Morningstar Investing Classroom

# Morningstar Investing Classroom - Morningstar Investing...

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Morningstar Investing Classroom http://news.morningstar.com/classroom2/printlesson.asp?docId=143. .. 1 of 7 11/21/2009 9:51 PM Return to: Previous Page Morningstar.com's Interactive Classroom Course 108 Learn the Lingo--Basic Ratios Introduction Now that you've learned the basics of reading financial statements (the language of business), let's learn the basic language of investing. Ratios are a common tool investors use to relate a stock's price with an element of the underlying company's performance. These quick and dirty ratios can be useful in their own way, as long as you're aware of the limitations. But before we get to calculating any ratios, we must first cover some essential definitions. Earnings Per Share Earnings per share (EPS) is a company's net income (typically over the trailing 12 months) divided by its number of shares outstanding. EPS comes in two varieties, basic and diluted. Basic EPS includes only actual outstanding shares of a company's stock, while diluted EPS represents all potential stock that could be outstanding with current stock option grants and the like. Diluted EPS is the more "conservative" number. EPS = (Total Company Earnings) / (Shares Outstanding) Although EPS can give you a quick idea of a company's profitability, it should not be used in isolation without also looking at cash flow and other performance metrics. Market Capitalization Market capitalization is essentially the market value of a company. It is calculated by multiplying the number of shares outstanding by the current share price. For example, if there are 10 million shares outstanding of ABC Corporation and ABC's stock is currently trading at \$25 per share, the market capitalization of ABC is \$250 million. As we will find out shortly, market capitalization not only gives you an idea concerning the size of a company, it can also be used when calculating the basic valuation ratios.

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Morningstar Investing Classroom http://news.morningstar.com/classroom2/printlesson.asp?docId=143. .. 2 of 7 11/21/2009 9:51 PM Market Capitalization = (Stock Price) x (Shares Outstanding) Profit Margins Just as there are three types of profits--gross, operating, and net--there are also three types of profit margins that can be calculated to offer insight into a company's profitability. Gross margin is simply gross profits divided by revenues, and so on. Margins are usually stated in percentages. Gross Margin = (Gross Profits) / Revenues Operating Margin = (Operating Profits) / Revenues Net Margin = (Net Profits) / Revenues Price/Earnings and Related Ratios One of the most popular valuation measures is the price/earnings ratio, or P/E. The P/E is the price of a stock divided by its EPS from the trailing four quarters. As an example, a stock trading for \$15 per share with earnings of \$1 per share during the past year has a P/E of 15. P/E = (Stock Price) / EPS =
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## This note was uploaded on 11/22/2009 for the course HR GM600 taught by Professor Na during the Spring '09 term at Keller Graduate School of Management.

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Morningstar Investing Classroom - Morningstar Investing...

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