How To Use Financial Ratios To Rank Companies?

In company analysis, financial ratios are very useful tools to gauge a company’s financial health, operating efficiency and earnings quality.  There are many categories of financial ratios such as Activity Ratios, Liquidity Ratios, Solvency Ratios, Profitability Ratios, Valuation Ratios and others.  Often, ratios from different categories may give contradicting messages.  This article will discuss a simple method to rank companies using various financial ratios.

First, we shall identify the ratios that we would like to include in the ranking process.  The following ratios are chosen for illustration purposes only.

Category	Ratio	Interpretation
Activity Ratios	Inventory turnover	Higher Better
	Total assets turnover	Higher Better
Liquidity Ratios	Current Ratio	Higher Better
	Quick Ratio	Higher Better
Solvency Ratios	Debt to Equity Ratio	Lower Better
	Interest Coverage	Higher Better
Profitability Ratios	Gross Profit Margin	Higher Better
	Net Profit Margin	Higher Better
	Return On Equity	Higher Better
Valuation Ratios	Price to Earnings	Lower Better

Next, we choose ten companies from the same sector.  For this article, we have chosen the Plantation Sector in Malaysia.  The following table shows the respective financial ratios for ten plantation companies listed on Bursa Malaysia.

   * Sime Plantation is not included due insufficient data and relatively short listing duration

  

Once the financial ratios are ready, we could rate it according to a scale from 10 (Favourable) to 1 (Least Favourable).

From the above table we could see that some companies may have scored well in certain ratios but performed poorly on other ratios.  For quick comparison purposes, we could then calculate the average rating for each company as depicted in the following table.

This method is useful for investors who would like a first cut screening before carrying out more detailed financial analysis.  Investors shall not make investment decision solely based on a ratio analysis as there are other factors that may impact prospects for any investment in plantation stocks.

Disclosure: The authors may have interest in the stocks of the companies in this article.