One thing that separates fledgling investors from the pros is reading financial statements. For amateurs, comparing the so-called headline numbers — sales and earnings — to estimates is the full extent of research into a company, whereas in more experienced hands, they are just a starting point. If you want to become a better investor, make like a pro and digest the financials. It's the best way to truly understand a company's performance. In the lead up to the start of earnings season later this month, we've put together a five-part series to help Club members better understand all the tables and charts and how to analyze them. Here's Part 4: The ratios. Part 4: The ratios Now that you have a better understanding of the income , balance and cash flow statements — parts 1, 2, and 3, respectively — let's go over how to use them to get a complete picture of a company's financial health. That means using some key financial ratios. What follows is not an exhaustive list, but a good starting point for most investors, which includes many of the most important measures used by the Club. Current ratio The current ratio, which compares current assets to current liabilities, is a great first metric. As members will recall, current assets include cash, assets that can quickly be converted to cash (such as marketable securities), and those assets expected to be converted to cash within less than a year (such as receivables and inventory). Current liabilities are debts that must be repaid within the next year. Ideally, we want to see a ratio of greater than 1, which indicates sufficient current assets to cover current liabilities. If we take a look at Club holding Apple 's (AAPL) balance sheet statement for the third quarter of this year, we see current assets of $112.29 billion (represented on the release in millions as $112,292) and current liabilities of $129.87 billion. The former divided by the latter yields a ratio of about 0.865. (To represent that as a percentage, move the decimal point two places to the right.) That's not great. But there are a few reasons why we're not concerned with it comes to Apple. First and foremost, remember that Apple categorizes a significant amount of marketable securities as non-current assets. Simply adding this line item to the assets side of the equation would put us well over the 1 ratio threshold. That's a rather straightforward and appropriate adjustment to consider given those marketable securities are still highly liquid assets. Apple's management factors them into their calculation when discussing cash and equivalents on its earnings calls. Second, Apple generates a significant amount of free cash flow (roughly $21 billion expected in the upcoming quarter alone). Finally, Apple's overall strong balance sheet and top-tier credit rating mean that they could always roll over some debt by selling longer-dated bonds to help pay off some nearer-term obligations. While the simple equation — current assets divided by current liabilities — is how you calculate the current ratio, we encourage members to think critically about the inputs and possibly consider making adjustments that seem logical. For example, one adjustment we like to consider here is to exclude deferred revenue from the current liabilities. Recall that deferred revenue is a liability that will be fulfilled by delivering a service, such as Apple Music. It's a liability because Apple already collected the cash. That doesn't require a cash outlay and, as a result, is something we can exclude from the equation. In Apple's case, this would reduce current liabilities by $7.73 billion and lead to a modified current ratio of about 0.92, which is much closer to 1. The gap between current assets and current liabilities also falls to around $9.85 billion from around $17.58 billion, easily made up by one quarter's free cash flow. Another consideration is how to handle term debt and commercial paper. You definitely do not want to exclude these two line items. But remember that companies, especially ones with as strong a reputation as Apple, can always sell more debt to pay off maturing debt. For example, Apple could always choose to sell long-term debt to pull additional funds in now. Keep this in mind if the ratio falls below 1. Some high-quality companies may run current ratios below 1, but can remedy that with debt or equity sales. The current ratio also doesn't take into account cash flow generation, which companies can also use to meet near-term obligations. Quick ratio The quick ratio focuses only on current assets that can quickly be converted to cash. This usually means removing inventories, but some investors go a step further and remove any other current assets they deem less liquid and include only cash, cash equivalents, marketable securities and accounts receivables. The idea is to determine liquidity if we had to convert current assets to cash and pay off current liabilities quickly without worrying about the need to sell inventory, the value of which depends on consumer demand that can fluctuate. Current liabilities are left unchanged. When it comes to Apple, we start with current assets of $112.29 billion and remove the $5.43 billion in inventory we see on the balance sheet (again, see above, this is represented in millions as $5,433). This results in current assets less inventory of $106.86 billion. Dividing that by current liabilities yields a result well below 1. However, we could also opt to remove deferred revenue from the liabilities side to get a better picture of how large the gap is between what Apple has on hand and what it owes over the next 12 months. And again, in Apple's case, a significant amount of marketable securities are categorized as noncurrent despite their liquidity. It's important to consider at least a portion of these securities when thinking about the company's liquidity position, along with its high free cash flow. This consideration of noncurrent marketable securities and cash flow profile is not meant to be an excuse for a poor ratio, but rather demonstrates why diligent investors must think beyond just mindlessly plugging numbers into a predetermined equation. That said, we reiterate that a result less than 1 for either the current ratio or quick ratio absolutely warrants further investigation. Net debt-to-EBITDA Of the leverage ratios, net debt-to-EBITDA is the main one. This involves taking the net debt (which is essentially total debt minus cash and cash equivalents) and dividing it by a full year's earnings before interest, tax, deprecation and amortization (EBITDA). Corporations have the ability to take on debt to fund investments. As investors, we want profitable companies to lever up, to an extent, because strong management teams can make good use of that debt to provide strong long-term returns. The net debt-to-EBITDA ratio helps us determine appropriate debt levels given a company's EBITDA generation. What the appropriate level is will be highly dependent on the industry and company in question. As a result, the best way to think through this metric is by researching historical levels and levels across the industry. In Apple's case, this isn't really a ratio of concern because Apple actually has negative net debt as a result of having more cash equivalents (including current and non-current marketable securities) than outstanding debt. We previously raised the point ( in Part 1 of our series in the operating income section) that some investors may not prefer the use of EBITDA since it factors out the real cost of depreciation and amortization. But it does make more sense in this equation because, in a worst-case scenario, a company could look to pay off debts before replacing depreciated equipment, for example. Dividend payout ratio This ratio measures the portion of earnings being paid out in dividends. A ratio north of 1 is simply unsustainable as a company cannot pay out more cash to investors than it generates in net income. That would be like giving your kids an allowance that is greater than your take-home pay. Apple's third-quarter statement showed dividend payments of $3.81 billion (in millions as $3,811 on the release) and net income of $19.44 billion. If we divide the payout by the net income, we get a payout ratio of about 0.196. Clearly, Apple will have no issue sustaining these payouts. However, when you see a shockingly high dividend yield, it's important to consider whether or not it's a fluke — an "accidental high yielder," which is what we refer to as a stock that yields a lot simply because the shares became oversold despite a perfectly sustainable payout. Cash conversion ratio Another important ratio that ties into earnings is the cash conversion ratio. Investors may look to use operating cash flow or free cash flow for this equation. In our view, because free cash flow removes payments for capital expenditures, it is the more conservative of the two. This ratio compares earnings to actual cash received. Earnings that are backed by cash are of a higher quality because, after all, you can't pay dividends, buy back shares or invest in growth with IOUs. Ideally, we want a ratio as close to 1 as possible, which indicates that earnings are entirely backed by cash. Return on equity Return on equity (ROE) calculates the ratio of net income to shareholder equity — net income divided by shareholder equity, or total assets minus total liabilities. It tells us how many dollars the company makes for every dollar of shareholder equity. The higher the ratio, the more efficiently the company is making use of its equity, which is essentially shareholders' stake in the business after netting out assets and liabilities. Another way to calculate ROE is through what is known as the DuPont equation. The extended version is calculated by multiplying five individual ratios. While these ratios ultimately cancel out to yield a simple ROE equation (net income divided by equity), this breakdown allows one to better understand the individual components impacting a company's ROE. To better understand the utility of this equation, let's consider what it looks likes for two rival companies, Club holding Advanced Micro Devices (AMD) and Intel . (We will use numbers pulled from FactSet for the 2021 calendar year; the numbers are represented in millions.) AMD clearly offers a significantly better ROE than Intel, a result of lower tax and interest burdens. The company also makes more efficient use of its assets. Finally, we see that AMD has less leverage. Less debt also means less future obligations and a stronger balance sheet, which is especially favorable in an economic slowdown. All of these positives for AMD serve to more than offset Intel's superior operating (EBIT) margin. While calculating ROE is the goal — and we could have gotten the answer by simply dividing net income (found on the income statement) by shareholder equity (found on the balance sheet) — this breakdown allows us to better understand what is driving that ROE. Bottom line So, there we have it, a review of some noteworthy financial metrics. We hope this will help members better use the financial statements companies provide and allow them the ability to do even more due diligence on the companies in which they are invested or are thinking about taking positions. Stay tuned for Part 5 in our financial statement series for the Investing Playbook, where we will go over Apple's cash flow statement. (Jim Cramer's Charitable Trust is long AAPL, AMD. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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