Using ratios to analyse companies

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2. A word of warning

Investors who rarely look at accounts often have a touching belief in their objectivity.

Handsomely produced, professionally laid-out, printed on nice-smelling paper, the accounts of most listed companies are an essay in courtship, designed to convince the reader that here is a company that knows what it is doing and is a worthy place for you to park your money.

Seasoned investors know different. They know that accounts are full of gaps, guesswork and grey areas.

How do they get away with it?

• Auditors leave company managements considerable discretion on how to treat a wide range of items.
• The impression which accounts give is as much about the 'soft' information as the 'hard' information.

Managers of public companies know that investors like companies that produce steady earnings growth year after year. If managers know that earnings are heading for a short-term dip, it is tempting to prop them up, not by falsifying the figures, but by using various beautification techniques.

For now, it is enough just to flag that all that glitters is not gold.

1. Why bother with ratios? 2. A word of warning 3. The P&L and the balance sheet 4. Grouping the ratios 5. Profit margin 6. Return on capital employed (ROCE) 7. Sales as a multiple of capital employed 8. Stockturn 9. Debt collection 10. Payment of trade creditors 11. Cash-to-cash cycle 12. Gearing 13. Interest cover 14. Current ratio 15. Quick ratio (acid test) 16. Earnings ratios 17. Dividend ratios 18. Other ratios 19. Sources of information 20. Conclusion

• Magic Numbers