RATIOS

The analysts, with their computers or electronic calculators, can compute a head-spinning number of ratios, many of which, like astrological symbols, can assume meanings of varying importance for different people. Ratios without explanation frequently imply a picture that, in view of changing conditions and other factors, may not be accurate in terms of the corporation’s actual operations. Ratios, like any statistics, are a still picture of a corporation frozen at the moment the picture was taken, while the corporation continues to move on. It’s extremely important that any ratio that differs from the industry norm, either up or down, is a signal for the need for elucidation and explanation.

The array of ratios is imposing. The ratio of current assets to current liabilities, if it is less than two to one, sends a red flag flying. If the debt to equity ratio is too high, the analyst immediately wonders about the drain on future earnings by debt payments. The ratio of return on total capital. The ratio of depreciation and depletion to sales. The ratio of earnings paid out in dividends to earnings. The price to sales ratio for smaller, high technology companies. And this is exclusive of ratios of various factors such as earnings, dividends, assets, and sales to the market price of the stock. Graham, in his book, Security Analysis, leans very heavily on ratios as a measure of company performance.

Theodore Pincus, retired chairman of the investor relations consulting firm, The Financial Relations Board and an investor relations pioneer, believes that the ratio of the price–earnings ratio to the company’s average growth rate over a specified period-the PEG ratio—is very useful to analysts. An average growth rate of 15 percent during the period studied, and a P/E ratio of 30, would give a company a PEG ratio of 2-to-1. Using PEG ratios for various companies, analysts can get a good sense of whether a stock is too high or attractively low. This is not the same, however, as the old adage about buying a stock selling for one-half its growth rate, and is infinitely more useful.