There are a lot of measures to look at when studying a company. If you're foolish (with a small "f"), you might look at only one, such as the price-to-earnings (P/E) ratio. Fools (with a capital "F") will consider many measures, such as profit margins, cash from operations, earnings growth rates, and return on equity.
The more measures you learn about, though, the more confused you may become. So, try thinking about it this way: As you study a company you're thinking of investing in, there are two key questions that need to be answered by the information you gather:
- Is this a high-quality company that I'd love to own a piece of?
- Is the price right to buy it now?
Fools generally agree that it's best to invest in high-quality companies, but they put different emphases on the second question. To some, as long as you've got a terrific company, the price isn't that important. They reason that the company will keep growing -- and if it's overvalued now, it'll eventually grow into and surpass its price. To others, buying at a good price is critical to reduce risk and maximize gain. To just about all Fools, though, it's vital to understand a company's business and get a handle on its quality.
Conveniently, most company evaluation measures are related to either quality or price. Here's where some measures fall.
Company Quality: Sales and earnings growth, margins and margin growth, return on equity (ROE), return on invested capital (ROIC), leverage, inventory turnover, flow ratio, return on assets (ROA), product and service offerings, market share, competitive positioning, revenues per subscriber, proprietary technology or knowledge, brand strength, management savvy.
Stock Price (or Valuation): Market capitalization, enterprise value, price-to-earnings ratio, price-to-sales ratio (PSR), price-to-cash-flow ratio, price-to-book-value ratio, market-value-per-subscriber measures, and dividend yield.
Quality-related measures will help you understand how efficiently and profitably the company is run, how robust its financial condition is, and how quickly it's growing. Price-related measures will help you determine whether the stock is priced attractively or not.
Here's an overview of ROIC and ROE, with links to more information.
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