10 essential financial ratios

What it measures: How much the company generates per dollar invested

ROIC = NOPAT / Invested Capital

✅ Good: > 15% over 5 years · ⚠️ Average: < 10% · ❌ Avoid: negative

Buffett's favorite. A company that maintains ROIC > 15% over 10 years necessarily has a durable competitive advantage (moat).

What it measures: Real cash yield, independent of accounting tricks

FCF Yield = FCF / Market Cap

✅ Good: > 5% · ⚠️ Average: 2-5% · ❌ Avoid: < 2% or negative

More reliable than P/E (which can be manipulated). If a company generates 5% of cash per year of its market value, you're paid to wait.

What it measures: How many years of operating profit to repay debt

Net Debt / EBITDA

✅ Good: < 2x · ⚠️ Watch: 2-3x · ❌ Avoid: > 4x

Beyond 4x, any economic shock can kill the company. LBOs often load up to 6x — very risky.

What it measures: Pricing power and business quality

Gross Margin = (Revenue − COGS) / Revenue

✅ Excellent: > 60% (software, luxury, brands) · ✅ Good: 30-60% · ⚠️ Weak: < 20% (commodity)

A gross margin rising over 5 years = strengthened pricing power. Falling = competitive compression.

What it measures: Real traction, not buzz

CAGR = (Rev_n / Rev_0)^(1/n) − 1

✅ Growth: > 10%/year · ⚠️ Stagnation: 0-5% · ❌ Decline: negative

Growth > 15% over 5 years with stable margins is extremely rare and valuable.

What it measures: Ability to pay bills within 12 months

Current Ratio = Current Assets / Current Liabilities

✅ Good: > 1.5 · ⚠️ Tight: 1-1.5 · ❌ Danger: < 1

Below 1, the company lives on its cash reserves. Default risk if the market turns.

What it measures: Business model efficiency

Op. Margin = EBIT / Revenue

✅ Excellent: > 25% · ✅ Good: 15-25% · ⚠️ Weak: < 10%

Compare to sector average. A company outperforming its sector by 5+ points = solid competitive advantage.

What it measures: How much you pay for $1 of annual earnings

P/E = Price / EPS

✅ Discount: < 15 · ⚠️ Fair: 15-25 · ❌ Expensive: > 30 (unless growth > 20%)

Useless in isolation. Always compare to sector P/E AND to expected growth (PEG).

What it measures: P/E adjusted for growth

PEG = P/E / EPS Growth (in %)

✅ Undervalued: < 1 · ✅ Fair: 1-1.5 · ❌ Overvalued: > 2

Peter Lynch's favorite method. A stock at P/E 30 but growing 30%/year has PEG = 1 → fairly priced.

What it measures: Management's skin in the game

% held by executives / founders

✅ Excellent: > 10% · ✅ Good: 3-10% · ⚠️ Weak: < 1%

The more executives have their money in the company, the more aligned their decisions with shareholders. A founder still holding 15% after 10 years is a strong signal.

Before buying a stock, check these 5 points:

1. ☐ ROIC > 15% over 5 years
2. ☐ Revenue growth > 10%/year
3. ☐ Net Debt / EBITDA < 3x
4. ☐ FCF Yield > 4% (or PEG < 1.5 if strong growth)
5. ☐ Insider ownership > 3%

If 4 out of 5 are OK → deeper analysis. If 3 or less → move on.