5 Best Profitability Investor Ratios For Successful Stock Picking

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Why are Financial Ratios Important?

By analyzing investor ratios, stock pickers can seek out winning companies for purchase and eliminate the duds. The major investment ratio categories include profitability, valuation, liquidity, and debt. Profitability ratio analysis explains whether the company is making and keeping more money today than in the past.

Valuation ratios uncover whether the firm seems to be fairly priced or not. Debt ratios uncover a company’s debt levels, and liquidity helps investors understand how much cash is available to run the business.

You might find a growing company that’s increasing profits, but if the firm is selling at an excessive valuation or has excessive debt, then your future profit potential is limited. This article will focus on the most important profitability ratios, why they are important, and how to evaluate them.

I was a portfolio analyst and stock picker. It was fun to dig into the financial statements of public companies and study investor ratios. Profitability ratios show how much of a company’s revenue remains after expenses are paid. Profitability ratios are exciting because, similar to home budgeting, the more money that remains after paying the bills, the more flexibility there is to grow the firm, reinvest in the business, or buy back shares.

Investment Ratio Research Tips

  • Compare profitability ratios within the same industry.
  • Notice profitability ratio trends. Increasing profitability ratios are best.
  • Also study valuation ratios and future growth expectations for a company.

Clearly, the more profitable a company is, the better. But, there’s more to investment ratios than choosing the company with the highest profit margin.

Comparing Financial Ratios Between Companies

When evaluating a stock to purchase, compare the profitability ratios to competitors within the same industry. The reason is because industry profitability ratios vary. A supermarket chain like the Kroger Companies (KR) typically has a 2% to 3% profit margin, while a tech company like Intel (INTC) might have a 20% to 30% profit margin.

If investors didn’t compare investment ratios with competitors within the same industry, they would only buy technology companies and not supermarkets. You can make money investing in all types of growing businesses with sound financial management.

Understanding profitability margins doesn’t mean that you always choose the firm with the highest ratio. Ultimately, you can make money by investing in companies with high or low profitability ratios if the firm’s future growth is strong and you buy shares at a reasonable price.

When performing investment ratio analysis for stock picking, the percentages or profit margins shouldn’t be considered in a vacuum. Understand the industry norms, the historical profitability ratios for the specific company, as well as current valuation, growth potential, and the industry. Then, compare financial ratios between companies within the same industry.

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Disclaimer: I am a former portfolio manager, former university finance instructor, and successful investor committed to sharing my personal finance expertise with you. I am not a licensed financial ...

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