7 Key Ratios Every Investor Should Know Before Buying Stocks
When you look at the stock for the first time, the price is something that tells you very little. Just for instance, global debt has hit a new record of $317 trillion, highlighting the quick borrowing worldwide. At the same time, the investors are rapidly putting money into the stock market.
It clarified that the stock price is not a parameter to understand the market. Simple and fundamental financial ratios are reliable to assess a company’s price, value compared to price, debt margin, and sales performance.
Earnings Per Share (EPS)
Formula: EPS = Net Profit ÷ Number of Shares
EPS signifies the profit margin of the company for each share. It is quite a simple approach to evaluate if the business gains are growing or going down. For example –
| Company | Net Profit | Shares Outstanding | EPS |
| A | 100 crore | 10 crore | 10 |
| B | 100 crore | 20 crore | 5 |
Although net profit is the same for both of them, Company A earns more per share. That’s how EPS helps in comparing multi-sized companies with ease.
Price to Earnings (P/E) Ratio
Formula: P/E = Stock Price ÷ EPS
The P/E ratio shows whether the market is valuing the company’s earnings at a higher or lower level. A high P/E can mean strong growth expectations, while a low P/E may reflect slower expectations. The ratio becomes meaningful when compared with peers in the same sector.
| Company | Stock Price | EPS | P/E Ratio |
| A | 200 | 10 | 20 |
| B | 200 | 5 | 40 |
Both have the same price, but B looks more expensive relative to earnings.
Price to Book (P/B) Ratio
Formula: P/B = Stock Price ÷ Book Value per Share
P/B compares the stock price to its physical asset value without the debt. If P/B is near 1, the stock price is close to the company’s asset value.
Companies with bigger brands or innovative ideas usually have a higher P/B ratio. On the contrary, a lower P/B means that companies own a lot of physical things, like banks or factories.
Debt-to-Equity (D/E) Ratio
Formula: D/E = Total Debt ÷ Shareholder Equity
The D/E ratio highlights the company’s dependency on debt versus its own money. A high D/E ratio simply means that the company is borrowing more and is at higher risk in case of low earnings. A low D/E means that the company is in a strong financial position.
Return on Equity (ROE)
Formula: ROE = (Net Profit ÷ Shareholder Equity) × 100
The ROE (Return on Equity) ratio measures how effectively a company is using shareholders’ money to make profits. In simple words, a healthy ROE number means that the company is managing the business very efficiently.
However, having a very high ROE can be because of too much debt for the company. This can be misleading if not checked along with the Debt-to-Equity (D/E) ratio.
Price to Sales (P/S) Ratio
Formula: P/S = Market Cap ÷ Total Sales
The P/S (price-to-sales) ratio measures a company’s stock value against its total sales revenue. This number is helpful if a company is not making a profit despite having good sales.
An increasing P/S ratio suggests that the company’s products are in high demand and will likely be sold more. This ratio has been really helpful for analyzing companies that prioritize faster sales growth.
Dividend Yield
Formula: Dividend Yield = (Annual Dividend ÷ Stock Price) × 100
The dividend yield is the cash return as per the stock’s price. It’s a hassle-free way to evaluate the percentage of your investment paid back as a dividend.
If the dividend yield is very high, it signifies that the stock price has dropped sharply. However, a stable dividend yield is a signal that the company is having a steady cash flow.
Conclusion
Think of these seven ratios as the X-rays for a company’s value, strength, and performance. Keeping a check on all these will help you get a clear picture of the company’s health in the stock market. You can make the decisions and judgement accordingly without just relying on the price of the stock.
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This analysis is for informational purposes only. Please consult a SEBI-registered financial advisor before investing.
– Chandan Pathak
Equity Research Analyst, StockYaari