Each investor should consider these financial ratios to analyze a stock and gauge a company’s financial health and investment potential:
Price-to-Earnings (P/E) Ratio
Formula:-
It shows the level that investors are willing to pay for every dollar earned, thereby showing market sentiment. A high P/E value means there is high expectation. If the P/E is low, then it is undervalued and less probable of growth.
2. Price-to-Earnings Growth (PEG) Ratio
Formula:-
Purpose: This measures adjusts the P/E to provide for the earnings growth while offering a balanced view. Whenever the PEG is <1, it implies an undervaluation and higher than 1 indicates an overvaluation.
3. P/B Ratio
Formula:-
Purpose: The P/B ratios measure market valuation versus book value. If P/B is <1 then its stock is undervalued as compared to book values and higher P/B often implies an overvaluation situation.
Return on Equity (ROE)
Formula:-
Purpose: It is a barometer of the effectiveness of a company in utilizing shareholders’ equity to generate profits. High ROE is generally indicative of good management and profitability.
5. Debt-to-Equity (D/E) Ratio
Formula:-
Purpose: It measures financial leverage and risk as a result of comparing debt with equity. The more the D/E ratio, the higher the proportion of debt relative to equity. In times of recession or depression, it becomes hazardous.
6. Current Ratio
Formula:-
Purpose: Measures short term-liquidity. It determines whether the business enterprise can meet short-term obligations through its current assets. Typically, a ratio greater than 1 is favorable.
Quick Ratio (Acid-Test Ratio)
Formula:-
Purpose: More critical than the liquid ratio in this case, this ratio does not include inventory in its current assets. Therefore, it determines if a company has enough to meet its short-term obligations without inventory sales.
Gross Profit Margin
Formula:-
Purpose: Indicates the percentage of income over the cost of goods sold, which is the primary profitability. As higher is the gross profit margin, so is the pricing power and optimum control over costs.
9.Operating Margin
Formula:-
Purpose: Indicates profitability of the core operations unadjusted by non-core income and expense. The higher the margin of operation, the better is the operating efficiency
10.Earning Per Share (EPS)
Formula:-
Purpose: Shows percentage of a company’s profit going into each share, hence providing profits on per-share basis. Rising EPS often indicates improving profitability.
When used collectively, these ratios provide complete insight into the value of the stock, profitability, level of risk involved, and its growth. When compared with industry standards and average long-term values, this provides an added advantage in the evaluation of the relative attractiveness of the stock.