Another earnings season is underway, and traders will soon have access to more updated financial measures and metrics that they could ever want. But half the battle of trading during earnings season is understanding which numbers are important and what they actually mean.
Traders often need to look beyond the headline EPS and revenue numbers to understand what’s really going on inside a company. Here’s a look at five stock metrics every trader should understand.
New traders often focus too much on share price. From a valuation perspective, share count is also critical. A $1 billion profit is worth just 1 cent per share to a company with 100 billion shares outstanding.
Price-to-earnings ratio is a measure of the amount of money investors are paying per share for $1 dollar of earnings. In other words, PE is calculated by dividing share price by 12-month earnings per share. A low PE ratio suggests buyers are getting a good value.
There’s another part of the investing equation other than profits and price. Over the past 10 years, high-growth stocks have outperformed value stocks by a wide margin. The price-to-earnings-to-growth ratio, or PEG, is a metric that incorporates both value and growth.
PEG is simply PE ratio divided by a projected 12-month forward earnings growth. PEG ratio can help investors weed out profitable companies that have declining or stagnant earnings.
Some growth companies, such as Amazon.com, Inc and Netflix, Inc., are investing so much money back into their business that their earnings metrics may not be very impressive. Instead of relying on earnings per share, price to free cash flow incorporates free cash flow per share.
To calculate free cash flow, capital expenditures are subtracted from a company’s operating cash flow. Operating cash flow is the amount of cash flow generated by a company’s normal business operations. Price to free cash flow is a great metric to gauge growing companies that are aggressively spending their cash on scaling up their business and acquiring customers.
Sometimes, a stock may appear to hit all the growth and value targets that make it a great buy, but there may be a hidden danger. When times are good and the economy is strong, companies that rely heavily on debt to drive their business typically have nothing to worry about. However, when times get tough during economic recessions, credit markets can dry up leaving these companies stranded with major bills to pay and no sources of funding.
Debt to equity ratio is calculated by dividing a company’s total liabilities by its stockholders’ equity. In practical terms, it’s a measure of debt a company is using to pay for its business relative to how much the company is worth.
Most industries have key stock metrics that are specific to that industry, and they are often the most important metrics for traders to identify and monitor. For airline investors, its passenger revenue per available seat mile, or PRASM. For bank investors, its net interest margin, or NIM. For social media investors, its monthly active users (MAU) and average revenue per user (ARPU).
These measures are typically not included on lists of important stock trading metrics because they may only apply to a handful of companies within a given industry. However, you can bet traders of that handful of stocks are skimming right past a company’s revenue and EPS numbers and looking for these key industry metrics first.
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