Top Stories | Mon, 16 Dec 2024 03:35 PM

Top 11 Metrics Every Equity Research Analyst Should Know

Posted by : SHALINI SHARMA

1. Price to Earning (P/E) Ratio:

The ratio of price to earning generally shows about the current share price of the company vis-à-vis its earnings per share (EPS). A higher P/E ratio generally means higher expectations from the investors regarding future growth. On the other hand, a lower ratio may indicate either undervaluation of the stock or trouble faced by the company. But it should also be compared to its industry peers or its historical averages to really make sense. Equity analysts must also look at the forward P/E (applying projected earnings) along with the trailing P/E (applying past earnings) for a proper analysis. 

2. Earnings Per Share (EPS):

Earnings per share (EPS) is the most significant measure of a company's profitability ratio, obtained by dividing net income by all the outstanding shares. It provides stockholders with an indication of the profit the company puts into each share. A higher EPS is generally interpreted to be a good signal as it shows better profits. Analysts also check diluted eps, which refers to the effect of future issuance of shares as per stock options or convertible securities. Even trends in EPS will give a good picture of the financial health and growth of the company in future terms.

3. Return on Equity (ROE):

Return on equity is a measure in finance to summarize the profit earned by shareholders' equity. ROE is derived from calculating net income divided by total shareholders' equity. A high ROE means high financial performance and efficient capital use. The use of Analysts in computing ROE makes this ratio more applicable and appropriate when comparing companies within the same industry since various industrial sectors have different metrics of reference. A good judgment is a high constant ROE, but all the time, check that it is not caused by excessive debt.

4. Debt-to-Equity (D/E) Ratio:

The Debt-Equity (D/E) ratio looks at the total amount of liabilities that a firm has against the shareholders’ equity. It illustrates how much liability level the company is enjoying as compared to equity base. High D/E ratio may suggest that the company relies much on the borrowing, which is considered to boost the company’s financial risk. On the same note, a low D/E ratio may be interpreted to mean under-leverage. It also helps analysts evaluate the risk of a company by comparing the D/E ratio during the fluctuations in the market or economic crisis time.

5. Price-to-Book (P/B) Ratio:

The Price/Book (P/B) ratio is arrived at by calculating the company’s market value over its book value – price that investors place on the company’s net assets. The company with P/B ratio below 1 could be considered undervalued, in contrast, the company with P/B ratio above 1 refers could be considered overvalued. Although, it is more effective for assessing industries with significant assets, such as banking or estate. P/B ratio is a widely used means of defining value investment opportunities by equity analysts but they do not restrict themselves to the P/B ratio alone as they also look at such factors as growth prospects and intangible assets which are not reflected in balance sheets.

6. Free Cash Flow (FCF):

The concept of Free Cash Flow (FCF) is an indicator of the actual cash flow which a firm generates after excluding capital expenditures on assets. This ratio is vital for measuring the extents to which a company has operational financial freedom in terms of financing expansion or paying out dividends or reducing on its debts. FCF greater than zero exhibits good value for operational efficiency while FCF less than zero may show a symbol of over investment or even declining profits. The reason is that analysts prefer FCF to the reported earnings in the ads because it is less affected by any accounting adjustment.

7. Dividend Yield:

Dividend yield signifies measurement of yearly dividend over price of stock stipulated in percentage. It is primary concern for income-focused investors, who want consistency in income. High dividend yield maybe an indication of a mature and stable company but can also signal the possibility of financial trouble if there is an unsustainable payout. For equity analysts, dividend yield becomes use for comparisons of companies in the same sector and analysis of whether the dividend policy of the company shares alignment with the prospect of long-term growth.

8. Beta:

A stock's volatility as compared to market is called beta. The stock is more volatile than market if from one, beta turns to higher value and vice versa when less than one. Analysts use beta when determining risk associated with a stock investment of a type and its behavior towards market wildness. It is one of the significant inputs towards determining cost of equity within valuation models like CAPM. Higher returns are expected from beta stock because a higher beta comes with higher risk, while lower returns are also expected from lower risk.

9. EBITDA Growth:

EBITDA Growth relates to the fluctuation in Earning Before Interest Tax Depreciation and Amortization in respect of the firm for a particular period. This measure demonstrates the efficiency of the functioning and cash generation ability of the firm. A firm’s EBITDA Growth Rate will show by how much in percent, the earnings of the firm have improved or declined from any other period excluding non-operating activities. Elevated EBITDA growth rate mean that the company has been able to improve operations efficiency, expand its business or increase its profitability level.

10. PEG Ratio:

The Price/Earnings-to-Growth (PEG) ratio extends the P/E ratio by including the predicted growth rate for the company’s earnings. A PEG of a ratio less than 1 means the stock is currently trading below what was expected given its growth potential while the upside is that a PEG ratio greater than 1 means the stock is priced high in relation to its growth potential. It assists the analysts to weigh between the valuation and the growth factors by giving them a more rounded picture of the business prospects. Though it might be most beneficial for growth stocks in technology or healthcare industries to name a few. 

11. Current Ratio:

Current ratio is a liquidity ratio, which is computed through division of current assets by current liabilities of a company. It shows how far short-term obligations can be met by using short term assets. Current ratio above 1 generally implies sound financial health; lower than 1 may signal liquidity problems. Current ratio as a metric is utilized in the analysis on how productive a business entity is as regards entailing current liabilities and availability of cash to be churned for possible short time obligations compared to its revenue generation prospect.

1. Why is the P/E ratio considering an essential metric for equity analysts?

The P/E ratio gives a glimpse of how much investors are willing to part with in order to get each dollar of earnings. It gives analysts a tool for ascertaining whether a given stock is valued too high or too low compared to some other stocks or its past performance. When looking at the P/E ratio the analysts can see what is expected of the stock in the future to perform either very well or very poorly. It’s one of the most common indicators to value a company, but it has to be supported by other indicators to provide information.

2. What does a low EPS indicate about a company?

A low EPS might indicate poor profitability, increased expenses, or declining revenues. This could also be due to increased shares outstanding, diluting earnings. But the low EPS would have to be compared with average industry standards and historical trends. It usually does not mean poor performance on the part of the company, as it can be a phase as a result of investments being made for growth or expansion in markets.

3. How does ROE help in comparing companies?

ROE enables superior study of efficiency being applied by companies in the same industry on the use of allies for profit production. Generally, higher shares of ROE usually indicate a better performance of management, along with a better capital utilization. However, the same should be ensured with an exception that higher ROE is not due to increased debt which would increase risk. Those trend observations of ROE determine the most consistent performance through time.

4. What does a P/B ratio below 1 signify?

P/B < 1 means that the company's market value is lower than its book value. Such a case would indicate undervaluation and hence an attractive buying opportunity. It may imply also possible underlying issues such as bad management or declining asset quality. Other financial ratios and industry parameters are then analyzed prior to drawing any conclusions

5. Why do equity analysts monitor trends in EPS?

Earnings per share (EPS) trends are used in assessing a company's profitability in time. An EPS consistently going up can translate to a better earnings performance, while a downward EPS trend would mean that things are not looking good for the company financially. EPS trends also indicate how strategic measures have influenced factors such as cost-cutting or opening up new markets. As EPS could be compared with the industry, it can help analysts determine how competitively positioned the company is.

6. How does FCF influence a company’s valuation?

Cash Flow is a company's direct value because they show the actual cash available for investments in growth, dividend payments, or debt-related payouts. Thus, such high levels of cash flow mean that the company runs effectively and is financially strong and, hence, one of the major influences for considering the company's attractiveness by experts into investors. Hence, financial analysts have decided to employ FCF based models such as Discounted Cash Flow (DCF) models to estimate a company value and find out whether stocks are undervalued or overvalued based on these computations.

7. Why is the PEG ratio considered more insightful than the P/E ratio?

PEG ratio takes into account expected earnings growth from a company into the definition of valuation and therefore makes it a better-balanced metric than just P/E. For example, a PEG ratio less than 1 indicates that the product is performing well in its growth potentials. The PEG ratio tells analysts an average stock may be equal to popular growth stocks or may be selling at a discount. Also, it is very valuable for sectors with high rates of growth, such as technology or health care.

8. What does a beta greater than 1 mean for an investor?

Beta of more than 1 is said to imply that the stock has a greater volatility than that of the market. It means that the price changes more than the overall market index. So, for an investor, a stock with high beta might earn him relatively more returns during upward movement in prices of the market but involves a greater risk during downward movements. The analysts also use beta to compute the risk profile of a specific stock against a diversified portfolio.

9. How does dividend yield help equity analysts evaluate stocks?

Dividend yield is a way of measuring the return on investment dividends with respect to price per share. It is especially relevant to those people who invest for the income and focus on achieving stable profit. A high dividend yield may reflect a mature, well-established enterprise of stable cash generating capacity; however, analysts need to know if that is sustainable. Using the dividend payout ratio together with yields assists analysts identify whether the firm is investing on growth or paying out its profits to its shareholders.

10. Why is it important for analysts to study industry-specific metrics?

Each industry has specific factors that can influence performance and which are not necessarily reflected by general indicators. For example, in retail, it is very important to have Same Store Sales, while for technology, parameters such as Active Users or Customer acquisition cost are more reckonable. Industry average ratios help the analysts to gain further information on the position of the company and the growth prospects of the company in the particular industry.