The crisis we are experiencing this year is generally affecting all investment markets. Except for certain raw materials such as oil or natural gas, all types of assets are suffering large losses that do not seem to stop. Even so, we do not have to see the situation as something bad, difficult times are where better investment opportunities arise. So today we are going to see 5 key metrics for your investment training to avoid making mistakes when investing in stocks.
Price/earnings ratio (P/E)
Let's look at the first metric of this investment training. The price/earnings ratio (Price/Earnings in English) is a metric that allows us to compare the value of a share against the profits generated by the company. This ratio allows us to measure whether a stock is overvalued or undervalued. In this way, if we see that a stock has a high P/E ratio, it tells us that the price of that stock is expensive in relation to the profits it generates, so we can consider it overvalued. If, on the other hand, we see that it has a low P/E ratio, it tells us that the price of that stock is cheap in relation to the profits it generates, so we can consider it undervalued.
Comparison of P/E ratios of Ford's main competitors. Source: Simply Wall.st.
This ratio helps us find undervalued stocks, but it must be interpreted judiciously. This is because a company's earnings are based on future or historical earnings data, making future results difficult to predict. Furthermore, the P/E ratio does not take into account profit growth, as does the following metric that we will explain in this trading training.
Price/Earnings/Growth Ratio (PEG)
The second metric we will analyze in this investment training is the price/earnings/growth (PEG) ratio. The PEG (Price-Earnings-Growth in English) is an improved version of the P/E ratio that, in addition to measuring the relationship between a stock's price and its earnings, also measures earnings growth. The PEG ratio gives us a more complete view of whether a stock's price is overvalued or undervalued by analyzing both current earnings and projected earnings growth.
Ford's PEG ratio for the last 4 years. Source: Zacks.
Therefore, a stock with a PEG ratio below 1 can be considered undervalued, given that its price is low compared to its expected earnings growth. On the other hand, with a PEG ratio above 1 we could consider it overvalued, since it may indicate that the share price is too expensive compared to the expected growth of its profits.
Price/book ratio (P/B)
Let's look at the third metric of this investment training. The Price/Book ratio measures whether a stock is overvalued or undervalued by comparing a company's net worth (assets – liabilities) with its market capitalization. Basically, the P/B ratio divides a stock's price by its book value per share. The P/B ratio is a good indicator of how much investors are willing to pay for each dollar of a company's net worth.
Ford stock P/B ratio. Source: Simply Wall.st
The P/B ratio is more useful the more it differs from 1. A stock trading with a P/B ratio close to 0,5 is good because it implies that the market value is equal to half of the company's book value. It is an optimal ratio to look for companies with a market value lower than their book value. By understanding the differences between market value and book value, we can identify investment opportunities.
Debt/equity ratio (D/E)
The debt-equity ratio (Debt/Equity in English) is the fourth metric that we are going to analyze in this investment training. This metric makes it easier for us to determine how a company finances its assets. The ratio shows us the proportion of equity to debt that a company uses to finance its assets. Therefore, if a stock has a low D/E ratio, it means that the company uses a smaller amount of debt for financing compared to equity. Conversely, if a stock has a high D/E ratio, it means that the company uses more of its debt financing relative to equity.
Movements in the last 6 years of Ford's D/E ratio. Source: Simply Wall.st.
If a company has a high level of debt, it can pose a risk if it does not have the profits or cash flow to meet its debt obligations. The D/El ratio can vary from one sector to another. A very high D/E ratio does not necessarily indicate that the company is poorly managed. Debt is often used to expand operations and generate additional profits. Some asset-intensive industries, such as automobiles and construction, tend to have higher ratios than stocks in other sectors.
Free Cash Flow (FCF) Ratio
Free Cash Flow is the last metric we will analyze in this investment training. This ratio measures the cash produced by a company through its operations, excluding expenses. Free cash flow is the cash left after a company pays its operating expenses and capital expenditures (CapEx). This ratio is useful to us because it shows how efficient a company is in generating cash. It is an important metric for determining whether a company has enough cash, after it has made operations and capital expenditures, to then reward shareholders through dividend payments and share buybacks.
Ford free cash flow with two-year forecast. Source: Simply Wall.st.
Free cash flow can be an early indicator to value investors that earnings may grow in the future, as free cash flow growth typically precedes increases in earnings. If a company has free cash flow rising, it could be due to growth in revenue and sales, or a reduction in costs. In other words, free cash flow growth could reward investors in the future, which is why many investors appreciate free cash flow as a good indicator of business health.
Conclusions from this investment training
After completing this investment training on stock analysis metrics, we have seen the usefulness of knowledge of these metrics to be able to choose which stocks to add to our portfolio. It should be remembered that these metrics are useful for comparing the performance of companies in the same sector, and that at the same time it is very useful to take advantage of the publication of results together with fundamental data such as these metrics to be able to operate on days where volatility makes an appearance. .