Ratios are calculated from numbers. The attraction of ratios is that numbers are, in theory at least, scientific and 'hard' whereas non-numerical yardsticks are ambiguous and 'soft'. They should therefore be reliable indicators of a company's performance.
This ignores the years of practice which managers of public companies, assisted by the accountancy profession, have had in presenting numbers in a flattering light. Numbers, it transpires, can be ambiguous, misleading and open to many interpretations, just like words.
Nevertheless, investors have to start somewhere, and as a rule, numbers are the best place to start. Ratios simply relate one set of numbers to another, and provide a basis for comparing the performance of a company year to year and in relation to its competitors.
The numbers on which ratios depend come from two main sources:
This is the main source of historical information on a company's sales, assets, liabilities, pre-tax profits, borrowings, and other liabilities. When putting together a company's Report and Accounts, its directors and auditors have to follow Companies Act law and conform to accountancy profession rules which makes comparative analysis easier.
A number of key investor ratios use the current share price as one of the variables.
You can be a successful investor without ever doing any ratio analysis, but your chances of success increase significantly if you have a grip of the numbers.Recommend Reading
Quote"Investing without research is like playing stud poker and never looking at the cards."