What is a financial ratio? It is one number from a company’s financials divided by another. These ratios allow an investor to compare penny stocks to their competitors. Or even compare to blue-chip stocks while tracking the health of the company to see if they are growing stronger.
Only certain ratios are helpful to investors when it comes to finding a winning penny stock. Typically, these smaller and newer companies do not have earnings, resulting in being unable to calculate gross and net profits. But, valuation metrics like sales per share can be found from the latest financial results. Look for stronger financial ratio values compared to previous quarters or competition. Below are several ratios to determine if you have found a winning penny stock.
Price to Sales (P/S)
To see if the penny stock is over or undervalued, divide the current share price of the penny stock by the company’s annual sales. For example, if the shares trade at $2.50, and the company brought in sales for the year of $1 per share, that’s a P/S of 2.5. Lower values are better than higher ones, and anything close to or less than 2.0 is usually appealing.
By dividing current assets by current liabilities, one can see how the business can cover its short-term debts with short-term assets. For example, a company with $2 million in assets and $1 million in liabilities has a current ratio of 2.0. Typically, one would want to avoid a current ration of less than 1.0, 2.0 or more is ideal.
The quick ratio takes into considerations assets which can be easily used, focusing on cash, marketable securities, stock market investments, and accounts receivable. By dividing liquid assets by the current liabilities, you get an idea of how many times over the business can more-easily cover what it owes in the short term.
For example, if a penny stock has $3 million in quick assets, over $4 million in current debts this equates to a quick ratio of 0.75 and the business would not have enough to cover what it owes. Look for a quick ratio at the very least 1.0 but ideally 2.0 or more.
Operating Cash Flow
This considers a company’s cash flow from operations, then divides it by current liabilities to show how well the business can cover what it owes in the short term using its cash flow. Higher numbers are better, but even values slightly below 1.0 can be acceptable.
This shows how effective the business is in producing and selling products. The inventory turnover ratio will vary depending on which industry the business operates in. But if you use the ratio to compare to similar companies or previous periods for the same company it can provide insight.
To find the debt ratio take the company’s total liabilities, then divide by total assets. If a company has four times more in assets value than liabilities, the debt ratio is 4.0. Exercise caution if you see debt ratios anywhere near 1.0.