Owning Stocks

Common Measures of Value

Learning Objectives

1. Identify common return ratios and evaluate their usefulness.
2. Explain how to interpret dividend yield.
3. Explain the significance of growth ratios.
4. Explain the significance of market value ratios.

A corporation creates a return for investors by creating earnings. Those earnings may be paid out in cash as a dividend or retained as capital by the company. A company's ability to create earnings is watched closely by investors because the company's earnings are the investor's return.

A company's earnings potential can be tracked and measured, and several measurements are expressed as ratios. Mathematically, as discussed in Chapter 3 "Financial Statements", a ratio is simply a fraction. In investment analysis, a ratio provides a clear means of comparing values. Three kinds of ratios important to investors are return ratios, growth ratios, and market value ratios.

The ratios described here are commonly presented in news outlets and Web sites where stocks are discussed (e.g., http://www.nasdaq.com), so chances are you won't have to calculate them yourself. Nevertheless, it is important to understand what they mean and how to use them in your investment thinking.