Ratios: the investor's friend

Net asset value (NAV): The simple calculation is the total assets of a company minus liabilities, including capital charges, such as preference shares. It should indicate the value of a company, its capital value.

What investors need to watch out for are intangible assets. Often those depend on the directors’ idea of what an asset, such as a brand, is worth and this can be inflated.

NAV can be compared to the share price, indicating whether the market value of a company is higher or lower than its capital value.

Debt-to-equity ratio: Debt shown on a company’s balance sheet divided by shareholders’ equity (or shareholders’ funds).

A high ratio can indicate financial distress, but debt-to-equity (also called gearing) is very industry or sector specific.

Usually a company will set what it considers an acceptable gearing range. If the ratio falls within this, the company is probably doing fine.

High gearing can be good if the debt is being spent on future earnings growth, such as capital expenditure projects.

Investors can also look at free cash flow on the cash flow statement, an indication of how soon a company could settle its debt.

 - Finweek