Ratio analysis is a quantitative investment technique used to compare a company on a relative basis to the market in general. Changes in ratios can help signal important changes in the direction of the company's fortunes.
Examples of common ratios include:
The P/E ratio is the ratio of the current stock price to the current year earnings per share estimate when available, or, if not available, to earnings per share for the last 12 months. P/E ratios can vary widely among companies.
The acid-test ratio, or quick ratio, is used to measure corporate liquidity. The acid-test formula is stated as current assets less inventory divided by current liabilities. Normally, an acid-test ratio of 1:1 is satisfactory. However, an interruption or slowdown of cash receipts could spell trouble. Conversely, a company with a high acid-test ratio may not be using its capital effectively.
The debt-to-equity ratio is the relationship of a company's total debt to total shareholders' equity. It can be used to estimate the vulnerability of future earnings to variation.