- 1). Identify the relevant financial ratios. A publicly traded company is required by federal law to file certain financial statements with the Securities and Exchange Commission, or SEC. These SEC filings are available to the public and contain important financial information. Certain ratios can be used to help identify the quality of a company. For example, the company's debt-to-equity ratio is often seen as a good indicator of a company's financial stability. Just as with individuals, the more debt a company has relative to its assets, the riskier it may be as an investment. Another important ratio is the return-on-equity ratio, which essentially measures how much profit a company earns using a particular amount of investor equity. The higher this ratio, the higher the rate of return an investor can hope to earn on her stock.
- 2). Look for historical trends. Once you have identified the relevant financial ratios, compare them to the company's past performance. If the ratios seem to be improving, the company may be on a positive upward trend in terms of profitability and growth. If the ratios seem to be worsening, the company may be in a declining phase and you should possibly avoid it as an investment.
- 3). Compare the company to other companies in the same industry. It can often be difficult to determine the quality of a company without regard to other companies in the same industry. For example, a debt-to-equity ratio of 2 to 1 might be very high in some industries but relatively moderate in others. Because companies in the same industry are dealing with roughly the same external considerations, they tend to be good benchmarks for one another.
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