facebookWhat are some financial ratios that we can look at to assess a company overall financial health? - Seedly

Chunarn Tay

04 Nov 2020

SeedlyAMA

What are some financial ratios that we can look at to assess a company overall financial health?

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Can list some ratios, but it's not straightforward science, I learnt something from a fellow investor, chiamster, about Piotroski F-score. It would give you a good grounding for analysing financial performance over time - the basis of calculating is whether the ratio for current year versus last year, if its better, then 1 point, if not 0 point.

The notable dimensions for the F score I recall are centered around

  • 1 point for improving profit margin (profit / revenue)
  • 1 point for improving operating cashflow (excluding change in working capital)
  • 1 point for lower total debt
  • 1 point if no new shares issued
  • 1 point for improvement in return on assets (total profit / total assets)
  • 1 point for improvement in asset turnover (revenue / total assets)

The rest I think you can Google, but captured the main ones.

My personal experience and thoughts while learning to be a value investor

1) I ignore p/e, p/bv ratios because I can't use the information. A very strong example I learnt before why Keppel DC reit has higher price over book value ratio compared to Mapletree Industrial trust - majority of KDC's data centers are built on freehold land that is more expensive, while MINT are mostly on 99 year lease. It's like comparing freehold condo to hdb.... Can't directly compare. 2nd example is its a good idea to strip out special items like gain on selling a building or revaluation because those aren't recurring items. That's why looking at p/e is not so useful at times because the earning haven't been adjusted for special items.

2) different industry has different debt ratios by standard. If you look at sgx price screener, DBS has higher debt than UOB or OCBC. I think Hong Leong finance is not using same standard as the big 3 to account for customer bank deposits as debt. it's true that customer bank deposits are the debts of banks. Still learning at this stage but I have yet to find my way of looking at banks' debt levels.

3) but it is universally true, the less debt a business has, the healthier it is. And not difficult to understand, if you got mortgage and high credit card balances to clear vs your peers, you would also feel scared during recession if you were to lose your job, right?

4) but some industries are practically built around debt... Eg banks, reits, property developers... So try to compare within industry but not across.

I would encourage you to look at the company like a future husband or son-in-law and just ask Common sense stuff

  • does he make enough to support the family or not have money problems (profitability, consistency of earnings, and debt levels)

  • is the money real and dependable? (we look at operating cashflow more than p&l, because you can own expensive cars, houses and whatever, but if you don't earn enough cash to pay it off, the banks are going to claim it and auction them)

  • if anything bad happens, can they tahan the crisis? (that's why we look at cash or current ratios, it's like checking how much emergency funds you have)

  • I use the Governance and Transparency index on SGX to rate them as well. It's a good score to see, personally I rate those with GTI score below 70 as either don't care whether they are presentable for formal events / interview, or possibly not so trustworthy, or just don't really give a s*t about things. if you know people like what I mentioned, they don't really turn out all that well as they go through life*

James Yeo

04 Nov 2020

Editor at SmallCapAsia.com

Some of the ratios that you can consider will be: Current Ratio, Cash Ratio, Net Debt to Equity Ratio.

The other important metric that you might want to consider will be Cash Flow from Operations, which determines whether the company will be able to generate cash from its business to stay operational for the long run.

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