Building on my last post on key investment lessons, here are some of the ratios that I believe are critically important when screening for high-quality, undervalued, companies:
1) Management performance
➡️ ROE” How effectively management turns shareholder capital into profit. Generally, 20%+ is excellent. (note ROE can be distorted with high debt).
➡️ROA: How efficiently the business generates profit from everything it owns/uses. I usually look for 10%+.
➡️ROIC (sometimes labelled ROI in stock screens such as FT): How well the company turns all operating capital (debt + equity) into after-tax operating profit. 15%+ means the stock is a great long-term compounder.
2) Profitability
➡️EBITDA margin: I like EBITDA margins above = 20%+ which often signal a structurally strong business.
➡️Net profit margin: 10% is great, but any company that can maintain 15%+ for a long time is exceptional.
3) Debt
➡️Debt/Equity: I usually keep this at 0.8 or below (for companies with negative equity, you can screen for D/EBITDA at 2 or under).
➡️Interest coverage: How comfortably profits cover interest payments. Anything above 5 is very healthy.
4) Growth
➡️Revenues: 10% or higher over the last 5 years.
➡️EPS: 11% or higher over the last 5 years. (I like to see companies with faster earrings growth vs revenues growth).
5) Valuation
➡️EV/EBITDA: I look for 10 or under, but for high growth/high quality stocks low teens can work. (Note: Buffett consider EBITDA a useless metric, he prefers owners’ earnings: net income + DA - maintenance capex, but not many screens offer it).
➡️P/E: I usually cap that at 20 or under.
Important note: Looking at many of these metrics on TTM and 5 years basis is critically important to understand how things are trending overtime, and how today compares to prior years.
Finally, ratios don’t replace judgement. They’re just a fast way to spot businesses with strong economics, disciplined balance sheets, and a valuation that leaves room for error. Investors like Buffett don’t relay on ratios, and I tend to agree; ratios are a good starting point to start a deeper assessment of companies that might hold long term premise.