Equity Valuation and Portfolio Management

OVERVIEW OF TRADITIONAL METRICS

With numerous financial measures available, the investor is often left wondering which metrics are the most important to focus on. We address this metrics question by examining the information content of two well-known but seemingly distinct types of company and equity analyses—namely, traditional and value-based metrics (VBM) approaches to securities analysis. We begin our financial metrics journey with the traditional approach.

In the traditional approach to company analysis, there are several broad ratio categories. These categories include liquidity, activity, debt (leverage), and profitability measures. Within each category, there are several ratio choices. From the investor's perspective, growth rates and profitability measures are often combined with relative valuation measures (“multiples”) to assess the attractiveness or unattractiveness of a firm's common stock. As with the value-based metrics approach (discussed later), the end result of a traditional fundamental analysis on a company is a target valuation leading to a potential buy (or “overweight” relative to reference index), sell (“underweight” relative to index), or hold decision (benchmark weight) on a company's stock. Some widely used traditional measures of growth and profitability include:

• Revenue growth
• Earnings and cash flow growth
• Book value and asset growth
• Dividend growth
• Return on equity (reflects profitability)
• Fundamental stock return

Likewise, some key valuation measures ...