Financial ratios are the most important financial ratios that involve the comparison of the various figures of the financial statement in order to gain information about a company’s performance and these Most Important Financial Ratios to Analyse a Company will help you to find good stock.
Here are the six most important financial ratios to analyze a company’s stock for the investment portfolio. importance of ratio analysis
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1. Price to Earning Ratio (P/E)
This ratio will help you to understand whether a company is undervalued or overvalued:
Price-Earnings Ratio, also known as the P/E ratio, is the ratio of a company’s share price to the company’s earnings per share. This ratio is used to value the company and to find out whether they are overvalued or undervalued. important financial ratios
For Example: If a company’s net profits are Rs 20,000 and it has Rs 2,000 shares trading in the market, its ‘earnings per share would be Rs 20 and if they are trading at Rs 200 per share, its P/E Ratio would be 20. in other words, this means that investors are willing to pay Rs 20 to get Rs 1 from the company’s net profit.
Formula : Price to Equity Ratio = Share Price / Earnings Per Share
2.Return on equity (RoE)
ROE ratio is one of the most important profitability metrics for investors is a company’s return on equity (ROE). it helps you to understand a company’s ability to turn equity investment into profits and reveals how much after-tax income a company earned in comparison to the total amount of shareholder equity found on the balance sheet.
if we say In other words, it conveys the percentage of investor dollars that have been converted into income, giving a sense of how efficiently the company is handling their fund or money. All else being equal, a business with a higher return on equity is more likely to be one that can better generate income with new investment dollars. financial management ratio analysis.
For Example: If a company’s shareholder equity is Rs 200,000 and it generates an income of Rs 60,000, then the RoE is 60%. meanwhile, another company with the same total equity but an income of Rs 80,000 would have an RoE of 80%.
Formula : Return on equity = Net Income / Shareholder’s Equity
3. Debt to equity ratio
Get a glimpse of how much the company own’s versus owes
The debt to equity ratio is one of the most important financial ratios to analyze a company in the market and to understand a company’s financial health. It measures how much debt a company has and have to pay with respect to its shareholder’s equity.
A high debt to equity ratio is not a good sign for equity investors as it signifies high risk.
A good debt of equity ratio is considered less than 1 hence the company with a DE ratio of more than 2 is considered to be risky. It means the company owes Rs. 2 of debt on every Rs. 1 in equity,
For Example : If a company’s total liabilities are Rs 50,000 and its shareholder’s equity is Rs 25,000, the debt to equity ratio is 2. Debt to equity ratio varies widely by industry, but, in general, debt to equity ratio below 2.0 is considered ideal, unless the company is in a fixed asset-heavy industry (such as mining, aviation, construction )
Formula : Debt to Equity Ratio = Total Liabilities / Shareholder’s Equity
4. Dividend yield
It will help you to understand the return you can expect on an investment
A dividend is a part of the company’s profits given to its shareholders to reward them for their investment in the company. The dividend yield ratio is calculated by dividing the dividend per share by the share price.
The dividend is a part of the company’s profits given to its shareholder and they must be approved it through their voting rights. the cash dividends are common, dividends can also be paid as shares of stock or other property. Along with the companies, many mutual funds and exchange-traded funds (ETFs) also pay dividends.
this is the Most Important Financial Ratios to Analyse a Company for investors while finding a stock to invest
For Example: If the market price of a stock is Rs 100 and it pays a yearly dividend of Rs 5 per share to its shareholders then its dividend yield would be 5% Similarly, another company with a market price of Rs 80 also gives a dividend of Rs 5 per share would have a dividend yield of 6.25%.
Formula: Dividend yield = Annual dividends per share / Current share price
5. Current Ratio
The current ratio is a liquidity ratio that measures the company’s short-term debt repaying capacity, This ratio is calculated by dividing current assets by current liabilities.
For Example: If a company’s current assets are Rs 20,000and its current liabilities are Rs 10,000, then its current ratio is 2. A current ratio that is in line with the industry average or slightly higher is generally considered acceptable and usually, an ideal current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to cover its debts
Formula : Current Ratio = Current Assets – Current liabilities
6. Earnings Per Share Ratio (EPS)
The earnings per share ratio measure the amount of a company’s net income that is theoretically available for payment to the shareholders of its common stock. if a company gives dividends to its shareholders that means the company actually generating good profit or it may plow the funds back into its business for more growth; in either case, a high ratio indicates a potentially worthwhile investment, depending on the market price of the stock. and this is the Most Important Financial Ratios to Analyse a Company for investor
This measure is only used for publicly-held companies since they are the only entities required to report earnings per share information. importance of ratio analysis
For Example: If a company has Rs 1,000 shares and earns Rs 10,000, its earnings per share would be Rs 10/share.
Formula: Earning Per Share = (Net income – preferred dividends) ÷ average outstanding common shares.