Financial ratios serve as indicators, but not as proof about the financial condition of a company. Consider the following and comment on the pros and cons of each approach.
a. An analyst focuses on one financial ratio as the indicator of performance for a firm, an industry, and equities in general. You might note here how often investment strategists will judge the equity market on the basis of a single ratio, often the P/E ratio, as evidence of the market being either cheap or expensive.
b. Financial ratios represent the financial picture of a company. However, nonfinancial data, also critical to a company”s performance is not represented. How might this be an issue in the evaluation of a company?
c. What factors might account for the persistent differences in financial ratios between companies in the same industry?
d. Seasonality will influence the level of cash and inventories for any given company. What other influences might a factor such as seasonality have on other financial ratios?
e. Selected financial ratios, particularly those linked to leverage, appear to have changed over time. What might account for this long-term trend?