Analysing Financial ratios are very important while deciding to Invest in a company. Financial ratios are basically used to compare the different companies of the same Industry. You cannot compare financial ratios of the companies which are in different industries as these ratios differ with the business models. So let’s start with the ratios.
1. Earnings per share (EPS):
This ratio determines the profitability of a company. Formula for EPS is dividing the earnings of a company for the whole year with the number of outstanding shares. This tells an investor how much the company is earning per share. Higher the ratio more the company is profitable.
2. Price to Earnings Ratio(PE):
This ratio is obtained by dividing the current market price of a stock (cmp) with EPS. This shows how much investors are willing to pay for Rs.1 profit of the company. This ratio is widely used by the investors to value a company. But only depending upon this for valuation might cause you trouble. Many investors believe that high PE means overvalued and low PE means undervalued but this is not true everytime.
3. Debt to Equity ratio:
As the name suggests the ratio is obtained by dividing the debt of the company to their value of equity. This ratio shows us how the company is managing their debt. High debt becomes the major problem for the company in the long run so this ratio provides us the outlook of the debt. Lower the ratio more good for the company. Companies having debt to equity ratio less than or equal to 1 are good.
4. Return on Equity:
The ratio tells us how the company is using the shareholder’s equity fund to generate profits. It is obtained by taking the company’s earnings(after tax) , subtracting the dividends and dividing the amount with the value of shareholder’s equity. Higher the ROE more the company is using the fund efficiently to generate profits.
5. Return on Capital employed:
The ratio is obtained by dividing Earnings(after tax) of the company by Capital employed (total assets – current liabilities). ROCE shows how much the company is efficiently using the assets. Higher the ROCE, good for the company. Having ROCE more than 20% is good.
These were the 5 most important financial ratios to check on while analysing a company. If you want to read more about Investing in stock market do subscribe the blog page and share it with your friends and family.