Module 05 Understanding Ratio Analysis

Equity Edge

                                     Ratio Analysis

Decoding various Ratios

Ratio Analysis e.g. ICR, Debt Equity, Pat Margin, Debtors equity etc: Ratio analysis is a quantitative method of gaining insight into a company’s liquidity, operational efficiency, and profitability by comparing information contained in its financial statements. Ratio analysis is a cornerstone of fundamental analysis.

Step Wise DuPont Analysis: DuPont analysis examines the return on equity (ROE) analyzing profit margin, total asset turnover, and financial leverage. It was created by the DuPont Corporation in the 1920s.

Sharpe & Treynor Ratio, Alpha & Beta Analysis: The difference between the two metrics is that the Treynor ratio utilizes a portfolio beta, or systematic risk, to measure volatility instead of adjusting portfolio returns using the portfolio’s standard deviation as done with the Sharpe ratio.

Alpha and beta are standard technical risk calculations. They are used by investment managers to calculate and compare an investment’s returns, along with standard deviation, R-squared, and the Sharpe ratio. Both alpha and beta are historical measures.

PE, EPS, ROI, ROA Analysis: Price to Earnings, Earning Per Share, Return on Investment, Return on Assets.

Capital Budgeting & Cost of capital: Capital budgeting is the process that a business uses to determine which proposed fixed asset purchases it should accept, and which should be declined. This process is used to create a quantitative view of each proposed fixed asset investment, thereby giving a rational basis for making a judgment.

Capital Asset Pricing Model: The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

Weak form, semi strong form, and strong form market efficiency: Though the efficient market hypothesis as a whole theorizes that the market is generally efficient, the theory is offered in three different versions: weak, semi-strong and strong. The weak form suggests that today’s stock prices reflect all the data of past prices and that no form of technical analysis can be effectively utilized to aid investors in making trading decisions.

The semi-strong form efficiency theory follows the belief that because all information that is public is used in the calculation of a stock’s current price, investors cannot utilize either technical or fundamental analysis to gain higher returns in the market.

The strong form version of the efficient market hypothesis states that all information – both the information available to the public and any information not publicly known – is completely accounted for in current stock prices, and there is no type of information that can give an investor an advantage on the market.

Module 05 Ratio Analysis


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