Fundamental Analysis For Dummies, 2nd Edition

Chapter 8

Using Financial Ratios to Pinpoint Investments

IN THIS CHAPTER

Finding out how financial ratios let you quickly apply fundamental analysis

Discovering what the critical financial ratios are and how to calculate them

Uncovering how to interpret the P-E ratio to make investment decisions

Digging into how to measure and read how pricey the stock market is using its P-E

The financial statements, by design, give off an aura of orderliness. All the items are neatly arranged in rows and columns, giving the impression that finding everything you need to know is just a matter of flipping to the correct page and reading the number. If only it were that easy.

While accountants do a great job of recording a company’s financials in a tidy way, extracting the information you need for fundamental analysis gets a little messy. Reading the financial statements from top to bottom only tells you so much. To really take your fundamental analysis to the next level, you’ll need to learn how to put items on financial statements into perspective. That means taking a number from one financial statement and comparing it with another. Financial ratios are one of the best ways to do this. Ratios compare one financial measure with another to give you real insight into what the numbers mean.

In this chapter, I’ll show you some of the most critical ratios of the financial statements and how to apply them. Because it’s such an important ratio, I describe the price-to-earnings ratio in the most depth. ...