K-Ratio

A statistical tool that helps us measure the growth of return and the consistency of that growth over a specified period

What is the K-Ratio?

The K-Ratio is a statistical tool that helps us measure two things – the growth of return and the consistency of that growth over a specified period. It is often used to determine the risk vs. reward of investing in a particular asset, as well as the consistency of the return on that risk. The calculation for the K-Ratio is performed by creating a linear trend for a data set and estimating the slope/variability of the data.

A higher K-Ratio is indicative of better performance than that of a low K-Ratio. The ratio can be a useful tool for any trader or investor to compare different equities that they may be researching to determine if it is a prudent investment or to be avoided in its entirety. The K-Ratio is often used in statistics to determine the overall trend line of a variable.

 

History of the K-Ratio

Lars Kestner created the K-Ratio in 1996 to measure the overall profitability of a strategy. The ratio was designed so that an investor or financial manager could look at a data set and try to obtain a straight line with little deviation. This would help to signify that they are looking at an asset or investment product with a lucrative return.

The K-Ratio, according to Kestner, was introduced as a complementary ratio to the Sharpe Ratio. Over the years, Kestner made minor adjustments to the ratio, including adjustment factors for different types of return observations and different return periods.

 

How to Calculate the K-Ratio

The K-Ratio’s calculation is performed by creating a time series of data that pertains to an event or strategy. The returns are added up in a compound fashion, and then summed geometrically. In a paper written by Lars Ketner, the creator of the K-Ratio, he cites its calculation as follows:

 

K-Ratio - Formula

 

Finance Professionals and the K-Ratio

In the field of finance, K-Ratios can be used to measure the performance and long-term viability of equities and other securities. The K-Ratio is a useful tool; however, it is often used in conjunction with other key accounting and financial ratios to ascertain quantitative data on the viability of an investment.

Understanding trends is only part of the picture, and understating how qualitative factors can influence the trends is also critical in understanding potential dips in performance metrics like the K-Ratio. As finance professionals and students, we must always understand that no one tool is perfect in being a predictor of future performance, and often, knowing how to contextualize and interpret performance metrics in the broader picture can make us an effective professional or student.

 

Summary

  • The K-Ratio helps us measure two things – the growth of return and the consistency of that growth over a specified period. A higher K-Ratio is indicative of better performance than that of a low K-Ratio.
  • In the field of finance, K-Ratios can be used to measure the performance and long-term viability of equities and other securities.
  • The ratio’s calculation is performed by creating a time series of data that pertains to an event or strategy. It was designed so that an investor or financial manager could look at a data set and try to obtain a straight line with little deviation.

 

Related Readings

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Basic Statistics Concepts in Finance
  • Rate of Return
  • Time Series Data Analysis
  • Trading Mechanisms

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