The Successful Investor: The Smartest Way to Invest in Stock

What to look for in a company’s balance sheet?

If you ever plan on investing in the stock market, and want to be successful at it, you will need to understand what makes one company better than the other. A great way to compare companies and their financial strength is to look at the balance sheet. The balance sheet is a break down of all the assets, liabilities, and equity a company currently has. It’s the best way to judge a company’s strength at the present time. There are many things to look at when going through the balance sheet, but you can use three key ratios to help you along the way. Those ratios are the current ratio, cash-to-debt ratio and debt to equity ratio.

Current Ratio

The current ratio is a simple ratio that takes the company’s current assets and divides them by the company’s current liabilities. What the current ratio tells you is how solvent the company is to cover its short term debt. An ideal current ratio is between 1.5 and 2, but anything above 1 is pretty good. However if the current ratio comes in below 1 it may mean the company is going to have trouble covering its short term debts, and therefore going into financial trouble. You also don’t want the current ratio to be too high, and anything over 2 may mean the company is keeping too much cash and not using it to either pay down debt or reinvest for future growth.

Cash-to-Debt Ratio

This ratio is pretty self-explanatory as to what it will tell you about a company. The cash-to-debt ratio compares how much cash the company has on hand as compared to how much debt the company has. You take the cash and short term investments and divide them by all the debts. It is essential that the cash-to-debt ratio be above 1.5 so as to insure that the company can cover most debts. Anything below this could mean the company doesn’t have enough cash to cover its debts, and therefore could become insolvent.

Debt to Equity Ratio

This ratio helps give a potential investor a look at what the long term outlook is for a particular company. To find the debt to equity ratio you take long term debt and divide it by stockholders equity. Using this ratio you will not find a company’s current position, but you will be able to see long term and how the company has positioned itself.

Using these ratios can help you understand a little more as to how good an investment a company may be. While these aren’t the only things you should look at before putting money to work, they are a good start for the amateur investor. Of course you should do much more homework than this and possibly consult an investment advisor before investing.

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