Six simple sums are all you need to get you started…
The Commission for Financial Literacy and the NZX are trialling free lunchtime talks in basic investment to teach would-be investors the basics.
Hosted by the NZX, the talk by Elevation Capital’s Chris Swasbrook showed how primary-school level long division can go a long way towards showing whether or not you should invest in a company.
To get to grips with the basics: first pick a company you like the look of. Then download its annual report from the company website. This won’t be easy to read. But by starting with the figures in the report you can edge your way into investing.
These figures will help you with the six sums you need to do. These may seem hard at first, but you’ll soon get the hang of it. And they can be done easily on your phone’s calculator. The six sums will tell you if the company you are considering is worth investing in.
Sums tell you a company’s worth
- First look at the company’s return on assets (ROA). This will tell you how much money the company has made from using its assets. Divide the company’s net income by its total assets (the numbers are in the annual report) to get the ROA.
- To work out the company’s return on equity (ROE) – another word for the money or investment the shareholders have put in – divide the company’s net income by its equity.
- A company’s debt to equity ratio is arrived at by dividing its total debt by its equity. This tells you what proportion of equity and debt the company is using to finance its assets.
- To find out whether a company is good value for money, work out its price to earnings ratio (P/E). To calculate this, divide the company’s current share price (look at the NZX online to find this out) by its earnings per share over the last 12 months. This will tell you how many times earnings per share people are prepared to pay for the company’s shares.
- Dividend yield is the company’s return on investment for a share. You get it by dividing the dividend per share by the share price. Again, the annual report has this information.
- A company’s book ratio (P/B) is calculated by dividing its share price by its equity or investment per share (book value). This shows a company’s market value compared with its actual value.
A lot of this information will be in the company’s annual report, but it is good to do the sums yourself to get your head around school long-division again. It will make you more confident about your investment decisions.
Obviously, these aren’t the only things you need to look at – there are basic questions to ask too. But doing these sums is a good start.
See future blog posts for a fuller explanation of ROA and ROE etc, and for the questions you need to ask before investing in a company
© Johanna Bennett, 2014
Johanna Bennett is a financial and technology journalist who thinks women need to know more about the big picture when it comes to money. Her blog, Kate & Whio, is intended to help and to educate, but the information contained in it should not be taken as specific financial advice. You are responsible for your own money decisions.