How to use company financials
When it comes to a company’s financial health the volume of available data can be seemingly endless, but there are several relatively simple metrics and ratios to help you make sense of it.
Australian companies typically report their financial results to the market twice a year, publishing huge documents full of numbers.
One of the standout figures is net profit after tax, which shows what a company has earned minus all expenses, charges, depreciation and tax during a specified period.
Further measures of earnings like EBIT, EBITDA and EPS also provide an extremely useful gauge of how a company is tracking, and then there’s insightful ratios such as price to earnings and dividend yield.
Here are four other metrics, included within CommSec’s company research pages, which many investors find useful:
Cash flow
A measure of how much money a company actually brought in during a given period, generally split into three categories: cash flow from operations; investing; and financing.
Net operating cash flow is arguably the most important as it’s the money a company generates from everyday business operations, minus money paid out to suppliers and staff, for example. This can be useful for assessing how solvent a company is and how much it has available to invest.
Book value and price to book
Book value is essentially what a company would be worth in the event of liquidation. That’s the value of all of its assets that could actually be sold (so not intangible assets like brand value and patents) minus liabilities.
A company’s price to book ratio is its share price divided by its book value. So if a company’s shares are trading at $2 and its book value is $1 per share, it is trading at a price to book ratio of 2.
This can be a useful indicator of how fairly priced shares are at any given time.
Net gearing
A measure of how much debt a company has as a proportion of shareholders’ equity, also known as its financial leverage. The higher a company’s net gearing, the more vulnerable it would be in the event of a slowdown in cash flow and earnings because it would still need to service its debts.
If a company’s cash exceeds its debt, its net gearing will be negative.
Net interest cover
This helps to establish how easily a company is able to service its debts by paying interest owed. It is calculated by dividing EBIT by interest expenses.
The lower a company’s net interest cover, the more its ability to meet interest payments may be called into question.
These are just a handful of the metrics that can be used to assess a company’s finances and suitability as an investment.
It’s important to note that these metrics are likely to vary greatly between companies in different industries and at different stages of their growth, which is why it is favourable to use various methods of analysis when considering share investments.