast earnings) this basically shows how much each pound of profit costs to the shareholders so for example if the above companies shares were trading at £10 per share then the company would have a PE of 10/1 The FTSE 100 average P/E is around 17 (Historically) Simplified a company with a higher P/E is considered by the market to be "Growing" where as a Lower P/E would show that the market thinks that the company has limited growth prospects.


Liability Ratio

The Liability Ratio is a measure of how well a company can survive in hard times, it is calculated by dividing Assets by Liabilities. For Example if a company has £1,000,000 of Debts and Liabilities but has £3,000,000 of Assets on it's books then it will have a Liability ratio of 3/1 and so the company will be seen as having a good viability over the short term, The acceptable Ratio is different for different industries (With perceived riskier industries needing a higher ratio) The Average ratio is between 1.5 and 3.

Return on Capital Employed (ROCE)

The ROCE is a measure of how effective a company is at utilising its capital. it is calculated as Earnings/Capital Employed so if a company has a profit of £1,000,000 for the year and has employed £500,000 then it has a ROCE of 2/1 (So it can earn £2 for every £1 it uses.)