Ratios to Consider when buying stocks

Stock investing requires careful analysis of financial data to find out the company's true worth. This is generally done by examining the company's profit and loss account, balance sheet and cash flow statement. This can be time-consuming and cumbersome. An easier way to find out about a company's performance is to look at its financial ratios, most of which are freely available on the internet.

Though this is not a foolproof method, it is a good way to run a fast check on a company's health

P/E RATIO
The price-to-earnings, or P/E, ratio shows how much stock investors are paying for each rupee of earnings. It shows if the market is overvaluing or undervaluing the company.

PRICE-TO-BOOK VALUE

The price-to-book value (P/BV) ratio is used to compare a company's market price to its book value. Book value, in simple terms, is the amount that will remain if the company liquidates its assets and repays all its liabilities.

DEBT-TO-EQUITY RATIO

It shows how much a company is leveraged, that is, how much debt is involved in the business vis-a-vis promoters' capital (equity). A low figure is usually considered better. But it must not be seen in isolation.

OPERATING PROFIT MARGIN (OPM)
The OPM shows operational efficiency and pricing power. It is calculated by dividing operating profit by net sales.

EV/EBITDA

Enterprise value (EV) by EBITDA is often used with the P/E ratio to value a company. EV is market capitalisation plus debt minus cash. It gives a much more accurate takeover valuation because it includes debt. This is the main advantage it has over the P/E ratio, which we saw can be skewed by unusually large earnings driven by debt. EBITDA is earnings before interest, tax, depreciation and amortisation.

PRICE/EARNINGS GROWTH RATIO

The PEG ratio is used to know the relationship between the price of a stock, earnings per share (EPS) and the company's growth.

RETURN ON EQUITY

The ultimate aim of any investment is returns. Return on equity, or ROE, measures the return that shareholders get from the business and overall earnings. It helps investors compare profitability of companies in the same industry. A figure is always better. The ratio highlights the capability of the management. ROE is net income divided by shareholder equity.

INTEREST COVERAGE RATIO

It is earnings before interest and tax, or EBIT, divided by interest expense. It indicates how solvent a business is and gives an idea about the number of interest payments the business can service solely from operations.

CURRENT RATIO

This shows the liquidity position, that is, how equipped is the company in meeting its short-term obligations with short-term assets. A higher figure signals that the company's day-to-day operations will not get affected by working capital issues. A current ratio of less than one is a matter of concern.

DIVIDEND YIELD

It is dividend per share divided by the share price. A higher figure signals that the company is doing well. But one must be wary of penny stocks (that lack quality but have high dividend yields) and companies benefiting from one-time gains or excess unused cash which they may use to declare special dividends. Similarly, a low dividend yield may not always imply a bad investment as companies (particularly at nascent or growth stages) may choose to reinvest all their earnings so that shareholders earn good returns in the long term.

source:-business today

While financial ratio analysis helps in assessing factors such as profitability, efficiency and risk, added factors such as macro-economic situation, management quality and industry outlook should also be studied in detail while investing in a stock.

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