Top 10 KPIs Every Investor Should Know Before Investing

Having knowledge about where to invest is a must for financial success, which requires a strong hold on various asset classes, concepts, and market conditions. In the world of investments and investors, KPIs act as benchmarks used to evaluate a company’s performance. Before investing in the market, investors should focus on essential KPIs, as these indicators provide a holistic picture of a company’s financial health.

Key Performance Indicators (KPIs) are quantifiable measurements used to gauge a company’s overall long-term performance. KPIs specifically help determine a company’s strategic, financial, and operational achievements, especially compared to those of other businesses within the same sector.

Source: Investopedia

Essential Key Performance Indicators

1. Return on Investment (ROI)

ROI is a metric, a ratio, used to calculate the profitability of an investment. It measures the amount of return we can get on an investment compared to the cost of investment.

Advantages:

• Easy to understand.
• Universally understood.

Disadvantages:

• Time factor is not taken into account.
• Can be manipulated.

2. Earnings Per Share (EPS)

EPS is used to assess the profitability of a company. It represents the value an outstanding share of a company can earn from its common stock.

Advantages:

• It impacts the share price of a company directly. EPS is directly proportional to the share price.
• Reflects real profit to investors.

Disadvantages:

• Easy to manipulate.
• Does not take into account the share price of a company.

3. Price to Earnings Ratio (P/E)

The P/E ratio measures the current price of a company’s share in proportion to its earnings per share. It provides investors with a better picture of the company’s value.

Advantages:

• Comparable with other companies in the same industry.
• Easily understandable, accessible to a wide range of investors.

Disadvantages:

• Does not take into account the company’s debt level.
• Can be manipulated by accounting policies.

4. Working Capital

It is the metric of the difference between current assets and current liabilities of an organisation. It is commonly used to judge the short-term financial health of a company.

Advantages:

• High working capital can indicate high adaptability of a business to market changes.
• Depicts the stability of a business.

Disadvantages:

• Considers only monetary factors.
• Based on past events and figures, not recognizing sudden market changes.

5. Gross Profit Margin

GPM depicts the aggregate money a company makes after subtracting its business costs.

Advantages:

• An optimum criterion for comparing a company’s performance with its competitors.
• Helpful in setting competitive pricing while ensuring profitability.

Disadvantages:

• Does not include all contingencies, so it is not a measure of overall profitability.
• Not an apt measurement for comparing companies across distinct industries.

6. Operating Cash Flow (OCF)

OCF is the cash generated from a company’s regular business activities. It indicates whether a company produces enough positive cash flow to keep up and expand its operations without external funding. A company’s statement of cash flows encompasses three categories: operating, investing, and financing. Operating cash flows represent the inflows and outflows associated with a company’s core business activities, like selling and purchasing inventory, delivering services, and paying salaries. Transactions related to investing and financing, such as borrowing, purchasing capital equipment, and paying dividends, are excluded.

Advantages:

• Measures a company’s potential to generate cash from core business activities.
• Indicates a company’s potential to pay its bills and meet financial obligations.

Disadvantages:

• Does not consider long-term liabilities.
• Does not take into account the timing of cash flows.

7. Debt to Equity Ratio (D/E)

The D/E ratio measures a company’s financial leverage by dividing the company’s total liabilities by its shareholders’ equity. It indicates the extent to which a company is carrying out its operations with debt rather than its own resources.

Advantages:

• A high D/E ratio indicates that a firm can meet its debt obligations with its cash flow and leverage it to enhance equity returns and drive strategic growth.
• Increasing the D/E ratio to a certain level can reduce a firm’s weighted average cost of capital.

Disadvantages:

• It is an industry-specific metric; capital-intensive companies may have a higher D/E ratio.

8. Net Profit Margin

Net profit margin indicates the amount of net income or profit a company make as a percentage of its revenue. In simple terms, it is the ratio of net profits to revenue.

Advantages:

• Indicates earning capacity, showing the organization’s ability to make a profit from sales.
• Guides investors on which companies are likely to bring good returns.

Disadvantages:

• Does not account for size differences of companies.
• Does not reflect cash flow, which is crucial for day-to-day operations.

9. Cash Conversion Cycle (CCC)

The CCC measures the time required for a company to convert cash invested in inventory into cash obtained from selling its products or services. A shorter cash cycle is preferable.

Advantages:

• Assesses the company’s financial health by reducing the risk of liquidation.
• Can be used as a KPI for management to expand business operations.

Disadvantages:

• Differs from one industry to another.
• Not the best measure of business efficiency, merely indicating the time to clear dues and measure liquidity and operational viability.

10. Return on Equity (ROE)

ROE measures a company’s ability to generate profit from available equity. It represents the percentage derived from the company’s net profit relative to its shareholders’ equity, reflecting management’s ability to convert equity into profit.

Advantages:

• A strong ROE attracts more investors by indicating efficient use of equity capital.
• Shareholders can evaluate management performance.

Disadvantages:

• Does not provide an exact performance measure, as it depends on the amount of equity on the balance sheet.
• Can be manipulated through share buybacks.