Limitations of Financial Ratio Ranking

In previous article, we discussed about initial stocks screening method using financial ratios (Read more here).  This week, we would like to discuss more on the limitations of financial ratio ranking.

In the electronics sector, it is a common practice for companies to maintain high cash position and low debt levels.  The debt-to-equity (D/E) ratio for most electronics companies are very low or near zero.  Thus, D/E ranking may not be meaningful.

Also, financial ratios are computed using financial statements.  Different companies may have different approaches to recognize their costs.  For instance, MPI cost of sales is very high but their Selling, General & Administration (SG&A) costs are low.  As such, MPI’s gross margin is relatively low compared to its peers but its operating profit margin is on-par with its peers.

Users could either manually adjust the input data or carefully select at least two financial ratios in the same category, (example, Gross Margin & Operating Margin) to smoothen the impact of input data discrepancy.  Nevertheless, this methodology is a useful to benchmark companies in a selected sector.

Source: Ratios were calculated based on financial data from Bursa MarketPlace

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