Shareholders need financial statements to evaluate their equity investments and help them make informed decisions as to how to vote on corporate matters. When evaluating investments, shareholders are able to glean meaningful data found on financial statements. There are a number of tools shareholders can use to make equity evaluations, and it is important for them to analyze their stocks using a variety of measurements. Available evaluation metrics include profitability ratios, liquidity ratios, debt ratios, efficiency ratios and price ratios.
Profitability ratios are a group of financial metrics utilized to gauge how well a company generates earnings. Return on equity, or ROE, reflects the percentage of shareholders’ equity returned as net income. This tool acts as a metric for profitability by showing the amount of profit companies generate with a shareholder’s investment. Operating profit margin is an important metric for evaluating the efficiency of a company’s financial management.
Price ratios focus specifically on a company’s stock price and its perceived value in the market. The price/earnings, or P/E, ratio is an evaluation metric comparing current share price of a company’s stock with its per-share earnings. Higher P/E values indicate investors expect continued future growth in earnings. The P/E ratio is most helpful when compared to historical P/E values of the same company, those of companies in the same industry or to the market in general. The dividend yield ratio shows the amount in dividends a company pays out yearly in relation to its share price. Essentially, the dividend yield ratio is a measurement for the amount of cash flow received for each dollar invested in an equity.
These and other evaluation measurements can be calculated using the figures on a company’s financial statements. Investors and market analysts depend on financial statements for equity evaluation. Evaluations are done using different measures because there is no single indicator that adequately assesses a company’s financial position and potential growth.