# Financial Ratios

Investors use financial ratios to gauge the worthiness of an investment. There are seven key financial ratios that investors should use when evaluating a company.

By using a combination of the ratios below, you can make a more sound investment decision.

##### Price to Earnings (P/E)

The price to earnings ratio is one of the most commonly used ratios. The ratio tells you the multiple that you’re paying for earnings per share. For example, if a stock is trading at \$20 a share and the company earns \$2 per share, the price to earnings ratio is 10. To calculate the P/E ratio, take the stock price and divide it by earnings per share. Most investors compare the P/E ratio to that of the S&P 500. If the P/E ratio is lower than the S&P 500, the stock may be undervalued and vice versa.

##### Price to Sales (P/S)

The price to sales ratio is generally used when evaluating unprofitable or high-growth companies. The ratio tells you the multiple that you’re paying for sales (or revenue) per share. For example, if a stock is trading at \$30 a share and the company generates \$5 of revenue per share, the price to sales ratio is 6. To calculate the P/S ratio, take the stock price and divide it by revenue per share. Most investors compare the P/S ratio to that of the S&P 500. If the P/S ratio is lower than the S&P 500, the stock may be undervalued and vice versa.

##### Return on Equity (ROE)

Return on equity measures the effectiveness of the company’s management using shareholder’s equity. For example, if a company generates \$200 million in profit and has \$1 billion in shareholders equity, the ROE is 20%. To calculate ROE, take the company’s profit and divide it by the shareholder’s equity. Generally, a ROE above 10% is considered good, but ROE should be compared to sector peers when analyzing a company.

##### Return on Assets (ROA)

Return on assets measure the company’s ability to generate income from its assets. For example, if a company generates \$200 million in profit and has \$2 billion worth of assets, the ROA is 10%. To calculate ROA, take the company’s profit and divide it by the assets. ROA will typically be lower than ROE because companies typically have a higher asset value than equity.