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Saturday, November 29, 2014

Weekly Investment Term #6

If you have been mixing with people who are into investment, you will probably heard some people talking about buying stocks with good fundamentals or good prospects etc. There are also others who are looking into the technical chart to try and predict the market movement. 

Well, there is a way for you to answer some of the questions like:

a) How is the company being run?

b) Is it generating profits?

c) Is there a growth in the performance?

d) How does the company fare in comparison to the peers?

That way is what some people called: Profitability ratios

Profitability ratios measures the ability of a company to generate profits relative to sales, assets and equity. These ratios are useful to to measure a company's performance over the years and also in comparison to the peers. 

Here are 5 ratios that I would love to share with you today:

1) Gross Profit Margin (GPM) 

Gross Profit Margin (GPM) is calculated with the formula as shown with COGS equal to "Cost of Goods Sold". The GPM is not exactly a good indicator on the price of a stock but it's useful for one to analyze the financial health of the company. With a healthy gross margin, the company will be able to consider the operational cost, other expenses and also the ability to plan for the future. This ratio could be used to compare with other companies. Generally, a company with higher profit margins are viewed as being more efficient.

2) Net Profit Margin (NPM)

As for Net Profit Margin (NPM), one will take the net profit divide by the revenue. One can define this by saying NPM shows how much each dollar earned by a company is being converted into profit.

Generally, net profit = Revenue - COGS - Operating Expenses - Interest & Taxes.

Net profit margin varies from one company to the other but are generally at a certain range for different industry. With this knowledge, one will be able to recognize if a company's revenue is registering a healthy profit to the company or not.

3) Return On Equity (ROE)

Return On Equity (ROE) is defined as the amount of net income returned as a percentage of shareholders' equity.

Mathematically, this is the formula: Net Income/Shareholders' Equity.

ROE is quite an important indicator of a company's financial standing. The ROE is extremely useful especially in comparing other companies in the same industry. 

4) Return On Investment (ROI)

ROI is an important indicator on how efficient an investment is.

A simple calculation would be suffice to get the ROI.

Gain from investment generally refers to the proceeds obtained from selling the investment of interest. ROI is a very popular ratio being used because it's easy to understand and compute. Theoretically, the ROI that is negative are investments that should not be consider. 

5) Return on Assets (ROA)

This ratio is to show how is profitable a company in comparison to the assets of the company. This ratio helps investors to see how well are the assets being utilize to generate profit. 

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