Hey guys! Diving into the Philippine Stock Exchange (PSE) can feel like navigating a maze, right? Especially when you're bombarded with financial ratios! But don't sweat it; this cheat sheet is designed to simplify things and help you make smarter investment decisions. We'll break down the essential ratios, explain what they mean, and show you how to use them. Let's get started!

What are Financial Ratios?

Financial ratios are essentially tools that help you dissect a company's financial statements to understand its performance, health, and potential. Think of them as a doctor using vital signs to assess a patient. These ratios allow you to compare a company's performance over time and against its competitors. They fall into several categories:

• Liquidity Ratios: These measure a company's ability to meet its short-term obligations.
• Solvency Ratios: These assess a company's ability to meet its long-term obligations.
• Profitability Ratios: These indicate how well a company generates profits from its revenues and assets.
• Efficiency Ratios: These show how effectively a company is using its assets to generate sales.
• Valuation Ratios: These are used to determine the relative value of a company's stock.

Understanding these categories and the specific ratios within them is crucial for anyone looking to invest in the PSE. By using these ratios, you'll be able to pick out whether a company is financially robust, effectively managed, and reasonably priced. Remember, no single ratio tells the whole story, so it's important to look at them in combination to get a complete picture.

Liquidity Ratios

Let's kick things off with liquidity ratios. These ratios tell you if a company can pay its bills in the short term. Imagine you're running a small store; you need to have enough cash to pay your suppliers and employees, right? Same concept here!

Current Ratio

• Formula: Current Assets / Current Liabilities
• What it tells you: This ratio indicates whether a company has enough short-term assets to cover its short-term liabilities. A current ratio of 1 or higher generally indicates good liquidity. However, what constitutes a "good" ratio can vary by industry.
• How to use it: A higher current ratio suggests that the company is more capable of meeting its short-term obligations. But be cautious about excessively high ratios, which might indicate that the company isn't efficiently using its assets. For instance, they might have too much cash sitting idle instead of investing it.

Quick Ratio (Acid-Test Ratio)

• Formula: (Current Assets - Inventory) / Current Liabilities
• What it tells you: The quick ratio is a more conservative measure of liquidity because it excludes inventory from current assets. Inventory is often the least liquid current asset. This ratio shows if a company can meet its short-term obligations without relying on the sale of inventory.
• How to use it: The quick ratio can be more useful than the current ratio for companies that hold a lot of inventory, such as retailers. A quick ratio of 1 or higher is generally considered healthy. For example, if a company has a quick ratio of 0.8, it means they have 80 cents of liquid assets available to cover each dollar of short-term liabilities.

Solvency Ratios

Next up, we have solvency ratios. Solvency ratios help you understand if a company can manage its long-term debt. Think of it like this: Can the company not only pay its bills today but also manage its debts over the next few years?

Debt-to-Equity Ratio

• Formula: Total Debt / Total Equity
• What it tells you: This ratio indicates the proportion of debt and equity a company uses to finance its assets. It reflects the extent to which a company is relying on debt to fund its operations. A high debt-to-equity ratio suggests that a company is more leveraged and may face higher financial risk.
• How to use it: Generally, a lower debt-to-equity ratio is preferred, as it indicates a more conservative capital structure. However, what is considered an acceptable level can vary significantly by industry. For example, capital-intensive industries like utilities may have higher debt-to-equity ratios compared to technology companies. Always compare a company's ratio to its industry peers.

Interest Coverage Ratio

• Formula: Earnings Before Interest and Taxes (EBIT) / Interest Expense
• What it tells you: The interest coverage ratio measures a company's ability to pay interest expenses from its operating income. It indicates how comfortably a company can handle its interest payments. A higher ratio suggests that a company is in a better position to meet its interest obligations.
• How to use it: A general rule of thumb is that an interest coverage ratio of 1.5 or higher is considered healthy. A ratio below 1 indicates that a company may struggle to pay its interest expenses, which can lead to financial distress.

Profitability Ratios

Alright, let's talk about profitability ratios. These ratios show how well a company is making money. Are they just making sales, or are they actually keeping a good chunk of that revenue as profit?

Gross Profit Margin

• Formula: (Revenue - Cost of Goods Sold) / Revenue
• What it tells you: This ratio indicates the percentage of revenue remaining after deducting the cost of goods sold (COGS). It reflects a company's efficiency in managing its production costs. A higher gross profit margin suggests that a company can generate more profit from each dollar of sales.
• How to use it: An increasing gross profit margin over time is generally a positive sign, as it indicates that a company is becoming more efficient at controlling its production costs or is increasing its pricing power. Compare a company's gross profit margin to its competitors to assess its relative profitability.

Net Profit Margin

• Formula: Net Income / Revenue
• What it tells you: The net profit margin measures the percentage of revenue that remains after deducting all expenses, including taxes and interest. It reflects a company's overall profitability. A higher net profit margin indicates that a company is more efficient at managing its expenses and generating profits.
• How to use it: The net profit margin is a key indicator of a company's bottom-line performance. Like the gross profit margin, it's important to compare a company's net profit margin to its industry peers to assess its relative profitability. Significant fluctuations in the net profit margin should be investigated further to understand the underlying drivers.

Return on Equity (ROE)

• Formula: Net Income / Shareholders' Equity
• What it tells you: This ratio measures how effectively a company is using shareholders' equity to generate profits. It indicates the return that shareholders are earning on their investment in the company. A higher ROE suggests that a company is more efficient at generating profits from its equity base.
• How to use it: ROE is a widely used metric for assessing a company's profitability from the perspective of shareholders. A higher ROE is generally preferred, but it's important to consider the company's industry and financial leverage. A very high ROE can sometimes be the result of excessive debt, which can increase financial risk.

Return on Assets (ROA)

• Formula: Net Income / Total Assets
• What it tells you: ROA measures how effectively a company is using its assets to generate profits. It indicates how much profit a company is earning for each dollar of assets it controls. A higher ROA suggests that a company is more efficient at using its assets to generate profits.
• How to use it: ROA provides insight into a company's asset management efficiency. It's particularly useful for comparing companies in the same industry, as it normalizes for differences in asset size. Like ROE, it's important to consider the company's industry and financial leverage when interpreting ROA.

Efficiency Ratios

Now, let's dive into efficiency ratios. These ratios tell you how well a company is using its assets and liabilities to generate sales.

Inventory Turnover Ratio

• Formula: Cost of Goods Sold (COGS) / Average Inventory
• What it tells you: This ratio measures how many times a company has sold and replaced its inventory during a period. It indicates the efficiency of a company's inventory management. A higher turnover ratio suggests that a company is managing its inventory effectively.
• How to use it: A high inventory turnover ratio is generally a positive sign, as it indicates that a company is selling its inventory quickly and minimizing storage costs. However, an excessively high turnover ratio could also indicate that a company is not holding enough inventory to meet demand. Conversely, a low turnover ratio may suggest that a company is holding too much inventory, which can lead to obsolescence and storage costs.

Accounts Receivable Turnover Ratio

• Formula: Net Credit Sales / Average Accounts Receivable
• What it tells you: This ratio measures how quickly a company is collecting its accounts receivable. It indicates the efficiency of a company's credit and collection policies. A higher turnover ratio suggests that a company is effectively collecting its receivables.
• How to use it: A high accounts receivable turnover ratio is generally a positive sign, as it indicates that a company is collecting its receivables quickly and minimizing the risk of bad debts. However, an excessively high turnover ratio could also indicate that a company's credit terms are too strict, which could discourage sales. Conversely, a low turnover ratio may suggest that a company is having difficulty collecting its receivables, which can lead to cash flow problems.

Total Asset Turnover Ratio

• Formula: Net Sales / Average Total Assets
• What it tells you: This ratio measures how efficiently a company is using its assets to generate sales. It indicates how much revenue a company is generating for each dollar of assets it controls. A higher turnover ratio suggests that a company is effectively utilizing its assets.
• How to use it: The total asset turnover ratio provides a broad measure of a company's asset utilization efficiency. It's useful for comparing companies in the same industry, as it normalizes for differences in asset size. However, it's important to consider the company's industry and business model when interpreting the ratio, as some industries are inherently more asset-intensive than others.

Valuation Ratios

Finally, let's explore valuation ratios. Valuation ratios help you determine if a stock is overvalued, undervalued, or fairly valued compared to its earnings, book value, or sales.

Price-to-Earnings (P/E) Ratio

• Formula: Share Price / Earnings Per Share (EPS)
• What it tells you: This ratio indicates how much investors are willing to pay for each dollar of a company's earnings. It's a widely used metric for assessing a company's relative valuation. A higher P/E ratio suggests that investors have high expectations for the company's future growth.
• How to use it: The P/E ratio can be used to compare a company's valuation to its peers or to its historical valuation. A high P/E ratio may indicate that a stock is overvalued, while a low P/E ratio may suggest that it is undervalued. However, it's important to consider the company's growth prospects and industry when interpreting the P/E ratio. For example, growth stocks typically have higher P/E ratios than value stocks.

Price-to-Book (P/B) Ratio

• Formula: Share Price / Book Value Per Share
• What it tells you: This ratio compares a company's market value to its book value of equity. It indicates how much investors are willing to pay for each dollar of a company's net assets. A lower P/B ratio may suggest that a stock is undervalued.
• How to use it: The P/B ratio can be used to identify potentially undervalued stocks, particularly those with strong balance sheets. A P/B ratio below 1 may indicate that a stock is trading below its net asset value. However, it's important to consider the company's industry and profitability when interpreting the P/B ratio, as some industries may have lower P/B ratios due to the nature of their assets.

Price-to-Sales (P/S) Ratio

• Formula: Share Price / Revenue Per Share
• What it tells you: This ratio compares a company's market value to its revenue. It indicates how much investors are willing to pay for each dollar of a company's sales. The P/S ratio can be particularly useful for valuing companies that are not yet profitable.
• How to use it: The P/S ratio can be used to compare a company's valuation to its peers, particularly in industries where revenue is a key driver of value. A lower P/S ratio may suggest that a stock is undervalued relative to its sales. However, it's important to consider the company's profit margins and growth prospects when interpreting the P/S ratio.

Quick Tips for Using Financial Ratios

• Compare to Industry Peers: Always compare a company's ratios to those of its competitors in the same industry. This gives you a better sense of whether the company is performing well relative to its peers.
• Look at Trends Over Time: Don't just look at a single year's ratios. Analyze how the ratios have changed over the past few years to identify trends and potential problems.
• Understand the Industry: Different industries have different benchmarks. What's considered a good ratio in one industry might be terrible in another.
• Use Multiple Ratios: No single ratio tells the whole story. Use a combination of ratios to get a more complete picture of a company's financial health.
• Consider Qualitative Factors: Ratios are just one part of the puzzle. Also, consider qualitative factors like management quality, competitive landscape, and regulatory environment.

Conclusion

So, there you have it—your PSE finance ratios cheat sheet! I hope this guide helps you navigate the world of investing in the Philippine Stock Exchange with a bit more confidence. Remember, investing involves risk, and it's always a good idea to do your homework before putting your money into any stock. Use these ratios as tools to help you make informed decisions, and happy investing, guys!