JoshFor non-accountants, poring over a corporate balance sheet is no easy task. It’s important to know which metrics warrant close scrutiny and which you can safely glaze over — at least, for the time being.
Let’s take a closer look at 10 important financial metrics and statistics. Note that some of these numbers aren’t directly relevant for private companies with public profiles, though they’re often available from private companies for those who know where to look. (Bloomberg Private Company Snapshots is a great resource; so is LexisNexis.) And they’re not the only pieces of information prospective investors and employees ought to understand before taking further action.
But, together, they lay out a strong starting point.
- Share Price
This one is familiar even to finance novices.
A company’s share price is, literally, the price of one share of company stock. Technically speaking, share price is the highest price a buyer is willing to pay (bid) for one share of company stock and the lowest price a seller is willing to receive (ask) for one share of company stock.
Share price rises and falls based on market sentiment. When investors feel more confident in a company’s prospects, and/or the tangible value of the company’s assets rise, share price rises too. When the opposite occurs, share price falls.
- Price/Earnings Ratio (P/E)
The price/earnings ratio describes the relationship between the price of a share of company stock and the company’s earnings. Specifically, per Joshua Kennon of The Balance, “[T]he p/e ratio is the price an investor is paying for $1 of a company’s earnings or profit.”
“In other words,” continues Kennon, “if a company is reporting basic or diluted earnings per share of $2 and the stock is selling for $20 per share, the p/e ratio is 10 ($20 per share divided by $2 earnings per share = 10 p/e).”
Complicated enough? Might be time to dust off that high school math textbook.
- Earnings Per Share
Just as it sounds: this is the company’s total earnings divided by its total outstanding share count. Since share price is a function of the number of shares outstanding, this is a more accurate reflection of the organization’s profitability.
- Dividend Yield
Not all companies pay dividends. Those that do have what’s known as a dividend yield: the ratio between the company’s annual dividend yield and its share price. Yield is subject to change with the underlying dividend rate and share price, but it’s a good measure of the passive rate of return on the company’s shares.
Moreover, though shareholder dividends invariably reduce resources available to invest in growth initiatives, yield is an important measure of the company’s fiscal health insofar as its management team feels confident diverting a substantial portion of its cash flow to individual investors. There’s a reason companies that consistently pay dividends are known as dividend aristocrats.
- Net Income
Net income can be positive or negative, of course. Positive net income means profit; negative net income means loss.
Don’t be too quick to write off loss-making companies. Organizations run in the red for lots of legitimate reasons, especially early in their lifecycles. Savvy researchers know that other metrics, including cash flow rate and cash on hand, are more predictive of the organization’s long-term trajectory. But net income still matters, especially for investors seeking immediate returns on their investments.
- Return on Equity
Per Investing Answers, return on equity is “a measure of profitability that calculates how many dollars of profit a company generates with each dollar of shareholders’ equity.” Divide net income by shareholders’ equity — the total amount of equity in the company’s outstanding shares — and you’ve got return on equity.
- Market Capitalization
Market capitalization is the measure of a company’s market value: the total currency value of all its outstanding shares. It’s easy enough to calculate: just multiply shares outstanding by current stock price and you’ve got your market capitalization figure. Of course, it’s subject to change with the whims of the market.
- Cash on Hand
A company’s cash reserve is an important measure of its financial health. Cash helps companies weather temporary setbacks: recessions, product failures, recalls, theft, legal disputes, and more. Companies with substantial cash reserves are generally in stronger strategic positions than companies with limited cash reserves.
Likewise, cash flow is crucial. Cash flow isn’t exactly a stand-in for profitability, but it’s an important measure of the rate at which a company is accumulating or burning through resources. With good reason, investors prefer companies with strong, consistent positive cash flows.
- Institutional Ownership
Institutional ownership measures the total share of a company (as a percentage of shares outstanding) owned by larger organizations rather than individuals: pension funds, major financial institutions and money managers, universities, charitable organizations, and the like.
By itself, institutional ownership doesn’t tell us much about the state of a company’s financial health. However, to the extent that institutional holdings represent a vote of confidence by “smart money” — i.e., financial professionals — in a company’s governance and long-term outlook, it’s a useful metric.
- Liabilities
In corporate finance, liabilities are the nemeses of assets. They detract from a company’s balance sheet.
While debt is an essential commercial lubricant, too much of it is bad. And not all debts are created equal. Companies with hefty long-term liabilities often face reckonings down the road, particularly if cash flow growth isn’t sufficient to compensate.
Looking Beyond the Numbers
Wherever you come down on the question of whether corporations are in fact people, you understand intuitively that for-profit organizations have a lot in common with living organisms.
They’re certainly complex enough. And they’re comprised of varying numbers of living, breathing humans whose actions have ramifications far beyond their cubicles, or open-plan offices, or coffee shops, or…you get the idea.
Anyone who believes that can learn everything they need to know about a company by looking at its balance sheet is sooner or later in for a rude awakening. You can’t truly call your company research done until you’ve gotten a sense of the organization’s less tangible attributes — its soft skills, if you will. Think people, values, missions, goals — and, of course, the qualitative aspects of whatever’s in its product pipeline.
Sound exhausting? Perhaps. But, just as you shouldn’t just a new acquaintance on first impressions alone, it wouldn’t be very polite of you to write a company off based on its stock price or cash pile.