Cash and Context - Important to Stock Investors

Investors in the stock market love numbers or, at least they should be familiar with some of the most important ratios and indicators.

It is also important that stock investors understand the context of any internal number.

Here are three indicators that you should check before buying (or selling) any stock.

They aren't the only ones you'll want to know (others can be found in this series on fundamental analysis).

However, these three checks let you look at the importance of cash and then compare your findings to peer companies.

This comparison is the context that makes sense of the other two indicators (and all internal indicators, for that matter).

A reader recently asked about debt to cash flow ratios when analyzing a stock. The reader stated (in part):

"There was an analyst on TV and she mentioned the debt to cash flow ratio of two companies. With the first company she stated that their debt to cash flow is 17 times which is really off the charts. Normal in this time in the cycle is about 2 times debt to cash flow."

The reader asked for more information on this ratio and what would be a good number to look for in a company. Here's my answer.

Cash Ratio Good Measure of Liquidity

How much cash do you have in the bank? Can you pay all of your current bills and still have a positive balance?

If so you are considered highly liquid, meaning enough of your assets are either cash or easily converted to cash.

For stock investors, a company’s liquidity is an important consideration in looking for potential investments.

Companies that have good liquidity are able to ride out bumps the economy may put in their way.

The question for stock investors is how do you measure liquidity.

It is never easy picking good stocks, however during very difficult economic times it becomes more important than ever. When the economy is weak and the market even more unpredictable, good companies falter along with the bad.

A troubled economy tends to strip away any growth weak companies enjoyed in previous growth cycles.

However, because good companies may suffer also, investors need a way to judge a company’s performance.

Stories in this series: