Evaluating Quantitative Metrics: Part 2

Introduction

If you haven’t checked out my last article, feel free to do so here. I briefly talked about some relevant categories of quantitative metrics and general applications, as well as how important quantitative metrics are, while comparing the pros and cons of quantitative metrics in finance. Now, I want to take a deep dive into many of these metrics/ratios, what they mean, and how to analyze them in conjunction with one another.

These have deep implications for the finance world. For example, here is how much quantitative finance research is used, and it is clear it is progressively becoming more and more important.

Most Important Quantitative Metrics for Investors and their Relevance

Profitability Ratios:

1. Gross Profit Margin: This ratio indicates the percentage of revenue that remains after accounting for the cost of goods sold. A higher gross profit margin suggests better efficiency in production and pricing.
2. Net Profit Margin: This metric reveals the percentage of revenue that translates into net profit after all expenses. A higher net profit margin reflects effective cost management and profitability.
3. Return on Equity (ROE): ROE measures the return generated on shareholders’ equity. A higher ROE indicates effective use of shareholder investments, while a lower ROE may signal inefficiency.

Liquidity Ratios:

1. Current Ratio: This ratio assesses a company’s ability to cover short-term obligations with short-term assets. A current ratio above 1 suggests good liquidity.
2. Quick Ratio (Acid-Test Ratio): The quick ratio provides a more conservative measure of liquidity by excluding inventory. A ratio above 1 indicates the company can meet short-term obligations without relying on selling inventory.

Solvency Ratios:

1. Debt-to-Equity Ratio: This ratio gauges the proportion of debt used to finance a company’s assets relative to shareholders’ equity. A lower ratio indicates lower financial risk.
2. Interest Coverage Ratio: This metric indicates how many times a company can cover its interest expenses with its operating income. A higher ratio implies better solvency and the ability to meet interest obligations comfortably.

Efficiency Ratios:

1. Inventory Turnover: This ratio measures how quickly a company sells its inventory. A higher turnover suggests efficient inventory management and faster cash conversion.
2. Accounts Receivable Turnover: This ratio shows how quickly a company collects payments from its customers. A higher turnover indicates effective credit policies and timely cash inflows.

Valuation Ratios:

1. Price-to-Earnings (P/E) Ratio: The P/E ratio compares a company’s market value per share to its earnings per share. A higher P/E ratio may indicate that investors expect higher future earnings growth.
2. Price-to-Book (P/B) Ratio: This ratio compares a company’s market value per share to its book value per share. A ratio below 1 suggests the stock might be undervalued, while above 1 may indicate overvaluation.

Conclusion

Using these metrics, investors have a lot of tools at their disposal. We can use any combination of these metrics depending on our end goals, and we can even implement this using automation, AI, or any other method. In the next part, I’m going to talk about how this can happen, and explore the use of machine learning with stock forecasting, at least from a quantitative standpoint. Even still, using unstructured data and NLP allows us to look at more qualitative data, and then I’ll bring up the point that sometimes the data is on a spectrum between quantitative and qualitative that machine learning will convert to quantitative data. Of course, this is all very detailed and I will be covering this in the next part.

Disclaimer: The information offered by us may not be suitable for all investors. If you have any doubts as to the merits of an investment, you should seek advice from an independent financial advisor.