In Stock investing, fundamental analysis is the most common approach to understanding how good a company is.
However, fundamental analysis is often time-consuming and confusing for many investors. Here are 5 basic financial ratios you need to understand, to quickly analyse a stock.
1. Earnings Per Share (EPS)
Earnings per share is an important first step when using financial ratios. It denotes the amount of income the company earns per share it issues.
Analysts divide the net income of the company, by a weighted average number of shares in the market to get the EPS
If a company has negative earnings, then the EPS will be negative.
That’s why sometimes, the P/E ratio might be shown as N/A, as a negative EPS doesn’t make sense.
2. Price To Equity Value (P/E)
The price to equity ratio is basically the share price of a company, divided by the EPS of the company.
It allows investors to determine if stocks are overpriced or undervalued.
To do so, they need to compare a company’s P/E to the industry average.
P/E reflects what investor’s think about the future earnings of the company.
If a P/E of a company is 50, then that means an investor has to spend Rs 50 for every 1 rupee earned.
3. Price To Book Value (P/B)
This ratio is a simple comparison of a company’s market value to its book value.
The book value of a company is the value of the company if it sells all its assets, stops its business and pays back all its loans.
Let’s say that a company stops its business, sells all its assets, and pays its loans and is left with 1000 RS. Then, if it has 10 shares issued in the market, its P/B would be 1000/10 =100.
If a company has a high P/B, then it is overvalued, and if it has a low P/B it is undervalued.
Just like P/E, it has to be compared with the industry P/B
4. Debt To Equity (D/E)
This ratio summarizes the debt the company has.
It is calculated by dividing the debt of the company, by shareholders equity.
The higher the ratio, the higher the debt in the company.
High debt is not necessarily a bad thing, but it is a hindering factor to the company
There is no ideal D/E, but it just gives a picture of the debts in a company.
5. Return On Equity (RoE)
This ratio measures the rate of return of a stock.
The ratio is calculated by dividing the net earnings of a company by the common equity in the company.
The higher the RoE, the better the company is at generating profits.
6. Dividend Price Ratio
This ratio tells investors how much they can expect to make in dividends per rupee invested
It is calculated by dividing the amount of dividends paid by the company, by its current stock price.
Even if the stock price doesn’t rise, investors generate income through dividends, and that is an important thing to look for when investing in the stock market.
