How to Read a Financial Statement (Part 2)

Debt Equity Ratio or Gearing Ratio 

Gearing ratio of a company will indicates how deep is the company with debt. Naturally, the lower the ratio, the better the company. If the company has a gearing ratio of 1, it means that the company has RM 1 debt for every RM 1 of it’s assets. In actuality, we do not want to invest in a company that has huge debt. Should anything bad happens, the company funds will be utilized to settle the debt first. This will left the investors with risks of losing their investment. However, as an owner of the company, the shareholders must realize that not all debts are bad debts. There are also necessary, good debts for a company to undertake in planning for expansion of their business in order to secure more profits in the future. So, if the company is high in debt, it is not necessarily bad.

Gearing Ratio   =       Liabilities (Short term + Long term)                                                Shareholders’ Fund                                      0.5  <  1.0  <  1.5                                      Better       > Worse

Net Tangible Asset (NTA)

Net tangible asset of a company allows us to calculate the net worth of a company. If the company’s worth is higher, chances are the company is doing well in its business. There are certain opinions that advise investors not to buy shares if its price is higher than the company’s NTA, unless the company is in the service or finance industries. In comparing share prices with NTA, we can also formulate Price to NTA ratio. Then, we can compare the ratios with other companies in the same industry.

NTA =     Shareholder’ Fund - Goodwill (if any)                            No of Ordinary Shares

Price to NTA =       Market Price of the Share                                                    NTA

Profit Margin

Profit margin simply connotes whether the company can maximize its profit by using the lowest cost possible. In a sense, a high profit margin company proves that the management of the company is competent in doing their job by minimizing its cost and on the other hand maximizing the profits.

Profit Margin (%)  =                Net Profit      X  100                                                   Revenue

Dividend Yield 

Dividend yield is the annual cash return by the company, given to the shareholders. It is also one of the most awaited announcement because higher dividend is derived from higher profit and higher profit resulted from the efficiency of the management in running the company. A company with average of 5% or more dividend per year is considered as a good company. Nevertheless, if the company does not pay dividend to its shareholders, it does not necessarily means that the company is bad. Maybe the company decided to keep its profit to accumulate funds for future expansion. This usually happens with newly listed companies which are still growing. Once it reaches its optimum capacity, they will start to pay dividends to the shareholders.

Dividend Yield (%) =      Dividend per Share           X 100                                        Market Price of the Share

These are the most basic and important financial ratios that any investors should know. Most of these information can be obtained from the company’s annual reports. But to skip all the hassle and hardship in obtaining the reports and extracting the info, I suggest that you should buy the Stock Performance Guide by Dynaquest as featured here. This book is published twice a year (March & Sept) and it compiled all the relevant info of a company in the FTSE Bursa Malaysia for the past 10 years. I myself use this book as a guide to filter the companies, choose which stock to buy, at what price should I buy and when to sell it.