Top 5 Ratios To Use When Analysing A Stock

Here is what I believe. 

We are different individuals and thus, will have different wants and needs in life and thus, will invest differently. 

To me, I view stock investing as an act of building wealth over the long run from accumulation of shares of great businesses at their lowest possible stock prices. 

There are three key words: long run, great businesses and lowest price. 

First, the term ‘Long Run’ refers to a mindset of long-term share ownership and not attempting to reap trading gains for the short or mid-term. When I invest in stocks, I believe I’m (in a small way) a co-venturer of a business enterprise or an empire and I’m in it for the long-term. 

Second, the term ‘Great Businesses’ refers to stocks which have a solid resilient business model, have a great management team, and have a track record and a strong ability to continue to grow profits consistently for the long-term. They’re assets and grow shareholders’ wealth in the long run. 

Third, the term ‘Lowest Price’ refers to acquiring good stocks when their prices are trading at their lowest (and not when they are hot and exciting). It has a lot to do with common sense and logic as the investment approach is businesslike. 

With that, my personal top 5 ratios when assessing a stock deal is as follows: 

#1: Return on Equity (ROE)

Its formula is: 

ROE = (Shareholders’ Earnings / Shareholders’ Equity) x 100% 

ROE measures how efficient a stock is in generating profits per year from every $ 100 in shareholders’ equity. 

Let’s use Sheng Siong Group Ltd (SGX:OV8), a retailer in Singapore, as an example. In 2018, it has made as much as S$ 70.80 million in shareholders’ earnings and had reported a total of S$ 290.23 million in shareholders’ equity. Hence, its ROE is 24.39% and mean that it made S$ 24.39 in annual earnings from every S$ 100.00 in shareholders’ equity. 

ROE 2018 (Sheng Siong) 

= (S$ 70.80 million / S$ 290.23 million) x 100% 

= 24.39% 

In brief, the higher a stock’s ROE is, the more efficient it is in raking profits to its shareholders and thus, are preferred over stocks with lower or negative ROEs. 

#2: Debt-to-Equity (Gearing Ratio) 

Its formula is:

Gearing Ratio = (Non-Current Liabilities / Shareholders’ Equity) x 100%

Gearing ratio measures how reliant a stock is in using leverage on its operations at a single point of time. 

Back to Sheng Siong. As of 31 December 2018, it has reported S$ 2.92 million in non-current liabilities. Thus, its gearing ratio is 1.01%, indicating that it is a very low-geared company. It means, Sheng Siong is not reliant on debt to finance its operations or to expand its businesses. 

Gearing Ratio 2018 (Sheng Siong)
= (S$ 2.92 million / S$ 290.23 million) x 100%
= 1.01% 

In brief, stocks with low gearing ratio are preferred because they are financially more conservative and would incur less finance cost as opposed to high-geared stocks. 

#3: Price-to-Earnings Ratio (P/E Ratio) 

Its formula is: 

P/E Ratio = Stock Price / Earnings per Share 

It measures the price of a stock in relative to its earnings. 

From above, Sheng Siong reported S$ 70.80 million in shareholders’ earnings in 2018. It has issued 1,503.5 million shares and thus, its earnings per share works out to be 4.71 cents in 2018. The calculation is given as below: 

Earnings per Share 2018 (Sheng Siong)  

= Shareholders’ Earnings / No. of Shares Issued. 

= S$ 70.80 million / 1,503.5 million 

= 4.71 cents 

As I write, on 3 July 2019, Sheng Siong is trading at S$ 1.10 per share. Hence, it has a current P/E Ratio of 23.35. It means, if you buy the stock today at S$ 1.10 per share, you are essentially investing S$ 23.35 to make S$ 1.00 per year from this stock. 

Current P/E Ratio (Sheng Siong)

= S$ 1.10 / S$ 0.0471 

= 23.35 

In brief, I prefer to buy good stocks if they are trading at low P/E Ratio. Here, I’ll offer my personal definition of what low P/E Ratio is. They include: 

• Preferably Below 20.0.  
• Lower than its Multi-Year Averages (Can be 5 Years or 10 Years)
• Lower than Current P/E Ratio of its Peers. 

#4: Price-to-Book Ratio (P/B Ratio) 

Its formula is: 

P/B Ratio = Stock Price / Book Value of a Stock 

It measures the price of a stock in relative to its book value. It is one of the key valuation tool used widely by many investors.

What is the book value of a stock? Let’s use Sheng Siong. It has reported a total of S$ 290.23 million in shareholders’ equity and issued 1,503.5 million shares in 2018. Thus, the book value of a stock is S$ 0.19 per share, which is basically the stock’s shareholders’ equity on a per share basis. 

Book Value per Share 2018 (Sheng Siong)  

= Shareholders’ Equity / No. of Shares Issued. 

= S$ 290.23 million / 1,503.5 million 

= S$ 0.193

As such, based on current stock price of S$ 1.10 per share, it has a current P/B Ratio of 5.70. It means, its stock price is trading 5.7x its book value presently. 

Current P/B Ratio (Sheng Siong)

= S$ 1.10 / S$ 0.193

= 5.70

Likewise, I prefer to buy stocks with lower P/B Ratio over ones that have higher P/B Ratio. My personal definition of low P/B Ratio is as follows: 

• Lower than its Multi-Year Averages (Can be 5 Years or 10 Years)
• Lower than Current P/B Ratio of its Peers.  

#5: Dividend Yields 

Its formula is: 

Dividend Yields = (Dividends per Share / Stock Price) x 100% 

It measures the price of a stock in relative to its dividends per share (DPS). 

For Sheng Siong, it has paid out S$ 0.034 in DPS in 2018. Thus, based on current stock price of S$ 1.10, its dividend yield is 3.09% a year. If Sheng Siong is able to maintain its DPS at S$ 0.034 in subsequent years, you’ll receive a dividend yield of 3.09% per annum. 

Current Dividend Yield (Sheng Siong) 

= (S$ 0.034 / S$ 1.10) x 100% 

= 3.09% 

I prefer to buy stocks with higher dividend yields over ones that don’t. It makes sense for me to enjoy rewards for investing in stocks. Otherwise, I might as well use that money to pay off my mortgage or park in a fixed deposits (FD) account. My personal definition of ‘high dividend yield’ is as follows: 

• Above 5% per annum. 
• Higher than its Multi-Year Averages (Can be 5 Years or 10 Years)
• Higher than Current Dividend Yields of its Peers.  

Here is an E-Book discussing about 5 of our favourite dividend stocks that might interest you.

Conclusion: 

There you go: My top 5 Ratios when assessing a stock deal. 

They have served me well and hopefully, they would be of great help to you. 

You may use them to quickly screen through stocks and highlight the ones that you are interested to invest. From there, you can download their reports, study them, and do your due diligence in greater detail. 

All the best. 

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