High-Powered Investing All-in-One For Dummies, 2nd Edition

Chapter 3

Using Ratios as a Valuation Tool

In This Chapter

Understanding how ratios help your analysis

Interpreting and comparing specific ratios

As you gaze through the myriad numbers in financial statements, pretty soon eye and brain fatigue set in. After all, what do the numbers tell you? How do you take away any meaning from them — and quickly, because you don't have all day to address every number for every business you look at?

Are accounts receivable in line or not? Is the company's inventory scaled properly to the size of the business? What about fixed assets, debt, and profitability? Is the company using capital efficiently? And does its stock price make sense? How do you know? This chapter explains how to glean useful information from all the data. The secret: using ratios as a handy tool to make more sense of the numbers.

The Basics of Using Ratios

Applying ratios to numbers is like using a lens to bring them into clearer focus. Ratios explain the relationship between two or more numbers, thus providing you with scale and context.

For example, one major U.S. construction products manufacturer reported $204.1 million in inventory in 2012. That means little until measured against its $687.2 million in sales the same year. The inventory-to-sales ratio of 0.297 puts company ...