Q12RQ - Horngren'S Financial And Managerial Accounting

Question

Briefly describe the ratios that can be used to evaluate a company’s stock as an investment.

Step-by-Step Solution

Answer

The ratios that can be used for the evaluation of stock as an investment are earnings per share and price-earnings ratio.

Step 1 Definition of Ratio Analysis

The ratio analysis is defined as a technique by which the financial statements of the company are analyzed by comparing the values provided in the financial statement.

Step 2 Ratios that can be used to evaluate a company’s stock as an investment

The ratios which can be used are as follows:

1. Earnings per share (EPS): This ratio is computed to show how much of the profit earned by the company is available for distribution to the common shareholders of the company. It is computed by dividing the net income after the preference dividend by the number of outstanding equity shares.
2. Price-earnings Ratio: This ratio tells the company whether the shares of an entity are overpriced or underpriced. It is computed by dividing the market price per equity share by earnings per share.