TABLE OF CONTENTS Back in grade school, your teacher probably said something like, "One day you will need to know fractions. Trust me." Most likely, you figured this was a ploy to get you to do your homework. But your teacher was right.
Fractions under their grownup name, ratios are critical for financial statement analysis because they show relationships among the different elements of an income statement, balance sheet, and cash flow statement. This chapter introduces the fine art of ratio analysis, which is something professional investors spend a lot of time with. And for good reason. A correct interpretation of a ratio can shed quite a bit of light on an investment decision.
Of course, like any investment technique, ratio analysis is not foolproof. One ratio or another may well indicate that a stock is dangerous when the company is actually a good investment. Nonetheless, properly used, the technique can do a lot for your long-term prospects.
To make things more understandable, I've grouped the important financial ratios into the following categories:
Profitability ratios
Liquidity ratios
Activity ratios
Solvency ratios
Valuation ratios
Cash flow ratios
Simply put, a ratio is a comparison between two numbers. For example:
50/100 = 50 percent or 0.50
For most investment ratios, that's about as complex as things get. You won't need an advanced degree from Wharton to understand this stuff. But computing ratios can be very time consuming and downright boring. With online resources like Multex.com and Morningstar, you do not have...
