The current ratio (also called "working capital ratio") measures a company's ability to pay its short-term obligations. It is calculated by dividing a company's current liabilities from its current assets.
How can I use the current ratio when I invest in stocks?
- You use the current ratio to understand the company's ability to pay off its short-term obligations, given its most liquid assets such as cash, marketable securities, and accounts receivable. It gives you an indication of the company's financial health. For example, Microsoft has a current ratio of 2.52, while Tesla has a current ratio of 1.13. This shows that Microsoft has more current assets than current liabilities to meet its short-term obligations as compared to Tesla and this is an indication that Microsoft seems to be the better investment of the two
- However, as the quick ratio only shows a snapshot of the firm's liquidity status, it does not show how the firm's liquidity has progressed over the years. For example, Amazon's current ratio increased while Facebook's current ratio decreased over the past five years. This could indicate that even though Amazon's liquidity was lower than Facebook's in the past, it seems to be improving and could signal a substantial potential upside.
- Furthermore, when comparing current ratios to determine which stock is a better long opportunity, it is wiser to compare stocks within the same industry as stocks from different sectors may have different credit periods. In industries where it is typical to extend credits for 90 days or longer, their stocks may have lower current ratios compared to those where short-term collections are critical.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies