Ratios are an important ingredient of fundamental analysis. Investors and analysts use ratio analysis to evaluate the financial health of companies by evaluating past and current financial statements for value investing. Ratios express the performance of the company over a period of time and can also be used to estimate the future performance of the company. Ratios are ideally used with a combination of other ratios also to evaluate the performance. Ratios are also used to compare companies within the same sectors.
Earnings per share (EPS) are calculated as a company's profit divided by the number of outstanding shares. The results serve as an indicator of a company's profitability.
Formula:-
Earnings per Share = Net Income/No. of Shares Outstanding
Example:-
A company sold 10,000 units during the year, resulting in a net profit of Rs
1, 00,000. The stockholders of the company are entitled to distribute this
profit among themselves. If the company has 1, 00,000 outstanding shares
then distributing the entire profit among stockholders means that each share
will have a profit of Rs 1. So the EPS will be RS. 1. This calculation is
called earnings per share / EPS.
Key values:
The higher a company's EPS is, the more profitable it is considered.
Earnings per Share indicates how much money a company makes for each share of its stock and is a widely used metric for corporate profits.
The Earnings per share ratio is one of the most important variables in determining a share's price.
EPS is also a major component used to calculate the Price to earnings (P/E) valuation ratio.
EPS is an important indicator you could use to pick stocks.
The price to earnings ratio (PE Ratio) is the relation between a company’s share price and earnings per share (EPS). It denotes what the market is willing to pay for a company’s profits.
Formula:-
Price to Earnings = Current Stock Price / Earnings Per Share
Example:-
P/E ratio is calculated by dividing the current market price of a share by the earnings per share. Suppose the current market price of the share of XYZ Ltd. is Rs.100 and its earnings per share are Rs.10. The Price Earnings Ratio of XYZ Ltd. will be calculated as follows:
P/E = 100 /10 = 10
Now, it can be seen that the P/E ratio of XYZ Ltd. is ten times, which means that investors are willing to pay Rs.10 for every rupee of earnings.
Key values:-
A high P/E ratio could mean that a company's stock is over-valued, and a low P/E ratio could mean that a company’s stock is under-valued.
Investors often look at this ratio as it gives a good sense of the value of the company, and helps them analyze how much they should pay for a stock based on its current earnings
The P/E ratio varies across industries and therefore, it should either be compared with its peers having a parallel business activity (of similar size) or with its historical P/E to assess whether a stock is undervalued or overvalued.
A high P/E can also happen as in where the company is making much higher profits in recent years.
P/E ratios are used by investors and analysts to determine the relative value of a company's shares as it happens to be one of the essential tools used to study the intrinsic attractiveness of an equity share.
Book Value refers to the total amount of a company would be worth if it liquidated its assets and paid back all its liabilities. BV serves as the total value of the company's assets that shareholders would theoretically receive if a company was liquidated
Formula:-
Book value = Total Assets - Intangible Assets - Liabilities
Total assets include all kinds of assets, such as cash and short term investments, total accounts receivable, inventories, net property, plant and equipment, investments, and advances.
Intangible assets include patents, goodwill, etc
Total liabilities include items like short and long term debt obligations, accounts payable, and deferred taxes.
Example:-
If Company XYZ has total assets of 10 Cr and total liabilities of 4 Cr, then the book value of the company is 6 Cr.
It means that if the company sold off its assets and paid down its liabilities, the book value or net worth of the business would be 6Cr.
Book value is a key metric that investors use to measure a stock's valuation.
It is a helpful tool for investors wanting to determine if a company is underpriced or overpriced.
Book value is the total value assets of a business found on its balance sheet and represents the value of all assets if liquidated.
Companies with a lot of machine inventory and equipment, or financial instruments and assets tend to have large book values.
In contrast, gaming companies, consultancies, fashion designers, or trading firms may have little to no book value because they mainly rely on human capital
Price to book is used to evaluate a company’s current market value relative to its book value, which is defined as its total assets minus any liabilities. Price to book ratio can be useful for determining the best value of the stock at that moment of time.
Formula:-
Price To Book = Share Price / Book Value Per Share *
(*(Book Value Per Share = Book Value /Outstanding Shares))
Example:-
Company XYZ has a book value of 100 Cr on its balance sheet, and also has 10 Cr
outstanding shares, so by dividing the Book value by the outstanding shares we
will get a book value of 10 per share.
And If the current share price is 15, then by dividing it by book value per share we
will get 1.5 as Price To Book.
Key values:-
The P/B ratio measures the market's valuation of a company relative to its
book value or BV.
P/B ratio is used by value investors to identify potential stocks.
Low P/B ratios can be indicative of undervalued stocks.
A low P/B ratio could also mean that something is fundamentally wrong
with the company.
As like most ratios, this varies by industry.
The P/B ratio also indicates whether you are paying too much for what
would remain if the company went bankrupt immediately.
Buying a stock for less than its book value can create a "margin of safety"
for value investors
Market Capitalization is the total market value of a company’s outstanding shares.
Market cap determines the size and value of the company. Companies are
generally divided in three categories based on its value as Large Cap, Mid Cap &
Small Cap.
Formula:-
Market Capitalization = Current Share Price X No. Of Outstanding Shares
* (Number of outstanding shares represents the amount of shares in the open market, including all its shareholders, shares held by institutional investors and shares held by the company’s officers and insiders.)
Example:-
Company XYZ ltd. has 1 Crore shares, and the current market price of the share is
Rs. 20 per share. So the market Capitalization of the company will be Rs. 20 Crore.
This means you could buy XYZ ltd. for Rs. 20 Crores, if you have the money and
all the current stockholders are willing to sell you their shares.
Key values:-
The investors often use Market Capitalization as criteria to choose and
compare the companies according to their size and value for investing.
Market Capitalization is very effective in assessing the risk based on the
value of a company.
The companies are generally divided into three categories based on Market
Cap as:
Large Cap - Market Cap more than Rs. 20,000 crore.
Mid Cap - Market Cap between Rs. 5,000 crore & Rs. 20,000 Crore
Small Cap - Market Cap below Rs. 5,000 Crore.
For value investing, the investors usually compare the value of share from its
market size.
Market Cap is very helpful in building the portfolio by diversified
companies according to their capitalization and risk involved.
Enterprise Value is a comprehensive method of valuation of a company. As Market
Cap determines the value of company on the basis of its shares, Enterprise value
helps in determining the accurate value by including the debts and cash of the
company.
Formula:
Enterprise Value = Market Capitalization + Total Debt - Cash & Equivalents
Example:
Company XYZ ltd. has a Market Cap of Rs. 20 crores, Total Debt on the company
is Rs. 5 Crores and company has Rs. 2 Crores in cash.
So the Enterprise Value of the company will be 20+5-2 = Rs. 23 Crores.
Total Debt includes short term and long term debts from banks and other creditors
etc.
Cash includes cash in hand, cash at bank, liquidity investment, liquid assets etc.
Key values:
Enterprise value is used as the basis for many financial ratios that measures
the performance of a company.
Market Capitalization includes debt and cash in its calculation of valuating a
company, that’s why it is considered to be a more accurate ratio.
Enterprise value can be considered as a theoretical takeover price if a
company is to be bought.
EV can be negative if the company holds abnormally high amounts of cash
that is not reflected in the market value of the stock and total capitalization.
Investors use Enterprise value to evaluate the risk before investing in a
company.
Return On Equity determines that how much profit a company can earn from your
money. It is used to evaluate the investment returns. Return On Equity is
considered a measure of how effectively the company’s management is using
finance from equity to generate profits.
Formula:
Return On Equity = (Net Income (Annual)* / Share holder’s Equity*) X 100
*( Net income is the profit a company has earned before it pays out dividends to its shareholders.)
*(Shareholder’s equity, on the other hand, is derived by deducting the total value of a company’s liabilities from
the total value of its assets.)
Example:
Company XYZ ltd. net income last year was of Rs. 100 crores,
And company had an equity of Rs. 400 crores,
So by using the formula ROE will be 25%.
( 100 / 400 ) X 100 = 25% (ROE)
Key values:
A high ROE means a company is efficiently generating profits on the money
of the shareholders.
ROE is considered as a profitability ratio from the investor’s point of view.
It can also be said that ROE calculates how much money is made on the
investment made by the investors not the company.
Higher ROE is considered better.
ROE of a company should also be compared to its peer companies, as it can
vary in different industries.
ROE is a very prominent ratio used by investors for value investing, as it
determines the health and growth of a company.
Return On Capital Employed is a ratio that determines how efficiently and
effectively a company is using its capital. In other words ROCE measures how
well a company is generating profits from its capital
Formula:
Return On Capital Employed = EBIT / Capital Employed X 100
*(EBIT = Earnings before interest & tax, EBIT is also known as Operating Earnings)
*(Capital Employed = Equity capital + Debt capital))
Example:
Company XYZ ltd. has Rs. 20 crores as Equity Capital and Rs. 20 crores as Debt
capital, so the total capital employed will be Rs. 40 crores.
And the company generated EBIT of Rs. 5 crores.
So ROCE will be :
EBIT (5,00,00,000) / Capital Employed ( 40,00,00,000) X 100 = 12.50% ROCE
Key values:
ROCE is an important ratio of valuation as it calculates companies earning
based on shareholder’s equity and debt equity also, which provides a clearer
picture of the profitability of the company.
ROE of a company sometimes gets higher because the debt equity is not
considered in ROE ratio, so ROCE is considered to be more reliable ratio.
An investor should consider ROCE in case of a company which is having
debt in its books.
ROE determines the efficiency of a company in generating profits from
shareholder’s equity, whereas ROCE determines the efficiency in generating
profits from equity as well as debt’s.
ROCE of a company should be more than its cost of Debt.
ROCE has been given great preference by successful investors.
Higher the ROCE, the better the company is.
Return On Assets measures the amount of money that a company generates
relative to its total assets. In other words Return On Assets calculates how
efficiently a company manages its assets to produce profits.
Formula:
Return On Assets = Net Income / Total Assets X 100
Example:
Company XYZ Ltd. net income is Rs. 12 crores,
And their total assets are worth Rs. 80 crores,
So ROA will be: 12,00,00,000 / 80,00,00,000 X 100 = 15% ROA
Key values:
ROA is an indicator to measure how well a company utilizes its assets, by
determining how profitable a company is relative to its total assets.
ROA helps investors to see how well a company converts its investments or
assets into profits.
A good ROA indicates that a company is doing well in managing and
utilizing its assets.
ROA is a very good ratio in comparing companies of the same industries.
ROA is a useful ratio but it has some limitations, as different sectors have
different types of assets like the mining company has huge no. of machinery,
plants, lands, etc whereas an IT company has smaller assets like office,
computers, etc.
ROA is an accounting ratio, it tells about the profitability and efficiency of
the company.
The higher the ROA is, the better the company is, as the company is making
more profits from less investment.
Debt To Equity Ratio shows the proportion of shareholder’s equity and the debt a
company is using to finance its assets. In other words, the Debt To Equity Ratio
determines the amount or percentage of debt against the equity in the company.
D/E gives an idea of how much Debt can be fulfilled in the event of liquidation
using shareholder’s.
Formula:
Debt To Equity = Total Liabilities / Total Shareholder’s Equity
Example:
Company XYZ Ltd. has a debt of Rs. 15 Crores
and the shareholder’s equity in the company is Rs. 10 Crores.
So the Debt To Equity Ratio will be : 15,00,00,000 / 10,00,00,000 = 1.5
This means of every 1 Rupee of equity, the company holds a debt of Rs. 1.5
Key values:
Higher Debt To Equity ratio indicates a company or stock with higher
the risk to shareholders.
The high ratio also suggests the risk involved in bankruptcy due to debt
overburden and lesser growth.
Bankers & Investors use this ratio to value the risk health of the company.
Sometimes debt can also be helpful in the company’s expansion.
A lower ratio holds a lower risk, and the chances of loss on the investment
are lower.
While assessing the risk of debt investors should also focus on the long term
debt and short term debt of the company, as they have their own significance
and risk.
Dividend Yield determines how much a company pays out in dividends each year
to the shareholders relative to its stock price. In other words, Dividend Yield Ratio
expresses as to what percentage of earnings the company paid out to its owner or
shareholders.
Formula:
Dividend yield = Annual Dividend Per Share / Current Price of Share X 100
Example:
Company XYZ Ltd. paid Dividends totaling of Rs. 1 per share last year,
And their current stock price is Rs. 20,
So Dividend Yield will be: 1 / 20 X 100 = 5%
Key values:
Companies distribute a portion of profits as dividends, while they retain the
remaining portion of profits to reinvest in the business.
High dividend yield stocks are good investment options, as the risk involved
in these stocks is very less.
The investors usually check the dividend-paying track record of the
company before investing.
New companies that are growing quickly may pay lower dividends as
compared to the mature companies, because they reinvest the profits in the
business.
The investor should always keep in mind that higher dividend yields do not
always indicate attractive investment opportunity, as the ratio will be high in
the event of the declining price of the share.
A high dividend sharing company is sometimes looked at as they do not
reinvest the money to grow and generate more capital gains.
The PEG ratio is used to decide a stock's value while also factoring in the
company's expected earnings growth, and is thought to provide a more complete
picture than the more standard P/E ratio.
Formula:
PEG Ratio = Price To Earnings / Earnings Growth Rate
Example:
Suppose, company XYZ Ltd. is trading at PE Ratio of 18,
And their projected growth of earnings is 12%,
So the PEG Ratio will be: 18 / 12 = 1.5
Key values:
PEG ratio enhances the P/E ratio by adding expected earnings growth into
the calculation.
PEG ratio establishes a correlation between the company’s price valuations
with its future growth prospects.
A Company with a PEG ratio of 1 is said to be fairly valued, when the PEG
ratio exceeds 1 it is considered to be overvalued and when it is lower than 1
it is considered to be undervalued.
The Earnings growth rate can be the expected growth rate for the next year
or the next five years.
PEG ratio is widely used by the professional analyst and also by the
investors.
Limitation of PEG ratio is that it is calculated on future assumptions which
can vary by the time, as no one knows the exact rate of growth in the future
and Future growth of a company can change due to any number of factors:
market conditions, expansion setbacks, and other factors.
The Quick Ratio indicates the company’s short term liquidity position and
measures a company’s ability to meet its short term obligations/liabilities with its
most liquid assets. In other words it measures the ability of a company to pay its
current short term liabilities with its quick assets.
Formula:
Quick Ratio = Cash + Cash Equivalent + Marketable Securities + Current Receivable / Current Liabilities
Example:
Suppose, company XYZ Ltd balance sheet includes:
Cash Rs. 20,000
Inventory Rs. 15,000
Accounts Receivable Rs. 10,000
Investments In Stocks Rs. 2,000
Prepaid taxes Rs. 1,000
Current Liabilities Rs. 30,000
So Current Ratio will be : (20,000 + 10,000 + 2,000) / 30,000 = 1.06
The quick ratio of the business is 1.06, which determines that the company can pay
off all the current liabilities with the liquid assets at the disposal and still be left
with a few assets.
Key values:
The Quick Ratio shows a company's capacity to pay its current liabilities
without needing to sell its inventory or get additional financing.
The higher the Quick Ratio result, the better a company's liquidity and
financial health; the lower the ratio, the more likely the company will
struggle with paying debts.
Quick Ratio is very helpful for investors to judge the company’s financial
health.
This ratio should be analyzed in the context of other liquidity ratios such as
current ratio, cash ratio, etc.
The Liquidity ratios tell you about a company’s ability to meet all its short term
financial obligations, including debt, payroll, payments to vendors, taxes, and so
on. In other words, the current ratio is a ratio that measures whether a firm has
enough resources to meet its short-term obligations or not. It compares a
company’s current assets to its current liabilities.
Formula:
Current Ratio = Current Assets / Current Liabilities
Example:
Company XYZ Ltd has current assets of Rs. 50, 00,000 & Has a current liability of Rs. 20, 00,000, then Current Ratio will be 50, 00,000 / 20, 00,000 = 2.50
Key values:
Current assets which are available on a company's balance sheet comprises
cash, accounts receivable, inventory, and other assets that are expected to be
liquidated or turned into cash in less than a year. Current liabilities comprise
accounts payable, wages, taxes payable, and the current portion of long-term
debt.
A high current ratio is better than a low current ratio because a high current
ratio indicates that the company is more likely to pay the creditor back.
A current ratio of less than one indicates that the company may have
problems meeting its short-term obligations.
Difference Between Current Ratio & Quick Ratio
The Current Ratio is the proportion of the amount of current
assets divided by the amount of current liabilities.
The Quick Ratio is the proportion of only the most liquid current assets to
the amount of current liabilities.
In other words, quick ratio assumes that only the following current assets
will turn to cash quickly: cash, cash equivalents, short-term marketable
securities, and accounts receivable. Hence, the quick ratio does not include
inventories, supplies, and prepaid expenses.
An Interest coverage ratio explicitly measures a company’s capacity to make
interest payments on debts. In other words, the interest coverage ratio is used to see
how well a firm can pay the interest on outstanding debt.
Formula:
The interest coverage ratio is measured by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period.
Interest Coverage Ratio = EBIT / Interest Expenses
Example:
Company XYZ Ltd. has EBIT (earnings before taxes and interest) of Rs. 5, 00,000,
And its total interest payment requirements is Rs.2, 50,000,
Then the company's Interest Coverage Ratio is = 2 (5, 00,000 / 2, 50,000).
Key values:
The Interest Coverage Ratio helps lenders assess the company’s short-term
financial situation.
If the Interest Coverage Ratio is lower than 1, it indicates the company has a
higher debt burden with a high possibility of bankruptcy or default.
When a company's interest coverage ratio is equals to 1.5 or lower, its ability
to meet interest expenses may be questionable.
A Ratio of more than 1.5 or say a higher ratio will indicate the company’s
financial health and, at the same time, will mean that it is not taking risks or
leveraging too much to magnify its earnings.
Both shareholders and investors use this ratio to make decisions about their
investments.
This ratio tells the investors or creditors that the company is financially
sound or not.
The Operating Cash Flow Ratio determines how well a company can pay off
its current liabilities with the cash flow generated from its core business operations.
The Operating cash flow ratio determines the number of times the current
liabilities can be paid off out of net operating cash flow.
Formula:
The interest coverage ratio is measured by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period.
Operating Cash Flow Ratio = Cash Flow From Operations / Current Liabilities
Example:
Company XYZ Ltd’s Cash Flow from the operation is Rs. 15, 00,000 &
Has a current liability of Rs.12, 00,000, then Operating Cash Flow Ratio will be
15, 00,000 / 12, 00,000 = 1.25
It means company XYZ Ltd. can cover its current liabilities 1.25 times.
Key values:
A high number / greater than one indicates that a company has generated
more cash in a period than what’s needed to pay off current liabilities.
It reflects the amount of cash that a business produces solely from its core
business operations.
Investors closely view the OCF, as it gives them a clear picture of the company’s overall value and health.
Difference Between Operating Cash Flow Ratio & Current Ratio :
Both operating cash flow ratio and current ratio calculate a company’s
ability to pay short-term debts and obligations. The operating cash flow ratio
assumes cash flow from operations will be used to pay those current
liabilities. The current ratio, meanwhile, assumes current assets will be
used.
The Price to Cash Flow Ratio is a ratio used to compare a company's market value
to its cash flow. In other words, it measures the value of a stock’s price relative to
its operating cash flow per share.
Formula:
Price To Cash Flow = Market Price of Share / Operating Cash Flow Per Share
Example:
Company XYZ ’s current stock price is Rs. 1500, And their most recent cash flow
per share is Rs. 250.
So P/CF will be = 1500 / 250 = 6
It means you will pay Rs. 6 for one rupee of cash if you buy a stock of XYZ Ltd.
Key values:
The higher the P/CF, the more you are paying for a rupee of cash, and the
more expensive the stock is.
A low P/CF implies that a stock may be undervalued.
The Price to Cash Flow metric works well for companies that have large
non-cash expenses such as depreciation.
In some scenarios, companies with positive cash flows are not profitable due
to their large non-cash expenses.
The P/CF ratio allows analysts and investors to come up with a less distorted
picture of a company’s financial standing.
The operating profit margin ratio shows how much profit a company makes after
paying for variable costs of production such as wages, raw materials, etc.
The OPM calculation is the percentage of operating profit derived from total
revenue. For example, a 15% operating profit margin is equal to Rs. 0.15 operating
profit for every Rs.1 of revenue.
Formula:
Operating Profit Margin = Operating profit* / Revenue**
*Operating income is also called as earnings before interest and taxes (EBIT). Operating income / EBIT is that
income which is left in the income statement, after all operating costs and overhead, such as selling costs,
administration expenses and cost of goods sold (COGS) are subtracted from it..
**Revenue is income earned from the principal business activities
Example:
Company XYZ has a Sales of Rs. 10,00,000
Cost of Goods Sold Rs. 5, 00,000
And Operating Costs Rs. 2, 25,000
So Operating Profit will be = (5, 00,000 – 2, 25,000) = 2, 75,000
And OPM will be = 2, 75,000 / 10, 00,000 = 0.275 %
--Conclusion, this company makes $0.275 before interest and taxes for every dollar
of sales.
Key values:
Company’s operating margin, also known as return on sales, is a good ratio
to indicate how well it is being managed and how risky it is.
It indicates the efficiency of a company controlling the costs and expenses
associated with business operations.
A higher ratio reflects the efficiency of the business in procuring raw
materials and converting them into finished products.
While analyzing a company, one should see whether it has improved OPM
overtime or not.
The higher the Operating margin is, the better it is.
The promoter holding is the percentage of the total company held by the promoter.
So in simple words, the Promoters Holding Ratio tells us that what percentages of
shares are held by the promoter/promoters out of the 100% shares of a company.
Example:-
Company XYZ Ltd. has 10,000 shares in total and
The promoter of the company has 7,000 shares.
So, now the Promoters Holding Ratio will be 70%
Key values:
An investor should check the Promoters Holding ratio before investing as
this ratio shows a glimpse of promoter’s trust in the company.
A high Promoter Holding Ratio is generally considered as a positive sign for
value investing.
A low Promoter Holding Ratio is generally considered negative
A share with low but increasing promoter holding is also considered good.
The Stock that has low promoter holding but very high DII and FII holding
is a good sign.
An ideal Holding ratio is considered to be above 60-70%.
But generally Large Cap companies have around 25-50% of promoters
holding.
A decline in holding does not always indicate poor future prospects.
Sometimes promoters do sell their holdings as they are targeting an
acquisition or starting a new venture.
The pledging of shares means taking loans against the shares that one holds. It can
be done by both investors and promoters. Very often, promoters of a listed
companies pledge all or some of their shares with lenders. That means these shares
are offered as collateral to banks in exchange for loans.
Key values:
Pledging is one of the many sources of borrowing money, especially in a
volatile market with tight liquidity conditions.
Higher the pledging, the greater could be the risk of volatility in the
company’s share price.
Pledging of shares is the last option for the promoters to raise funds.
It is comparatively safer to raise funds through equity or debt for the
promoter.
As shares are also considered assets, hence it can be used as a security to
take loans from the banks.
If the promoters fails to make up for the difference, the lenders can sell the
pledged shares in the open market for the recovery of their money
Promoters can raise funds for various reasons-for meeting requirements of
the business or personal needs.