What is Ratio Analysis?
Ratio analysis is the exercise of calculating various pieces of financial data in relation to one another.
How Does Ratio Analysis Work?
There are dozens of financial ratios out there. In fact, there are too many to list here in this definition. Some examples of ratios used in financial ratio analysis include the price-to-sales ratio:
Price-to-Sales Ratio = Capitalization/Annual Sales
Price-to-Sales Ratio = Share Price/Revenue per Share
One of the most famous ratios in finance is the P/E ratio, which is price per share/earnings per share.
The formula for the PEGY ratio is:
PEGY = P/E Ratio/(Earnings Growth Rate + Dividend Yield)
Why Does Ratio Analysis Matter?
Regardless of the investment method, however, ratio analysis is crucial to understanding an investment. After all, it is through ratio analysis that we detect whether a company is encountering difficulties paying the bills, taking too long to collect from customers, unable to pay its , whether its stock is overpriced, and a wide variety of other insights. The mathematics typically only involve simple division, but the insights they yield can be invaluable.