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4 Important Financial Ratios That All New Investors Should Know About

Do you know these financial ratios?


If you want to enjoy financial independence and make good preparation for your retirement age, you have to learn how to invest responsibly. Wealth creation and wealth preservation are the key engines to achieve financial stability. Most  new investors give more importance to the wealth creation and completely overlook wealth preservation.

By making responsible future investments, you can easily achieve your wealth preservation targets as your investments grow in a sustainable manner. There are a number of ways in which you can make responsible investments to secure your future. You can invest in fixed deposits, corporate bonds, real estate portfolios, stocks and shares and investment-linked policies.

According to a recent BlackRock Global Investor Pulse Survey, Singaporeans rely too heavily on cash holdings in their investment portfolios. A typical investment portfolio for an average Singaporean investor comprises of Cash Holdings – 48%, Equities – 18%, Property – 8%, Bonds – 5%, and Other Alternatives – 3%.

The survey further reveals that the same trend is observed in other countries in this region. The Malaysians hold 44%, Indonesians 40%, and Thai 50% cash holding in their investment portfolios.

Important Terms to Know Before Learning the 4 Important Financial Ratios

If you are a novice investor, you need to familiarize yourself with the concepts of liquidity and barriers to entry before learning these 4 important financial ratios. Let us have a look at what these terms mean and how they can impact your business.

Liquidity

Liquidity refers to your ability to convert your assets into cash when the need arises. There are some assets that can be converted into cash easily, whereas others may require a lot more time to offload. For example, a stock investor will find it easy to sell his/her stocks purchased today within a week’s time. On the other hand, an investor who has invested in private property will find it hard to sell the property within a short period of time.

Barriers to Entry

When considering an investment option, you may need to fulfill certain prerequisites. For example, if you are considering making an investment in the real estate sector, you may be required to have at least 10-20% down payment to make an entry. These initial outlays can be termed as Barriers to Entry. Barriers to Entry play an important role in encouraging or discouraging investors to use a particular investment option.

While Barriers to Entry and Liquidity are the important concepts that you need to learn before looking at the 4  financial ratios, you cannot overlook the importance of research. Most of the novice investors listen to and follow the expert advice from their brokers or friends blindly. Such an approach may not deliver good results. Besides listening to the expert advice from your broker or friend, you should also consider doing your own research.

Let us have a look at the 4 important financial ratios and how they can help you make better investment decisions on the stocks that you want to invest in.

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# 1 Revenue Growth

The first important financial ratio every investor should know about is the Revenue growth ratio. This ratio shows whether the company has been growing at a decent rate over the years. As an investor, you should target a company that has been growing at a rate of 5 percent per annum over the last three to five years.

By going through company’s annual reports and by looking at industry or mainstream media publications, you will be able to get a pretty good idea about the annual growth rate. You can also use this data to predict the revenue potential of the company and how would it perform in the coming years.

#2 Net Profit Margin

Another important financial ratio every investor should know about is the Net Profit Margin of the company. You can calculate this ratio by deducting operating expenses, taxes, interest, and preferred stock dividends from the total revenue. The net profit margin shows the percentage of the revenue the company generates after deducting for these expenses.

If you want to be on the safe side, look for companies that enjoy net profit margins of 10% and above. However, businesses with 7% or above net profit margin are considered to be in the safe zone.

# 3 Return On Equity (ROE)

The third most important financial ratio that every investor should know about is the ROE or return on equity ratio. This ratio represents how many dollars of profit you will be able to generate from the company for each dollar invested. In other words, ROE reveals how much profit a company generates with all the money shareholders have invested in it.

A higher ROE ratio means a better performance by the company and vice versa. Look for companies that have a ROE ratio of 15% or above, as it is considered a good percentage.

# 4 Debt-to-Equity (D/E) Ratio

Lastly, another financial ratio investors should keep in mind before making any investment decision is the Debt-to-Equity ratio. This ratio is a reflection of the amount of debt used to finance a company’s assets and the relative proportion of shareholder’s equity. You can get this figure by dividing company’s total liabilities by the stockholders’ equity.

If you are an investor, you need to look for companies with D/E ratio of 0.5/1 or even lower. The lower the D/E ratio is, the lesser debt a company is saddled with.

Conclusion

Although there are a number of other financial ratios that you need to keep in mind before commencing a journey in investing, these 4 financial ratios are considered a benchmark while evaluating an investment venture.

Read Also: Step-By-Step Guide To Investing Better In Stocks

 

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