Updated: Mar 8
I already have a section regarding Financial Indicators, how to pick a stock. This section covered basic indicators: P/E ratio, Dividend yield and Beta.
Please note that Financial Indicators should not be viewed in isolation. A company ticking most of the boxes for the specific sector should be a confirmation to your understanding of the company. In this section I want to go a little bit further into detail and investigate other fundamental indicators and give a basic understanding of the value of a stock.
I made use of TradingView, selected my criteria and can now view from the list possible companies I can invest in for a specified sector.
ROA determines how efficiently a company uses its assets to generate a profit. It is calculated by using a company's net income divided by its total assets. A higher ROA means a company is more efficient and lower means there is room for improvement. Make sure that you compare the ROA with companies in the same sector. Companies have different asset basis if you look at oil compared to retail.
A ROA of over 5% is generally considered good and over 20% excellent.
Return on equity (ROE) is the measure of a company's net income (sum of financial activity over 12 months) divided by its shareholders' equity (changes in assets and liabilities). ROE indicates a corporation's profitability and how efficient it is in generating profits.
A common shortcut for investors is to consider a return on equity near the long-term average of the S&P 500 (18.6%) as an acceptable ratio and anything less than 10% as poor. A good rule of thumb is to target an ROE that is equal to or just above the average for the company's sector.
Extremely high ROE is often due to a small equity account compared to net income, which indicates risk. The first potential issue with a high ROE could be inconsistent profits. Company A makes losses for a long period that is recorded in the Shareholders Equity and if the company turns profitable the Shareholders Equity is small and the calculation results in a high ROE. If a company has been borrowing aggressively, it can increase ROE because equity is equal to assets minus debt which decreases the Shareholders Equity.
A firm has a competitive advantage when its net margin exceeds that of its industry. Companies can increase their net margin by increasing revenues, such as through selling more goods or services or by increasing prices and reducing costs like finding cheaper sources.
When investing in a company, an investor wants to see it grow or improve over time. Comparing a company's financials from one period to another gives a clear picture of its revenue growth rate and can help investors identify growth potential. Also remember that some companies have cycles and that the results should be looked at over a period of several months.
Happy stock hunting ! 😊