Using Key Financial Ratios to Pick the Best Stock Among Peers

Using Key Financial Ratios to Pick the Best Stock Among Peers

Investors across the spectrum – from new traders to seasoned analysts – rely on fundamental metrics to gauge a company's performance. By focusing on a few key financial ratios, you can cut through market hype and objectively compare businesses.

These ratios distill profitability, efficiency, and value into clear numbers that make it easier to identify which stock is fundamentally stronger among its closest peers.

In this article, I explain some of the most important metrics – like ROE, ROA, ROIC, Free Cash Flow Yield, EV/FCF, PEG ratio, Gross Profit Margin, and OCF/Sales – and how investors use them to pick winners.

I’ll then apply these metrics in a real-world case study comparing NVIDIA (NVDA) to Broadcom (AVGO), two semiconductor giants, to see which stock looks better based on the numbers. (Spoiler: I obtained the data using the Stocks2Buy fundamental analysis web app, which makes such comparisons quick and insightful.)

---

Key Financial Metrics and What They Tell Investors

Fundamental ratios each provide a different lens on a company's health. Here are some of the most widely-used metrics and how they help investors compare stocks:

1. Return on Equity (ROE)

This profitability ratio measures how effectively a company’s management uses shareholders’ equity to generate profits.

It is calculated as Net Income / Shareholders’ Equity.

A higher ROE means the company produces greater profit for each dollar of equity – a sign of efficient management and a potentially strong competitive advantage. Investors often prefer stocks with consistently high ROE, especially relative to industry peers, as it can indicate superior ability to create shareholder value over time. (For context, professional investors consider an ROE of 15-20% as a positive sign in many industries)

2. Return on Assets (ROA)

ROA shows how much profit a company earns for each dollar of its total assets. Essentially, ROA reveals how efficiently a company’s assets – including cash, inventory, property, etc. – are used to generate earnings.

It is defined as Net Income / Total Assets.

A higher ROA indicates more effective asset utilization, which is particularly useful when comparing companies in the same sector. This metric helps investors spot firms that squeeze more profit out of the assets they own.

3. Return on Invested Capital (ROIC)

ROIC measures how well a company allocates its capital (debt + equity) to generate operating profits.

It’s often calculated as Net Operating Profit After Tax (NOPAT) / (Debt + Equity).

In plain terms, ROIC shows the percentage return a company earns on the capital invested by both shareholders and debt holders. A ROIC higher than the company’s cost of capital (WACC) indicates it’s creating value; if ROIC is consistently above peers’, it suggests the business is exceptionally efficient at deploying capital.

Investors love companies with high and rising ROIC, as they tend to be “compounders” that generate wealth over the long run. (By contrast, a ROIC below the cost of capital signals the company might be destroying value).

4. Gross Profit Margin

Gross margin is the percentage of revenue that the company retains after paying for the cost of goods sold (COGS).

It is calculated as (Revenue – COGS) / Revenue

Usually expressed as a percentage. This metric gauges the core profitability of a company’s products or services before overhead costs. A higher gross profit margin means a company is efficiently producing its goods (or has strong pricing power) and keeps more profit from each dollar of sales.

When comparing peers, gross margin highlights which company has a superior handle on production costs or the ability to charge premium prices. Consistently high (or improving) gross margins often point to durable competitive advantages in product quality or cost structure.

5. Operating Cash Flow / Sales (OCF/Sales)

Also known as the cash flow to sales ratio, this metric looks at how much operating cash flow a company generates relative to its revenue.

It is calculated as Operating Cash Flow ÷ Net Sales.

In essence, OCF/Sales shows what proportion of a company’s sales is turning into actual cash. A higher percentage is better – it means the company is adept at converting revenue into cash, which is crucial for paying expenses, investing in growth, and returning money to shareholders.

Investors compare OCF/Sales to gauge earnings quality (high cash conversion can signal that profits are not just paper earnings) and to assess liquidity.

For example, if Company A has OCF/Sales of 40% and Company B has 10%, Company A is generating far more cash from the same revenue – a potential sign of a healthier, more efficient business.

6. Free Cash Flow Yield (FCF Yield)

This valuation metric tells you how much free cash flow a company produces relative to its price. It’s analogous to an “earnings yield” but based on cash flow rather than accounting earnings.

One common definition is Free Cash Flow per Share / Price per Share

A higher FCF yield indicates an investment is generating more cash per dollar you invest in the stock. For investors, FCF yield is handy for comparing how “cheap” or “expensive” a stock is based on cash generation.

A stock with a 10% FCF yield, for instance, is producing $0.10 of free cash flow annually for each $1 of market value – a very strong cash return. In contrast, a 2% FCF yield (or lower) means you’re getting only $0.02 of cash per $1 invested, which might be acceptable for a high-growth company but could also be a red flag for overvaluation if growth prospects don’t pan out.

This metric helps investors find cash-rich bargains and avoid pricey stocks that aren’t backing up their valuations with real cash flow.

7. EV/FCF (Enterprise Value to Free Cash Flow)

EV/FCF is another way to evaluate valuation through the lens of cash flow. It takes the company’s Enterprise Value (EV) (which includes market cap plus debt minus cash) and divides it by annual free cash flow.

In formula form: EV / FCF

This ratio tells you how many dollars of Enterprise Value correspond to one dollar of free cash flow per year. For example, an EV/FCF of 20× means the company’s total value is 20 times its yearly FCF.

A lower EV/FCF is generally better – it suggests the stock might be undervalued relative to its cash flow, as the investor is paying fewer dollars for each $1 of FCF. A high EV/FCF (say 50× or 60×) indicates the stock is priced at a premium, possibly because investors expect FCF to grow rapidly in the future.

This metric is especially useful to compare companies with different debt levels, since EV includes debt; it puts firms on more of an “apples to apples” basis by looking at total value instead of equity price alone.

When picking stocks, investors can use EV/FCF much like the classic P/E ratio – spotting potential bargains or overpriced names by how their valuation stacks up against hard cash flow.

8. PEG Ratio (Price/Earnings to Growth)

The PEG ratio evaluates a stock’s price-to-earnings (P/E) ratio in the context of its earnings growth rate.

It is calculated as (P/E) / (EPS Growth Rate).

This metric helps investors answer the question: Is a high P/E justified by high growth? A company with a P/E of 30 and an earnings growth rate of 30% would have a PEG of 1.0, indicating the price is in line with its growth.

A PEG below 1.0 is often interpreted as the stock being undervalued relative to its growth (a potential bargain), while a PEG above 1.0 suggests the stock price may be high given its growth prospects.

For example, a PEG of 2.0 means investors are paying twice as much for growth compared to a baseline PEG of 1. The PEG ratio is a favorite of growth investors because it standardizes valuation for growth – it can highlight cases where a low P/E stock is actually a trap (if growth is also low) or where a high-flying growth stock might still be reasonable value because its growth rate is exceptional.

When comparing peers, PEG helps identify which company’s stock might be overvalued or undervalued after accounting for growth.

---

Each of these metrics serves as a tool in an investor’s toolbox. The real power comes when you use them together to build a well-rounded picture of a business.

For instance, high returns on capital (ROE, ROA, ROIC) coupled with robust cash flow metrics (OCF/Sales, FCF Yield) can signal a high-quality company – but if the valuation ratios (EV/FCF, PEG) are sky-high, it could mean the stock’s greatness is already priced in.

The goal is to find companies that excel in fundamentals relative to their peers, ideally without an excessive price tag. To illustrate how these ratios work in practice, let’s compare two well-known tech stocks on these key metrics.

Case Study: NVDA vs. AVGO – Which Stock Scores Better on Fundamentals?

Let’s put the metrics into action by comparing NVIDIA (NVDA) and Broadcom (AVGO). Both are large semiconductor companies, often considered peers in the high-tech chip industry. I analyzed each using the Stocks2Buy fundamental analysis app, which gave me the following figures:

Key Metrics (TTM) – NVIDIA vs. Broadcom (capital efficiency & cash generation):

Metric	NVIDIA (NVDA)	Broadcom (AVGO)
Return on Assets (ROA)	61.5%	11.4%
Return on Equity (ROE)	105.2%	27.0%
Return on Invested Capital (ROIC)	70.7%	14.4%
Free Cash Flow Yield	1.5%	1.5%
EV / FCF	65.98×	69.80×

Financial Ratios (TTM) – NVIDIA vs. Broadcom (profitability & growth valuation):

Metric	NVIDIA (NVDA)	Broadcom (AVGO)
Gross Profit Margin	69.8%	66.8%
PEG Ratio (P/E to Growth)	4.31	1.91
OCF / Sales	46.6%	42.4%

At a glance, NVIDIA’s numbers are strikingly strong. Its return metrics are far higher than Broadcom’s: ROA of 61.5% vs. 11.4%, and ROE of 105.2% vs. 27.0%. This means NVIDIA generated an extraordinary profit relative to its asset base and equity. In fact, NVIDIA’s ROA and ROE are several times higher, indicating it has been dramatically more efficient and profitable with its resources over the past year.

The ROIC tells a similar story – NVIDIA earned about 71% on its invested capital, vs. ~14% for Broadcom. Such outperformance in ROA/ROE/ROIC suggests NVIDIA has recently hit a sweet spot with its business (likely due to booming demand for its AI chips) and is operating at a level of efficiency rarely seen in its industry.

Broadcom’s return ratios in the teens and twenties are respectable for most companies, but NVIDIA’s are in a different league.

When it comes to cash flow generation, both companies show strengths, though NVIDIA still has an edge. Free Cash Flow Yield is 1.5% for each, which means that in the last year both companies’ free cash flow amounted to about 1.5% of their market value.

This is a fairly low FCF yield, telling us that investors are paying a high price for each dollar of free cash flow (common for popular tech stocks). The reciprocal of that yield is the EV/FCF: NVIDIA trades around 66× EV/FCF and Broadcom around 70× EV/FCF. These high multiples imply the market anticipates significant growth ahead (or is willing to accept low cash returns now in exchange for future gains). NVIDIA’s EV/FCF is slightly lower – meaning NVIDIA’s stock is valued a bit less expensively relative to its current FCF than Broadcom’s.

In other words, both stocks are expensive on a cash flow basis, but Broadcom is marginally more so (69.8× vs 65.98×). Practically speaking, this difference is small; both companies have a similar cash yield profile (about 1.5%). An investor comparing just these would note neither stock is a cash cow at the moment – they’re priced for growth.

NVDA's Key Metrics

NVDA's Key Metrics

Profitability and cash conversion metrics also tilt in NVIDIA’s favor. NVIDIA’s Gross Profit Margin of 69.8% slightly exceeds Broadcom’s 66.8%. Both are very high gross margins (typical for semiconductor and software-related businesses with high intellectual property content), so both firms operate efficiently and can command premium pricing.

NVIDIA’s edge here suggests it currently has a bit more pricing power or lower production costs relative to sales – potentially due to its unique position in AI GPUs.

Operating cash flow to sales shows a similar pattern: NVIDIA turned 46.6% of its revenue into operating cash, while Broadcom converted 42.4%. Again, both figures are impressively high (indicating strong cash-generating ability in their sales), but NVIDIA squeezes out a bit more cash per dollar of sales. This hints at excellent operational efficiency on NVIDIA’s part – its earnings are high quality and backed by cash flow, which investors typically love to see.

The one metric where Broadcom outshines NVIDIA is the PEG ratio. Broadcom’s PEG is about 1.91, compared to NVIDIA’s lofty 4.31. Remember, PEG considers the stock’s price relative to earnings and growth. A PEG of 4.31 indicates NVIDIA’s stock price is very high relative to its current growth rate – in fact, more than four times its growth, suggesting the stock may be overvalued unless its earnings growth accelerates beyond expectations.

Broadcom’s PEG of 1.91 is much lower; it implies Broadcom’s valuation is more moderate once you factor in its growth (a PEG near 2 is still above the ideal of 1.0, but it’s reasonably in line for a steady grower). This contrast tells us investors are paying a hefty premium for NVIDIA’s superior growth and profitability, whereas Broadcom, despite being expensive in absolute terms, is priced closer to its growth rate.

In simpler terms, NVIDIA is the higher-risk, higher-reward play – it’s executing brilliantly, but the stock’s high PEG suggests a lot of that brilliance is already baked into the price. Broadcom might be the more reasonably valued stock relative to how fast it’s growing.

NVDA's Financial Ratios

NVDA's Financial Ratios

So, which stock is better based on these numbers? Pick the Best Stock Among Peers

In most fundamental aspects, NVIDIA looks stronger than Broadcom. NVDA clearly wins on returns (ROA, ROE, ROIC) and edges out Broadcom on margins and cash conversion. These figures imply NVIDIA has been more effective at generating profit from every dollar of assets, equity, and sales – a sign of an outstanding business performance. If we consider quality alone, NVIDIA’s fundamentals are superior.

However, valuation matters. NVIDIA’s high PEG (and high EV/FCF) suggest investors must pay a steep price for that quality and growth, whereas Broadcom offers solid (if less spectacular) fundamentals at a somewhat more palatable growth-adjusted price.

From a pure fundamental metrics perspective, one could argue NVIDIA is the “better” stock because it delivers much higher returns and cash flows relative to its operations. A shareholder of NVDA enjoys exceptional profitability metrics that are off the charts in the industry. But a value-conscious investor might counter that AVGO is better value, since Broadcom’s more modest performance comes at a far lower PEG ratio.

Ultimately, the choice depends on your investing style – do you favor the company with the best business metrics (NVDA), or the one with more reasonable pricing relative to growth (AVGO)?

---