Start With What You know: A Beginner’s Guide to Making Stock Investment Decisions

Better than consistency alone is consistency with a favourable trend. Growing profit margins, return on equity, asset utilization, and financial strength are all very desirable, particularly if valuation ratios (P/E and so on) haven’t kept pace. Value investors who study trends carefully have information that most investors don’t have.

 For many analysts, and especially credit analysts, who are trying to get a picture of a company’s health, a comparative analysis is the most important use of ratios. A ratio acquires more meaning when it’s compared to direct competitors, the company’s industry, or much broader standards, like the S&P 500.

A profitability measure, such as gross profit margin, reported at 25 percent tells more when direct competitors are at 35 percent plus.

These numbers tell you something without looking at any comparisons or trends. Want an early test for determining whether a ratio is good, bad, or ugly? hink of the company’s ratio as it would apply to your personal finances.

A household with 3 times as much debt as equity is in dire straits, as is a household that turns over inventory (say, groceries) only once a year, as is a household that achieves only a 2 percent return on its investments, or a household that’s owed a third of its annual income. You can’t apply this test to all ratios, but where common sense tells you something, use it!