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21 Dec 2018

STOCK MARKET--Financial Ratio Analysis that Every Stock Investor Should Know:

    1. Earnings Per Share (EPS) – Increasing for last 5 years
    2. Price to Earnings Ratio (P/E) – Low compared to companies in the same industry
    3. Price to Book Ratio (P/B) – Low compared companies in the same industry
    4. Debt to Equity Ratio – Should be less than 1 (Preferably debt<0.5 or Zero-Debt)
    5. Return on Equity (ROE) – Should be greater than 20%
    6. Price to Sales Ratio (P/S) – Smaller value is preferred
    7. Current Ratio – Should be greater than 1
    8. Dividend – Increasing for the last 5 years
1.       Earnings Per Share (EPS):

This is one of the key ratios and is really important to understand Earnings per share (EPS) before we study other ratios. EPS is basically the profit that a company has made over the last year divided by how many shares are on the market. Preferred shares are not included while calculating EPS.
Earnings Per Share (EPS) = (Net income – dividends from preferred stock)/(Average outstanding shares)
From the perspective of an investor, it’s always better to invest in a company with higher EPS as it means that the company is generating greater profits. Also, before investing in a company, you should check it’s EPS for the last 5 years. If the EPS is growing for these years, it’s a good sign and if the EPS is regularly falling or is erratic, then you should start searching another company.
2.       Price to Earnings Ratio (P/E)
The Price to Earnings ratio is one of the most widely used financial ratio analysis among the investors for a very long time. A high P/E ratio generally shows that the investor is paying more for the share. As a thumb rule, a low P/E ratio is preferred while buying a stock, but the definition of ‘low’ varies from industries to industries. So, different sectors (Ex Automobile, Banks etc) have different P/E ratios for the companies in their sector, and comparing the P/E ratio of the company of one sector with P/E ratio of the company of another sector will be insignificant. However, you can use P/E ratio to compare the companies in the same sector, preferring one with low P/E. The P/E ratio is calculated using this formula:
Price to Earnings Ratio= (Price Per Share)/( Earnings Per Share)
It’s easier to find the find the price of the share as you can find it at the current closing stock price. For the earning per share, we can have either trailing EPS (earnings per share based on the past 12 months) or Forward EPS (Estimated basic earnings per share based on a forward 12-month projection. It’s easier to find the trailing EPS as we already have the result of the past 12 month’s performance of the company.
3.       Price to Book Ratio (P/B)
Price to Book Ratio (P/B) is calculated by dividing the current price of the stock by the latest quarter’s book value per share. P/B ratio is an indication of how much shareholders are paying for the net assets of a company. Generally, a lower P/B ratio could mean that the stock is undervalued, but again the definition of lower varies from sector to sector.
Price to Book Ratio = (Price per Share)/( Book Value per Share)
4.       Debt to Equity Ratio
The debt-to-equity ratio measures the relationship between the amount of capital that has been borrowed (i.e. debt) and the amount of capital contributed by shareholders (i.e. equity). Generally, as a firm’s debt-to-equity ratio increases, it becomes riskier A lower debt-to-equity number means that a company is using less leverage and has a stronger equity position.
Debt to Equity Ratio =(Total Liabilities)/(Total Shareholder Equity)
As a thumb of rule, companies with a debt-to-equity ratio more than 1 are risky and should be considered carefully before investing.
5.       Return on Equity (ROE)
Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. ROE measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders has invested. In other words, ROE tells you how good a company is at rewarding its shareholders for their investment.
Return on Equity = (Net Income)/(Average Stockholder Equity)
As a thumb rule, always invest in a company with ROE greater than 20% for at least last 3 years. A yearly increase in ROE is also a good sign.
6.       Price to Sales Ratio (P/S)
The stock’s price/sales ratio (P/S) ratio measures the price of a company’s stock against its annual sales. P/S ratio is another stock valuation indicator similar to the P/E ratio.
Price to Sales Ratio = (Price per Share)/(Annual Sales Per Share)
The P/S ratio is a great tool because sales figures are considered to be relatively reliable while other income statement items, like earnings, can be easily manipulated by using different accounting rules.
7.       Current Ratio
The current ratio is a key financial ratio for evaluating a company’s liquidity. It measures the proportion of current assets available to cover current liabilities. It is a company’s ability to pay its short-term liabilities with its short-term assets. If the ratio is over 1.0, the firm has more short-term assets than short-term debts. But if the current ratio is less than 1.0, the opposite is true and the company could be vulnerable
Current Ratio = (Current Assets)/(Current Liabilities)
As a thumb rule, always invest in a company with a current ratio greater than 1.
8.                               Dividend Yield
A stock’s dividend yield is calculated as the company’s annual cash dividend per share divided by the current price of the stock and is expressed in annual percentage.
Dividend Yield = (Dividend per Share)/(Price per Share)*100
For Example, If the share price of a company is Rs 100 and it is giving a dividend of Rs 10, then the dividend yield will be 10%. It totally depends on the investor whether he wants to invest in a high or a low dividend yielding company.

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