Ratio Analysis: The KEY to understand Business and Investing | Uday Gehani | Skillshare

Ratio Analysis: The KEY to understand Business and Investing

Uday Gehani, Dedicated to make complex topics easy!

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11 Lessons (1h 4m)
    • 1. Promo Video

      2:04
    • 2. What is RATIO ANALYSIS?

      4:51
    • 3. The Different CATEGORIES of Ratios

      6:00
    • 4. LIQUIDITY Ratios: Can a Business survive in the short term?

      5:37
    • 5. SOLVENCY Ratios: Seeing if a Business is Sustainable

      5:03
    • 6. ACTIVITY Ratios: Measuring the Efficiency of a Business

      7:07
    • 7. PROFITABILITY Ratios: How much money is left over?

      9:42
    • 8. VALUATION Ratios: A look at the P/E Ratio

      6:46
    • 9. Ratio Information Sources

      9:42
    • 10. Second Level ThinkingSS

      6:03
    • 11. Saying GOODBYE (Sort Of!)

      1:06

About This Class

Have you ever wondered why so many people fail in running a business but some succeed? 

OR

Why do some get rich investing and others lose all their money? 

Well, if you meet many of the successful business people and Investors, the answer gets pretty obvious.

The ones who succeed have the knowledge - in particular, of the Numbers.  

They know how to easily read and analyze Financial Statements and make their business and investment decisions based on that. 

After all, it's only through understanding numbers can you understand the inner working of any business. 

Now, the funny part is, while this should probably be prerequisite learning for most Entrepreneurs before they start a business, most business owners don't understand them and many Investors avoid them.    

In this course, we take a deep dive into the numbers by learning Ratio Analysis. 

Understanding how a Ratio Analysis is done takes the knowledge of the numbers in Financial Statements to the next level. 

So join me in this course.  

If understanding a Business or Investing has ever seemed like a mystery to you, then I guarantee that learning how to conduct a thorough Ratio Analysis will illuminate the way you have looked at Businesses and Investments forever.  

Transcripts

1. Promo Video: Hi there. Welcome to my class. Learning how to do a complete ratio analysis in this class, I teach you how to use financial ratios to analyze any business, including your own. But to fully understand this class, you will need some basic knowledge about financial shape, which I'm sure you have seen my other still check class on understanding Financial Street. So if you have a watcher set aside some time to go through that one first, and if you do have a basic understanding of foul financial statements, work well then let's move on. If you're a business owner, a financial analyst or in investor, you probably already know how important reading financial statements is. But there's a difference between leading financial statements and truly understand why. Because financial statements by themselves can be deceptive. They give off in order. Off order leans by design all items on the arranged in rows and columns, giving most people the impression night Hey, understanding of businesses as devious, simply leading the finances that finding everything you need to know is just a matter of flipping to the correct bridge and eating the numbers. What if only anything in life was that these Is it any wonder that people lose so much money on investments or so many people failing business despite the neighbors read financial statements. So while accountants do a great job of recording a company's financials and a tiny bit your job if you truly want to understand the business, I used to know how to perform a ratio analysis. Since simply leading financial statements from top to bottom can only tell you so much. Learning this skill will teach you harbor sport trends in any business. Find any here initials, which are otherwise extremely difficult to spark, give you benchmarks on any industry and measure how business stacks up against any of its competitors. So thank you so much for watching this video. I hope you decide to take this journey with me and I will see you on the inside. 2. What is RATIO ANALYSIS?: one of my favorite supervillains is the Riddler. You know from Backman. How if you don't know who they realize, What in the world are you doing, Buddy? Stop this lecture series right now and go watch a Batman movie. That stuff is pretty important, you know. But if you don't know who the Riddler is, you can continue and find out what the Riddler has to do with ratio analysis. Hi there and welcome to our deep dive into ratio analysis. So let's start by asking this question. What's a racial? Well, if you're familiar with some basic Matt, the new probably already know that Simply put financial ratio means taking one number and dividing it violent. There are hundreds of financial ratios you can calculate with your financial statements because, after all the just division problems. But what's the point? Well, in the context of business US water ratio analysis can do, it allows you to take full numbers taken from companies, financial statements, divide them together and gain insights into our businesses performance. How cool is that? Let me show you what I'm Let's see Martians Computer shop at $100,000 in current assets and $50,000 current liabilities. By the end off your 2021 you can take the 100,000 current assets and divided by the 50,000 current liabilities, and you come up with the number two now. This means that the business has two times the number of current assets. Worse is its current liabilities. Or, put another way, the business has $2 current assets for every $1 off current library. This is so important than let me repeat it. The number two signifies that the business has $2 in current assets for every $1 off current liability. Well, now in your head, you may think that the business is doing great, but the Sherlock Holmes that you are, you know that things are not always what they seem at the surface, and you obviously decide to investigate this further. So you look at the last year's finances treatments and look at the current assets off 145,000 and you're divided by the current liabilities of 60,000 and you come up with the number 2.42 Certainly, in comparison, the current ratio for 2021 doesn't look so great. Why? Because you notice that the current ratio declined in 2020 you had $2.41 for every dollar in current liabilities. Now you only have to. So what happened? Why did the current ratio go down? Well, the current assets fell in comparison to current liabilities. But the question is, why did the cash balance decline current assets? If so, why did the company take on some sort of short term debt and increase its current liabilities? If so, why? What did the company use the cash for their use? It increase expenses, ordered user to invest in another asset, which will bring the company more money in the future. See how many questions or, let's say, the news, just a simple drop in a number East. So, like the great super villain, the Riddler, the object off a good ratio analysis is not only to do the mat, but to raise questions questions, which you need to answer. Now. We have only spoken about one ratio as an example, but imagine doing that were dozens of ratios taken a step further, you can then compare companies current ratio to its direct competitors or even larger corporations for greater insight. This technique provides you superpowers and increases your understanding off any business it can make. All the difference in your analysis are in this turning off any business, improving investment results and offer much more clarity to your decisions. That's how you get to understand inner workings off a company to racial analysis, and that's the topic of this section. And to put your mind at ease. Looking into many of these ratios involves some work, but you can find many of them calculated for you and displayed on several major online financial portals. I will walk you through some of my favorite online sources later in the section, but first, I want you to learn more about racial analysis, this report, your it and wanted to other people who don't put the working. So thank you so much for joining me in this lecture. I will see you in the next one 3. The Different CATEGORIES of Ratios: What is the ratio analysis have to do with an orchestra? Find out in this lecture continuing. Reavie left off in our last lecture we spoke about. When we do a ratio analysis, each calculated ratio represents a number. The number represents the relationship between the two items used to calculate the racial. We spoke about the current ratio and how it is calculated by taking the company's current assets from the balance sheet and dividing it by its current liabilities, similar to the current racial. We have several other ratios. And while there's nothing to stop you from comparing just about anything on the financial statements with something else, the real question, though, is whether or North a ratio is valuable or meaningful. That's why, in the following lectures, I'm gonna walk you through the greatest hits of financial ratios that are the ratios most commonly used in the world of finance. Keep in mind that there are many ratios out there, but I'm covering the most commonly used ones the ones that you all most likely to encounter , and those that I personally believe will add the most value now in a broad context. To really understand the concept of ratios. I want you to think about an orchestra If you observe in orchestra, the performers are divided into several categories. This percussion, brass, woodwind and strings. In a similar fashion, you can divvy up the financial ratios into five categories. Each category of financial racial tells you something different about the business. The five categories are liquidity ratios, debt ratios, also called solvency ratios, activity ratios, profitability ratios and evaluation ratios. Let's go through each of these categories. Liquidity simply means of forms ability to pay its short term obligations. If we see a company's liquid, it simply means that the company has enough cash to pay its short term news. Common liquidity ratios are the current ratio quick ratio and the cash racial. Don't worry about how these ratios are calculated. For now, they're going to go through this in the upcoming lectures. Simply understand the categories so that if in the future you want to see how liquid a company is, you know that you can check the liquidity ratios category. If you want to check how to value a company, you conjecture ratios in the valuation category and so on. Moving on debt or solvency ratios are concerned with the longer term ability off a form tau bay off its ongoing debts. Common solvency ratios used in the financial Orla, their debt ratio, the debt to equity ratio and the interest coverage ratio. The liquidity and solvency ratios combined give you insights into how sound the businesses and off particular interest to banks and people who are planning to lend money to the company. After all, it's only when a company is able to exist. Can it be its lenders Back next we have the activity ratios. These ratios demonstrate how efficiently of business operates. In other words, you can see how well the business uses three sources, such as assets available to generate sales or even use debt to purchase the right assets. Activity ratios are commonly known as efficiency. Rachel's a few great examples off activity issues analysts or investors should apply in the research include inventor Donald Receivable. So nor be Able Stone or and total asset tonal Moving on. We have profitable. These ratios are used to judge how profitable a company is, even if there is a limited amount of business activity. What is Asia's check is how much profit has been produced. How much trouble has been produced for dollar sold? How much profit is left over after paying taxes? After all, profits are what matters most right. These ratios are typically called margins and their several kinds of margins. When we cover profitability ratios in detail, we will be covering cross margins, operating margins and neck margins. The activity and profitability ratios combined give you insights into how well the business is doing. And if management is making the right decisions for a company are declining. Trend in these categories means you'll have to put your thinking cap on and investigate further. Last but not the least. We have water core valuation ratios, while the previous categories I mentioned examine of businesses in Donald Workings with valuation ratios, the businesses stock price enters the picture Valuation issues are the fixation for most investors. And if you have been in the stock market game even for a little bit of time, it may not be uncommon for you to have heard about the price to earnings ratio. Also called the P ratio, which makes its introduction here, common valuation ratios are priced warnings, racial earnings to price ratio the P E G ratio, the price to book ratio, toe price to sales ratio and their dividend yield. So now you know the different categories that ratios fallen? No. Let's take a look at the ratios themselves in further detail. Thank you so much for joining me in this sector. I will see you in the next one. 4. LIQUIDITY Ratios: Can a Business survive in the short term?: hi there. And welcome to the lecture on liquidity ratios. Before we dive into liquidity ratios, I thought, I'll clarify water tome liquid stands for in the world of finance. In finance, the word liquid generally means how quickly an asset can be converted into cash. The more liquid an asset, the faster it turns into cash. When you look at the balance sheet, the most liquid off assets are usually listed first in the current assets section, while cash is usually the starting point and is the most liquid of all assets. For obvious reasons, it was followed by other liquid assets such a short term investments, trading securities, accounts receivable and inventory. You can simply test for liquidity by asking the simple question. Can this acid be easily exchanged for cash without losing much of its value? Now, as you go down the balance sheet, you quickly run into longer term assets such as vehicles, property, plant and equipment, real estate, etcetera, which are not considered liquid assets, since it usually requires considerable effort to change these assets to cash. So now that you understand the term liquid, you'll be able to easily understand the purpose off liquidity ratios when we calculate liquidity ratios were simply trying to understand how liquid the businesses that is. How quickly can a form tone its current assets into cash? If there's an immediate need to meet, it's shark come obligations the most commonly used liquidity ratio, as we've discussed before other current ratio, which simply compares the current assets to the current liabilities by using the formula current assets divided by current liabilities. So, let's say, are Martians. Computer Shop has eight million current assets and four million and current liabilities. We simply take the eight million and divided by the four million and we get to, which means that the form has two times more current assets than it does current liabilities. Now, calculation of the current ratio always includes inventory and current assets. But there are Conservative and Liston investors out there who think that in case off a crisis in the business or maybe in the economy in general, ah, companies in eventually may not sell quickly enough to cower it short term obligations, so they prefer to not include inv entry. In these calculations, these kinds over the folk prefer using what is called a quick ratio which does not include in Venturi. And it's calculated by using the formula cash and cash equivalents, plus short term investments plus accounts receivable. The whole thing is divided by current liabilities. Now notice how the numerator has all the current assets listed except the inventory figure . So in our previous example, if $8 million off current assets has $4 million off inventor included in that you were only take four million as a current asset figure and divide that bike the current liabilities of four million and you will come up with the number one, which means the business has $1 for current assets for every $1 off current liabilities. Now, if you want to get even more conservative than that, you may use something called the cash ratio, which compares just cash and readily convertible investments to current liabilities. So, for example, if Martians Computer Shop has $2 million in cash kept, we take that number and divide it by the current libraries of four million, which means that the form has 50 cents off Gash left for every dollar off its current liabilities. As such, this makes it the most conservative all the liquidity ratios and so may be useful in situations where current liabilities are coming due for payment in the very short term. Okay, so now that you know the three mean ratios protest for liquidity in a company, you're probably wondering what is a good liquidity ratio? As a rule of Tom, the higher the company's liquidity ratios, the better prepared it is to pay for libraries do within the coming year. Companies with high current ratios have a greater safety cushion in case business drops off . Now, if you really, really want the number, I would say a current ratio has to be at least one or 1.5. Where is the quick ratio and cash ratio can be lower. But also here's why. I hesitate in giving you a number. Every industry is different, and some industries in general have higher liquidity ratios than others. For example, comparing the liquidity ratio off a utility company voices an e commerce giant isn't an Apple Stream apples comparison, and the liquidity ratio in either of these industries at any given time will be different. You'll have to compare an e commerce giants data of it. Another AECOM assigned to make any sense of their data. Speaking about data, we're gonna be covering racial information sources in an upcoming lecture. But for now, let's dive into our next Lecter, which is about debt also called solvency ratios. Thank you so much for joining me in this lecture. I will see you in the next one. 5. SOLVENCY Ratios: Seeing if a Business is Sustainable: many times, businesses take on lots of dates to help accelerate the revenue and therefore generate more profits and in the end, become a bigger business. But increased reliance on long term debt can be a sign of trouble. That may seem fine when things are going cos way, but if used excessively, it could spell potential danger, especially if things don't turn out the way a company expects them. Too much. Long term red costs money increases risk and can place restrictions on management in the form off restrictive lender covenants governing water company can and cannot do to check your. For companies handling its debt well, especially its long term debt, we can make use of what are called debt, also called solvency ratios. Solvency ratios. Examiner Company's ability to meet its long term debt obligations commonly use solvency ratios, our debt to equity ratio and interest coverage ratio. Let's start by looking at their debt to equity ratio. Here's the formula. Debt to equity equals the total debt divide by Owner's equity. Both these numbers can be found in the balance sheet off a form north are typically accounts payable are not included in their debt section If you observe, you can quickly understand that the comparison is happening between the border amount of data company has with the amount off equity that belongs to its owners. As a rule of Tom in this case, the higher the number, the more loaded the company is were debt compared Toa Owners Equity and a high debt to equity ratio is often associated with high risk. Let's talk about our favorite company, Martians Computer Shop. To illustrate this point, it's Martians. Computer Shop has $5 million in overall date and $10 million in equity. We will take the $5 million in debt and divided by their $10 million in equity, and would come up with the number of 0.5, which means that the company has 50 cents for each dollar. It has an equity, the next solvency ratio that is commonly used an excellent metric to measure. The impact of debt on a company is called interest coverage ratio. The interest coverage ratio will help you figure out how well the company is able to afford the interest payments on the debt that it has two calculated. You compare the company's profits toe the interest course to see how able the company is to pay its bills. The formula is net profit before interest in taxes, divided by the interest on debt, the net profit before interest and taxes, also known as Ebert, which is short for earnings before interest in Texas. The higher the interest coverage ratio, the better door number below 1.5 can be considered a red flag, which means it needs to be investigated for the Let's say, Martians. Computer Shop has an Ebert of 40,000 and its interest expense equals 35,000 which gives us an interest coverage ratio off 1.14 The interest coverage ratio will show you that the company is just able to service its interest now. This is what would raise a red flag for me when I am looking at a financial statement, and I would check to see if the company's interest coverage ratio has been reducing over the past several years. If I noticed that the train in the ratio is started to dip below 1.5 and seems to stay there, that may indicate signs off a struggling company. So now that we've covered boat, the solvency ratios as well as the liquidity ratios. I am gonna play Devil's Advocate here and leave you with a bit of food. Fourth Heart. The downside of date is easy for a store industry, and the financial crisis of 2008 and 2009 remains one of the best. Recent examples in history of white debt can be a big disadvantage, but just because the company has, that doesn't mean it's doomed to fail. So while both liquidity and solvency ratios are great and don't get me wrong, you should always proceed with caution. When a company has dead, there will be moments of time where you will see companies have topsy turvy fundamentals. Even a company like Walmart was all ordered rid it at some point in time in their history before they became the retail giant's that they are. So that goes to show you that sometimes companies were debt. Don't always end up having a negative story, but, like with anything in life, use your common sense and proceed with caution. Evaluate the quarter picture and then make your judgment about the company. Thank you so much for joining me in this lecture, and I will see you in the next one 6. ACTIVITY Ratios: Measuring the Efficiency of a Business: I'm pretty sure you know the importance off cash in your life similar to your personal life . I cannot overstate the importance of cash in a business. Now, in a business, you have cash in the bank, which the business can use. But other than that, the business also has cash tied up in many places. For example, it has cash, which is tied up in its invent trick, or cash, which is tied up in accounts receivable, which is the money order the business from sales it has already made but still not received . Now. For any analyst, business owner or in investor, it's important to know and understand the movement of cash and activity ratios of financial tools that help you measure that they helped check how long it takes a business to convert its assets to cash or, in other words, how efficient of business is in generating cash. That's why they can often also be referred to as efficiency ratios. Their several activity ratios, amongst which the inventor return your days in wintry receivable, stone or and the receivable collection period are ones that are particularly useful for a moment. Let's put on the head of a business owner. To truly understand these, imagine that you own a business that sells construction equipment. Let's call it Super Power Construction Inc and you need to know, on average how often during the year you sell, invent tree and so how often you would have to replenish it. For this, you can use the inventor tonal racial, which is cost of goods sold, divided by average in wintry. The cost of good sore number can be found in the income statement, and the average inventor is calculated by adding the beginning and ending in the country for the period that you're measuring and dividing it by toe. Both the beginning and ending in wintry figures can be found in the balance sheet. So if your cost of good sore for a year is seven million, while the average inventory for the same Peter to 700,000 therefore your invention don't know it would be 10 which means that your company sold and replenished the invented 10 times during the This ratio is critically important because torture don't or dictates to fundamental components off a business. The first is in Renji purchase. Let me explain this with an example. So let's say one of your suppliers who sells you tractors approaches you at the beginning of the urine, says that he'll give you a huge discount if you pour chase within 30 days and you decide to stock up for the entire because it's a great discount. Knowing the inventor Tono number will prevent you from over shooting and buying too much. If you didn't know this number and you got carried away and bought too much, you could have been stuck within reentry and incur unnecessary stories and other holding costs. The second reason in rent Giordano is helpful is sales. Once you know this number, you will have a good handle on setting sales targets for a sales team. Now, if you want to take you on the signing off a new entry movement in your company to the next level, it's also helpful. Another days in reentry racial. The days in 20 ratio simply extends your understanding off inventory movement in a company by letting you know how long in days does it take for invent tree to get sold? The ratio simply takes the number of days in a year, which is 3 65 and divides it with the inventory. Donna. More racial to illustrate. Let's use our previous example, which harden in Renji. Don't know a show off 10 and we can take 3 65 the right by 10 which equals 36.5, which means that it takes approximately 36 a half days, or a little over a month for superpower construction in Crotone. It's in wintry. So in a nutshell, in wintry donor shows you how quickly a company sells its goods. If sales go down or the economy's underperforming, you'll usually see that reflect in a lowering off the inventor eternal racial and obviously ah higher in men tree ratio is preferred as it indicates that more sales are being generated, given a certain amount of in my entry. The next important activity ratio is the receivable generation receivable. Don't know helps measure how long cash is tied up as unpaid customer commitments to a company, or, more specifically, it measures how many times over a year cash is cleared out and replaced by similar obligations from other customers. Rapper don't know or not lingering or debts is what any business wants to see. The formula is sales divided by average accounts receivable. The CIA's figure can be found in the income statement and accounts receivable Figure can be taken from the balance sheet to calculate the average accounts receivable. We simply take the beginning accounts receivable and add ending accounts receivable and divided by two. So, for example, let's say Super Bowl Construction Inc has $8 million in sales and $1 million in accounts receivable. The receivable tono would be eight. Another way to look at this is that for every dollar invested in receivables, $8 comes back to the company in the form of sales similar to today's invent recalculation. We deduced from the inventory turnover ratio that we explained earlier. We can also come up with their days receivable from the receiver down, or you simply take 3 65 and divided by the CBO Stone or so for Superpower Construction Inc that is 3 65 divided by eight and you come up with 45.63 days. So for many places where construction suppliers usually have a 30 day billing cycle, you would expect 30 days or less off sales and receivables. It's important for you to know that if you see a trend in which the average collection period is increasing, the company may be losing control off its collections or selling to customers with questionable credit. Now, the way you need to think of accounts receivable in a company is that its resource like any other? And essentially, if a company's very liberal with credit, it's sacrificing cash that could have been made available to find some other part if it's business. So now you know about the main activity ratios. Remember that, like all other issues, these ratios are more useful when compared to a computer or industry to establish whether and entreaties processes are favorable or unfavorable. Thank you so much for joining me in this Lector. I will see you in the next one. 7. PROFITABILITY Ratios: How much money is left over?: one of my favorite scenes in any movie is this one. Show me the money, but still, in case you didn't recognize it, it's the scene from Jerry Maguire, where Cuba Gooding Jr is asking Tom Cruise to show him the money. I love that scene. Believe it's a perfect transition into this lecture. If you could talk to your financial statements in, tell them, show me the money, then they would probably throw out the next type of racial right you, which is profitability ratios. Profitability ratios cut to the chase and tell you word is probably the main reason a company exists, which is to make a profit. So let's dive in and understand more about profitability ratios in this lecture. So what is profit? Any res in the simplest of terms, it's the amount of company has left over after paying for all its expenses. It's a financial gain that a company makes if it is operating successfully, and it's what makes the owners off the company rich. That's probably why profitability ratios are off the highest importance to business owners . These ratios are also typically called margins, and three off the most common profitability ratios are cross profit margins, operating profit margins and net profit margins. The numbers to calculate each of these ratios can be found in the income statement. Now let's go over them one by one. Accompanies gross profit is the simplest way to look at the profitability. Gross profit is the profit off a company after being costs directly connected with producing the product or the cost directly associated with providing services? Let's walk through this together with an example. Let's a superpower construction in creep ported revenue, or $55.2 million its cost of goods sold was $39.8 million. By taking the revenue of $55.2 million subtracting the cost of goods sold of $39.8 million you'll find that the gross profit comes up to $15.4 million. That's great. But now, to get a deeper insight into this number, we have to calculate what's called a gross profit margin. The gross profit margin number makes it easier to understand the gross profit itself by comparing the gross profit with the company's revenue and describing it as a percentage. So divide the company's 15.4 million gross profit by its torture revenue of 55.2 million and multiplied by 100 you'll see that the gross profit margin comes up 28%. So what does this mean in plain English? The gross profit margin means that after paying the cost of goods sold, such as steel and labourers, time on the assembly line, etcetera, Superpower Construction Inc gets to keep 28 cents of every dollar it makes in revenue. So by definition, the higher the gross margin, the more our company gets to keep off each sailor it makes now, gross margins differ significantly based on the sector you're looking at. For example, gross profit margins for a construction company would be low, do too much off its forms, cost being associated to cost of goods sold and highly concentrated in raw materials and other direct course, such as transport in labor. In other industries, though, like, for example, the software industry or an Internet company, you won't have that many direct costs, which is why you would typically find gross profit margins in such industries to be higher . So remember gross profit margins contain significantly based on the type of business. Just make sure when you're comparing, you're comparing apples to apples, as in your comparing gross margins from one industry toe the same industry to measure profitability. Orel, just to give you an idea of four gross profit margins typically are amongst 500 companies in the Standard and Poor's index. The average gross profit percentages there is 45%. Next, let's move on to the second profitability ratio you should familiarize yourself with, which is the operating profit margins. As we move down the income statement, we start with revenue and minus cost of goods sold to arrive at the gross profit. After that, conventionally, all income statements taken to account other operating costs, such as rained utility bills, marketing costs, depreciation, amortization, etcetera. When we deduct all other operating costs from revenue except interesting taxes, we arrive er, were this cold operating profit. That's why operating profits also called Ebert, which stands for earnings before interest in taxes with or Ning's being just another name for profit, you might be thinking, but wait, why don't we subtract interesting taxes to calculate the operating profit because operating profit is meant to show you the prophet of business owns from the business it is in directly from operations. Taxes don't really have anything to do with how well a company's being run, and interest expenses can vary significantly depending on whether the companies finance were debt or equity. Also, the financial structure of the company doesn't say anything about how well it is run from an operational perspective. So operating profit, or Ebert is a wonderful gauge of how well the company is being managed but converted into a percent, which is operating profit margin. It is beyond magic in terms of the insights you gain about how business is being run. The operating profit margins are watched closely by all stakeholders because it measures both overall demand for the company's production services and the company's efficiency in delivering news products or services. So let's a Superpower Construction Inc has $8.4 million in operating profits after deducting all the expenses except interesting taxes to come up with the operating profit margin, we simply take this 8.4 million number and divided by the revenue off 55.2 million and multiplied by hundreds to come up with an operating profit margin off 15.2%. Now, when comparing companies air downward trend, an operating margin should be, ah, flashing yellow light. It shows that costs and expenses are rising faster than sales, which is north of hell design. As with the gross margin number, it's easy to see the trains and operating results when you're looking at percentages rather than raw numbers. Percentage change shows not only in the direction off the change, but how great the changes. Last but not least, we have the net profit margins. Also called the bottom Line. The Net profit tells you how many dollars a company has kept after paying all its costs and expenses. The net profit margin off a company shows you how the company's managing all the expenses associated with the business. So here we throw in the whole enchilada. Of course, that is, we take the revenues and minus all the costs from it, including interest in taxes and see if the company has made a profit. Continuing with our Superpower Construction Inc example, let's either interest costs were $1 million taxes were $4 million. We subtract this from operating profit off $8.4 million come up with a net profit off $3.4 million to come up with net profit margin. We'll take this $3.4 million off net profit and divided by the revenue off $55.2 million multiply that by hundreds to come up with a net profit margin off 6.2%. By analyzing how the gross operating and net profit margins compared to each other, you can get a clear picture off water company Strengths and weaknesses are, for example, you may see a company may be investing more in marketing campaigns that increase operating costs for period, which can decrease your operating profit margins. During that, Peter or AH company could also Reese Capital through debt, which can decrease their net profit margins as their interest payments race for the remember that market and business factors affect each of the three margins differently. For example, increasing fuel costs would affect the gross margins for the airline industry as a whole. Okay, so that wraps up our lecture on profitability ratios. Let me know if you have any questions, and I would be happy to answer them for you. Thank you so much for joining me in this lecture. I will see you in the next one 8. VALUATION Ratios: A look at the P/E Ratio: So far, we've covered liquidity ratios, solvency ratios, activity ratios on profitability issues. The general aim off all these issues has been appraised the company's performance, see how well it is managed and how well it functions. But next category of ratios, which are the valuation ratios, are completely different. Valuation ratios are where the eyes of most investors are fixated as they seek to answer the question. How much is a company worth? It is heard that the stock price of the company in those states, while there are many evaluation ratios such as the price to sales ratio, toe price to book ratio and more the most popular valuation ratio off all is called the price to earnings or the P issue, which is like the granddaddy off all valuation rations. In fact, be ratio is so popular. Then I'm going to dedicate this entire lectured justice. Racial. One of the beauties of the bi racial lies in its simplicity. That is, with just one number, you can find out how much investors, on average, are willing to pay for a claim to each dollar off the company's earnings. The formula for the being ratio is exactly what it sounds like e equals price of the stock divided by net earnings. Bullshit. For example, if a company shares are trading at $50 its earnings per share was $3.25 over the past year , the B would be 15.4 times for her deep dive on work. Earnings per share is you can check out discourses lecture on earnings per share, notice that the B ratio is not expressed in dollar terms, but as a multiple of mornings. That's because the dollar terms in the numerator and denominator off the P ratio formula cancel each other out as a rule of Tom Or higher be indicates a high evaluation and a low P e indicator relatively low or more conservative one. So, for example, if a second company in the same industry was stating with a B off 10 times, an investor would assess that the 10 Times company was underpriced relative to the company . Trading at 15.4 times. See how P E gives us an easy apples to apples comparison off evaluation between two companies. But when you're comparing piece from company to company, you also have to consider the role Market dynamics play when combatting the bead issues of one company with another, understand their different industries have different. Be easy. Short range is there are considered normal. For example, technology companies may sell it on average, be ratio off 20. While textile manufacturers may only trade an average be ratio off it, there are exceptions. But all things considered, these variances between sectors and industries are perfectly acceptable. They arise in part out of their different infrastructures off each industry. Software companies usually sell it larger P ratios because they have much higher growth rates and on higher returns on equity, while a textile mill subject. With this mill profit margin and low growth prospects, my trade at a much smaller multiple from time to time. No, this situation turns on its head. For example, in the aftermath of the great recession of 2008 in 2009 extra extra later lower P E ratios than many other types of businesses, such as consumer staples because investors got frightened and they wanted to own companies that manufactured products and that people would continue purchasing no matter how strange their finances garp. Companies like Procter and Gamble which makes everything from laundry soap shampoo. Colgate Palmolive, which makes toothpaste and the soap Coca Cola, Pepsi and the Hershey Company, was still in demand at the time. There's a saying in the international investing market for really families that sums up the sentiment when the going gets tough. The tough by Nestle For those that don't know, Nestle is a Swiss food giant and one of the largest companies in the world with generates billions of dollars in nearly every country, no matter how terrible things get next, let's talk a Barbie issues in the market. It's important to understand that the peas expand and contract like an accordion when times are good or bad. During periods of sluggish economic growth, investors pay less for most companies, as they do in the market, is soaring. For example, the P ratio of the S and P 500 has fluctuated from a lower forearm six times in 1949 to over 120 times in 2009. Keep in mind, too, that stock be ratios can also be high during extremely poor markets. Also, core bear markets. That's because its earnings fall apart. It's the denominator off the P ratio, which elevates the P as a final Northern a bi racial. Remember, just because the P ratio off a stock is low doesn't mean you should go ahead and buy it. Even companies like Enron traded at one time or another with Low Pe's. But the business it served turned out to be a pretty bad investment. For those of you young enough not to know Enron, I suggest you type it in Google and take a look at it. So why the low P e can be part of the investing equation? It is far from the whole story. If you're tempted to buy a stock because the P E ratio appears attractive, do your research and make sure other factors are okay to do a full racial analysis. Ask questions like, Is the management honest? Is the business losing key customers? Is the weakness in the stock price on the lying financial performance a result of forces across the entire sector? Or is it caused by form specific bad news? Is the company going on a permanent state of decline? So that's it for this lecture, folks. Thank you so much for joining me. I will see you in the next one 9. Ratio Information Sources : When doing a ratio analysis, there are two types of companies you'll come across. You have private companies and public companies. The amount of ours that you'll have to put into the technical side of ratio analysis depends on whether the company you are analyzing is a private or public company and where you are as an individual. For example, in the case of private companies, you may be the owner of a company and could be using racial analysis to simply analyse your own company to see how your company's doing. Or you may be at the stage where you're evaluating an investment in a private company. For example, you may want to buy your local bakery or a chain off running restaurants, and you'll be doing a racial analysis for that. Either way, you will have to work out each of these ratios using tools such as a calculator or maybe Excel. And a thorough ratio analysis will be your best friend. Now I want to make racial analysis is a bit easier for you, and so I have a That's a checklist off many of the most commonly used A shows, along with the formulas to the project section off this course in the checklist I have also written Arrange for what? Each ratio should ideally fall within. However, as I have emphasize previously, these are rules of come and can very significantly based on industry. And it's best to compare ratios with other companies in the same industry to see the norm off the industry you're analyzing. If you plan to be a credit or financial analyst for a bank, most investment forms off banks have their own software where you import the financial statements of a company or someone does it for you. And the software does the calculation off the ratios and just Spitzer your job, then, as a credit or financial analyst, simply remains to analyze these Rachel's off course. This is not such an easy task, often because approval off a person's a small business loan or some sort of funding depends on your analysis. If you're analysing a public company, though, there's a Lord of Data available online. Some of it is free, and some of her to speed one of the more popular online sources to get free ratio data is Yahoo Finance, so simply go to the U. R L S d DPS colon forward slash forward slash finance or yahoo dot com and in the search box, like the name of the company who's a shows you like to see. For example, type in Walmart, and once I see the name of the company, click on that and I have the Wal Mart stock price show up and somebody of the stocks. What I am interested in is mainly the ratio data. So I clicked the statistics tab, and on the left hand side we'll be able to see some of the ratios, which we would be interested. For example, if you're interested in the valuation ratios, you be received a trailing P the forward p e. The PG ratio, the price to sales ratio of the price to book ratio and so on. As you scroll down, you'll also be able to see other issues such as the profit margin, operating margins, efficiency ratios and as you scroll down, you will be able to see some more, such as the liquid radiations, which are the current ratio. Now, Yahoo finance is a great site, and I really like it. But personally, I'm more foreign off in the other side, which scored Morningstar. Let me show you why I'll open up a new tab and I'll go to Morningstar dot com Now. Why 11 Morningstar. Let me just explain a few things about how the site works. There's a free version, and there's a premium version the three versions completely free for now, but I read that they're going to be making a sign in mandatory even to access their three data. So just a heads up on that and the time you're watching this video, it may be possible that you are required to sign in to get access to even the free data. For those of you interested, though, in the premium version it gives you investment. Recommendations from Morningstar's analysts on were dating are good stock picks as well as some fancy bells and whistles. Track your portfolio and to keep your portfolio real diverse. Fight now. Personally, I don't use the premium version, and so it will not be right for me to recommend it. But if you are interested, they do have a 14 day trial so you can check it out. Okay, so moving on with our free version and I'll continue with Walmart is our example. So to go and see the ratios of Wal Mart, you simply type Walmart in the search books and click on the Walmart Burton. Now the ratios are hidden in the financial stab. And even when the financials open up, what will have to do is click on all financials. Rita. Once you've done that, you will have to click the balance sheet tab, and new tab opens up so as you can see the little bit hidden. But But, Jason, this case is forced it. Okay, now, in this screen, you'll see the key ratios stop. So let's just like Archy, their show stab and you're is very real finder date of your looking, for sure at the bottom of their key ratios. Stab initially whenever I'm scanning accompany a public company. I always like to first check the financial health so you go to the financial health. And at the bottom you'll see the first category of ratios that we spoken about, which is the liquidity ratios. So you'll see the current ratio and the quick racial mentioned right here and what I really like about the date on Morningstar's because they give you the past 10 years of historical performance, it's really easy to spot trends. So once I've checked the liquidity ratios, then I want to check out the solvency ratios, which are also listed right here. The debt to equity ratio is a solvency ratio, and they keep an other issue, which is a solvency racial in their profitability tab. So the interest covers racial is listed right here. Now, what's very interesting when I'm looking at this right now is automatically Aiken CIA trained, and as you get use aeration analysis, you will be able to see these trends as well. So, for example, in this case, the interest coverage ratio is 11.69 in 2010 and it remained stable for a while and starts falling. Now this to me would be, ah, good yellow flag in the sensor. I would want to investigate this further. I were born investigate. Is something happening toe the operating profit? Is it going down for some reason, or, for example, is the company taking on more debt? So like I mentioned, it's really awesome to get all of this data together, and it's really easy to be able to support prints. Now, when I am Ah, done with my liquidity and solvency ratios, the next thing, which I usually check out, is the efficiency ratios, which you Congar Oto by clicking the tab right here, you'll be received or receivable and inventory and fixed asset. Nicer. Don't all right here. And once you're done with that, if you're interested, you can check the same data in days like we have already spoken about. Once I'm done with the liquidity, the solvency and the efficiency. Then after that, what I'm interested in is checking the company's profitability. When I click the profitability tab, I'll be received a gross margins, the operating margins as well as the next margins. Now, once you're satisfied with these three, the next thing is the valuation ratios. A lot off what you learn in racial analysis is dependent on. Like I said in the beginning, you wasn't individual and why you want to loan racial analysis. So, for example, if you're a financial analyst, a credit analyst or someone who is learning a bit off advanced accounting, you'll be satisfied with all of the ratios that we've learned so far. But if you want a toe investor in particular. Value Investor One of the key categories of ratios that you'll be interested in is the valuation ratios, which you confined by simply scrolling on top and clicking the valuation Burton and you'll be able to see the important valuation rituals, which are the price to earnings ratio, price to book ratio, price to sales ratio, price to cash flow, and so on and so forth. What's great about this is that you'll be able to compare the current valuation with the industry average, the S and P 500 average and the wall march 5 year average and so on. Okay, now I don't want to wrap up this lecture without mentioning a few. Other resource is for you to check out, which are great for fully done racial analysis of public companies. But you do need to pay a modest fee if you want to get the ratio analysis for a public company completely done for you, you can also check out the site venture line dot com. This is also pretty good site to get access to a Lord off re shore data like public company analysis, industry ratios, private company and Al assistants one for I hope this Lecter's help you in your journey. I thank you so much for joining me in this video, and I will see you in the next one. 10. Second Level ThinkingSS: imagine you're a newly hired manager for a laptop manufacturer to boost the productivity of your team and impress senior management. You independently set your team and ambitious Stargher to create 20% more productive month inspired by our leadership, your team, and are producing 40% more. Ah, great result. But wait. Once your celebrations die down, you'll discover the largest 16 is complaining. The Warehouse wasn't equipped to handle so much in flux. Not only that, but the sales team is struggling to sell the increase in my country, and the front end work has doubled their troubles. Your seemingly good idea ended up costing the organization money and gets you fired in state. Now what happened here, after all, your initial decision appeared reasonable. You wanted your team to be more productive, and you wanted to do well for your company. So why didn't you foresee the wider impact? Well, you could have avoided all this by deploying what's called second level thinking. So what is second level thinking? Let's find out in this video. One of my favorite investors in the world is this man, Howard Marks. He wrote a book called The Most Important Thing with dyes into the mindset required to be a successful investor. In this book, he talks about two ways of thinking first level thinking and second level thinking in his own words. First level thinking is simplistic and superficial, and just about everyone can do it. But second level thinking takes effort. It is deliberate and proactive, and it goes past immediate results, looking at as many outcomes as possible, considering the impact long term. I bring this topic up in this section off ratio analysis because this is the mindset required while conducting a ratio analysis look, you'll get the technical part. It's just using a formula. It's just dividing one number by another, but not accepting and answered the surface level. Diving deeper and applying second level thinking is what will set you apart as an investor . You may have scoffed at my story in the beginning about the manager that produces too many laptops, thinking that, of course, that will never happen to you. But remember this our minds, a program to look for solutions right at the surface to find the easiest solution and move on, And that's why so many of us find it hard to look beyond the initial conclusion. This is especially true if you're pressed for time, inexperience, Norrell or feel or only confident in our abilities. Let me tell you an other one of Howard marks courts, which I think is applicable here. Remember, your goal in investing isn't on average returns. You want to do better than average. Thus your thinking has to be better than that of others more powerful and at a higher level . Since other investors may be smart, well informed and highly computerized, you must find an edge that they don't have. You must think of something that they have not part off seatings the day Miss, Bring inside the diran possess you have to react differently and behave differently. In short, being right may be a necessary condition for investment success, but it won't be sufficient. You must be more right than others, which by definition means you're thinking has to be different. So how do you develop your second level thinking skills is in investor. Okay, remember And write down these five points. Look at them before you start any ratio analysis, these five steps to prime you to look for things that others don't sport number one Question everything. Don't stop. Once you reach your first conclusion or even your second or even your third, keep questioning and ask what happens then continue to do so under you've reached a roadmap of potential outcomes. Number to involve others. When you bring other trusted advisers into your decision making process, you're likely to get new perspectives. These alternative viewpoints could be extremely valuable. Number three. Think long term. The power of second level thinking comes from being able to look past immediate results and consider the impact long term. Sometimes a good outcome now might result in a bad outcome in the future. One way to do this is to explore how the decision will play out at different points in time . What might the results look like in our day, a week, a month in a your even dares. It's important not to assume that conditions will be the same at each of these points. Number four don't discount options too quickly. Keep all your options on the table. Initially, the purpose of second level thinking is to examine all options carefully and then marinate on with time. You'll gain insights and see rich option is the best fit. Number five keep practicing for Most of us rely on first level thinking more than we care to admit. And since second level thinking is their different approach to thinking, it will need a lot of practice aimed to apply it in all kinds of your decisions, not just investments to help you build up the skill. The basis of second level thinking is that extraordinary results can Onley be achieved through extraordinary actions. If you're thinking remains confined to the norm, there is no way that the results will die. What's from the normal? Instead, it is only when your thoughts diverge that your results will diverge and become different from the ordinary. Thank you so much for joining me in this video. I will see you in the next one. 11. Saying GOODBYE (Sort Of!): hi, everyone, and thank you so much for taking my class by now. You have a pretty good idea on water ratio analysis is and how it can be useful in your life. But let's not say goodbye. Just it be good at anything in life. You have tow, practice, practice and practice, and racial analysis is no different. So it's time to put your newly found knowledge about ratios to one final test from my side . How do you take that test? Simply look at the project section of this class and complete the assignment as follows. If you have any grecians for me, you can click the community tab and asked them, I would love to help. If you would like to see any future classes that I create, please click on the follow button on your screen. And if you want to see any of my past classes, please check out my profile page on sculpture and for one final time from my side, it was truly a pleasure to go on this journey with you. Thank you so much for joining me in this video, and I will hopefully see you. In other words,