A financial ratio measures the relationship between individual numbers on a company’s financial statements. An example of a financial ratio is the debt-to-equity ratio, which measures how much debt a company has for every dollar of stockholders’ equity. Industry ratios are the financial ratios of a company’s competitors and the average financial ratios of its industry. A financial ratio alone provides limited information. An industry ratio acts as a type of benchmark, with which you may compare a company’s financial ratios to determine its relative financial strength.
1. Identify a company’s competitors, listed in its annual report on Form 10-K in the section in which it describes its industry. You may download a company’s Form 10-K from the investor relations section of its website or from the U.S. Securities and Exchange Commission’s EDGAR database.
2. Visit any financial website that provides stock information. Type the company’s name or trading symbol into the required text box and click the button next to the text box to bring up the company’s information.
3. Click the company’s “Financial Ratios” section. Identify and write down the financial ratios you want to compare to the company’s industry ratios. For example, assume a company has a return on equity, or ROE, of 20 percent and a debt-to-equity ratio of 0.5. ROE measures a company’s profit as a percentage of stockholders’ equity. These are just two examples, but there are numerous other financial ratios you may compare.
4. Identify and write down the industry averages for those same financial ratios, which are generally listed next to the company’s financial ratios. In this example, assume the industry average ROE and debt-to-equity ratio are 15 percent and 0.7, respectively.
5. Pull up the financial ratios section of each of the company’s competitors on the same financial website. Identify and write down the financial ratios you are comparing. For example, assume the company’s competitor has an ROE of 18 percent and a debt-to-equity ratio of 0.6.
6. Determine whether each of the company’s financial ratios is better or worse than the industry average and those of its competitors. It is better for some ratios, such as ROE, to be higher, and better for other ratios, such as debt-to-equity, to be lower. A company with many financial ratios that are better than its peers generally has a strong financial position relative to its industry. In this example, the subject company’s ROE and debt-to-equity ratio are better than the industry averages and those of its competitors, which suggests that those aspects of the company’s financials are relatively strong.
7. Identify any of the company’s financial ratios that are considerably higher or lower than the industry ratios. A company’s financial ratios should generally be within close range of its industry ratios. Read through the company’s annual report to investigate the cause of the disparity. For example, if a company’s ROE is 5 percent and the industry average ROE is 25 percent, this could be a sign of financial trouble.