Teach Your Self Finance And Investment Basics

• Current Ratio – traditional analysis suggests 2 or greater but a very high number may reflect an inability to reduce inventory.
• Operating Cash Flow = EBITDA.
• Tobin’s Q is a ratio of the value of the firm to replacement cost and some think it a better measure than Book Value.
Multiples should be used along with their companion variable: PE with Earnings Growth; PBV with ROE; PSR with Net Margin; EV/Sales with Operating Margin. Each multiple should be compared with the average for the sector. If the difference cannot be explained by the fundamentals then the firm can be classed as undervalued. Firms in the same sector are presumed to have similar risk, growth, and cash flow profiles. PE/EPS Growth rate = Growth adjusted PE Ratio; PBV/ROE = Value Ratio; PSR/Net Margin = Margin adjusted PSR. Comparing with firms outside the sector can be done as follows: PE = Actual + EPS Growth + Payout Ratio (cash flow) + Risk (Beta); PBV = Actual + EPS Growth + Payout Ratio (cash flow) + Risk (Beta) + ROE; PSR = Actual + EPS Growth + Payout Ratio (cash flow) + Risk (Beta) + Net Margin.