Financial Ratios for stock analysis are the important ratios for valuing companies and by comparing the same financials ratios of the different companies to see whether a stock is fairly valued, under valued or over valued. To find the right valuation of the stock or a company, there are some famous financial ratios like PE Ratio, PB Ratio, ROE, ROCE, etc. Without the knowledge of these financial ratios, we cannot have the right idea of the valuation of the company. https://fintalk.in/indian-stock-market-future-prediction/

There are multiple of metrics to find the valuation of the stock. You should have the good idea of these metrics before investing in the any company. Here are some of the important metrics:

PE Ratio

PE ratio is the most common and most important ratio to get the idea of the valuation of the company. It is the ratio of the current price of the stock to the Earning Per Share (EPS). EPS of a company is its net profit divided by the number of common shares it has outstanding. It indicates how much money company is making per share of its stock. To evaluate the current PE ratio we take EPS of the last 12 months. For example, suppose that a company’s share price is Rs.1000 and the sum of the last 4 quarters’ (12 months) EPS is Rs.20, then the PE Ratio of the company is 1000/20 i.e. 50.

When EPS is taken for the past 12 months then the PE ratio we get by division is called as the Trailing PE Ratio while if we take the expected EPS of the company for the next 12 months, then the PE ratio is called as the Forward PE Ratio. The lesser the PE ratio the more undervalued the company is and vice versa. The valuation of the company is decided by comparing the PE ratio with its peer companies.

PB Ratio

To understand the meaning of PB ratio, we first have to understand the meaning of the Book Value. The book value of the company indicates its net asset value on a per share basis. It means, Book Value=Total Asset-Total Liability.

Now the PB Ratio is the ratio between the current price of the share and the book value of the share. Needless to say, the higher the PB ratio the more overvalued it is and vice versa. Now let’s take an example to calculate the PB ratio. Suppose that the current share price of the listed company is Rs.1000 and its book value is Rs.100 then the PB ratio of the share would be 1000/100, i.e., 10. PB ratio is really important while calculating the valuation of the banks and NBFCs.

Dividend Yield

Dividend yield of the stock, expressed in percentage, is a financial ratio between the dividend of company given to its shareholders on per equity basis and the current share price (Dividend/Share Price)*100. Now to completely understand the dividend yield of the share we first have to understand what a dividend is. Dividend is the part of the profits that are paid to its shareholders. For example, the current share price of the company is Rs. 500 and the company announces the dividend payout of Rs. 10 to its shareholders, then the dividend yield will be (10/500)*100=2%.

Mostly the PSUs give the higher dividend to the shareholders since the companies’ primary focus is to give the money to the government since majority shareholder of PSUs is always the Government. While the companies with a vision being small companies barely give dividends because they mostly use this money for expanding their business and hence make more money. Dividend received to the bank account is usually spend as the free money and hence this money will never come back again and make more money for you. While if this dividend amount is invested back to the good companies it can be used to make more money.

EV/EBITDA Ratio

To understand EV/EBITDA Ratio, we’ll first the EV and EBITDA separately. EV means Enterprise Value. It is a financial measure representing a company’s total value. It is calculated by adding market capitalization (current share price * total outstanding shares), Debt and minority interest then subtracting its cash and cash equivalents.

EBITDA stands for Earning Before Interest, Taxes, Depreciation and Amortization. It is a financial metric that represents a company’s operating earnings before accounting for non-operating expenses and non-cash items like depreciation and amortization. EBITDA is often used as a proxy for a company’s cash flow and profitability, as it provides a more accurate representation of a company’s operational performance by excluding non-operating factors.

The EV/EBITDA multiple is used to assess a company’s valuation and financial performance. Investors and analysts use this metric to determine how much they are willing to pay for each dollar of EBITDA generated by the company. A high multiple may indicate that the company is overvalued, while a low multiple may suggest that the company is undervalued. Needless to say, that EV/EBITDA ratio should compared with the companies in the same industries.

Debt To Equity (D/E) Ratio

D/E ratio measures how much debt a company has taken on relative to the value of its assets net of liabilities. It is a ratio of total liabilities of a company to its total shareholder’s equity. This ratio indicates the financial leverage of the companies. The D/E of the companies should be lesser as if the D/E is higher then it has pay its huge part of profits as interest. While if the D/E is lower or zero, then the company needs to pay low amount or no amount as interest and in this way the company can invest this amount in the company for more growth.

ROE And ROCE

ROE, or Return on Equity, is a financial ratio that measures the profitability of a company relative to its equity. It gives us an idea of how well a company utilizes its shareholders’ equity to produce profits. For example, if a company’s ROE is 20%, it has generated ₹20 of profit for every ₹100 of shareholders’ equity. ROCE stands for Return on Capital Employed, and it measures a company’s profitability in relation to all its capital, both equity and debt. In other words, it tells you how efficiently a company uses its capital to generate earnings.

To illustrate, let’s look at an example: If a company has a ROCE of 15%, it generates a return of ₹15 for every ₹100 of capital it uses. ROE and ROCE are both important financial ratios, but they measure different things. While ROE reveals how effectively a company uses shareholders’ equity to generate profit, ROCE demonstrates how efficiently a company uses all its sources of capital, including debt.

These are the 7 most important financial ratios the investors should be aware of, before investing in any stock. It should also be noted that these ratios are only compared with the same industry and market capitalization. Suppose that two shares are compared with the same industry but the difference of these ratios might be very different but once company is small cap and the other one is large cap. Since the smaller companies have the better growth opportunities, market can give the smaller company a greater value compared to the larger one.