How to value a business before you invest?
Here are the standard ratios you should be aware of but not limited to, to decide on potential stocks:
1. Price to Earnings Ratio
The price-to-earnings ratio (P/E ratio) is calculated by dividing a stock’s share price over its earnings per share. This helps to compare the valuations across companies.
Equation: Stock share price / Earnings per share
2. Debt Equity Ratio
The Debt Equity Ratio is calculated by dividing the total liabilities of a company over the shareholders’ equity (equity is ownership).
Equation: Total liabilities / Shareholders’ equity
3. Price to Free Cash Flow
The Price to Free Cash Flow ratio is calculated by dividing the value of a company that is traded on the stock market (also known as Market capitalisation). Then calculated by multiplying the total number of shares by the current share price.
Equation: Market capitalisation value / total free cash flow (measure of how much cash a business generates after accounting for expenses)
4. Price to Book Ratio
The price-to-book ratio (P/B ratio) is calculated by dividing a stock’s share price over it’s net assets .
Equation: Stock share price/Net assets
5. Price to Sales
The price to sales ratio can be calculated by measuring what value investors put on a company for each pound of revenue generated by the firm by comparing the stock price with total revenue (income).
Equation: Dividing the stock price by sales per share
For example a low ratio may suggest the possibility of an undervalued company, whilst a high ratio may suggest an overvaluation of the company.
6. Price/Earnings to Growth ratio
The price/earnings to growth ratio (or PEG ratio) is calculated by dividing the price to earnings ratio by the earning’s growth rate. This will help to find companies that are potentially undervalued and give you an idea of the growth potential.
Equation: Price to earnings ratio / Earnings growth rate
7. Enterprise Multiple
The Enterprise Multiple ratio (or EV/EBITDA) can be calculated by dividing the enterprise value of a company by its EBITDA (Earnings before interest, taxes, depreciation, and amortisation). The EV/EBITDA ratio is used to firmly value a company, while considering the company’s debt. Amortisation is a process of paying off a debt over time through regular payments
Formula: Enterprise Value / EBITDA
The great thing about this ratio is that it takes debt into account. This is the one to keep in mind (very important).