If you are new to the field of share market and are taking the advice of friends, or stock market expert, then you will definitely get the suggestion to buy and sell shares only after analyzing the basic aspects of the company. This means that you should study the company’s financial records before investing. Special analysis should be done on whether the company is eligible to invest or not. But to study and analyze which aspects of the company to know whether it is appropriate to invest or not?
For this, there are some basic areas where investors need to pay attention. The most important aspect for a fundamental analysis is the company’s various financial ratios. Studying and analyzing these ratios can be a great help in determining your investment method. Let’s discuss some of the financial ratios that investors need to know and what these ratios indicate.
1. Price-to-earnings ratio (PE ratio):
The PE ratio is the number of times the company’s market price is divided by earnings per share. It helps to know whether the company is overvalued or undervalued. The PE ratio also gives information on how much to invest to earn a profit of Rs. For example, if a company’s earnings per share are Rs 10 and the market price is Rs 100 per share.
Based on this, its PE ratio becomes 10. This means that you are spending 10 rupees to earn 1 rupee from that company. Therefore, investors need to choose companies with as little PE as possible. But PE ratio should be done with companies in the same sector.
2. Return on Equity (ROE):
Equity is obtained by subtracting liabilities from total assets. Mathematically, the ROE is obtained by dividing the net profit by the total equity. It provides information on how much return a company is able to make on a stock investment. For example, you are the founder of a company and have invested Rs 100 in equity.
Therefore, the total equity of the company is 100 rupees. If the company makes a profit of Rs 20 from that Rs 100 equity, the return on its equity will be 20%. Therefore, a company with a lot of ROE is considered good. But just like in PE ratio, it is appropriate to compare ROE only in companies of the same sector.
3. Price to book (PB) ratio:
The number obtained by dividing the market price of a company by its book value per share (book value) is called the PB ratio. To know the book value of a company, you have to deduct the total liability from the total assets. In the case of a company, the total book value and shareholder equity are the same.
Dividing the total book value by the total number of shares gives the book value per share. The PB ratio is also a means of determining whether a company is undervalued or overvalued. Companies with a low PB ratio are considered undervalued while companies with a high PB ratio are considered overvalued.
4. Dividend Yield or Dividend to Price Ratio:
Dividend to price ratio is when a company divides the amount it distributes to its shareholders in one year by its market value. This ratio is an indicator of the return on your investment.
Some companies are giving good returns even if the market price does not support them. Therefore, this ratio is considered important. Even if there are two investments of the same type, the investor is likely to get a higher return from a company with a higher dividend yield.
5. Debt to equity (DE) ratio:
This ratio summarizes the company’s liabilities and equity. Debt to equity ratio is found when the total equity of the company is divided by the total equity. It indicates how much the company is operating on loan and how much on its own assets.
This ratio helps to determine if the company is indebted. A higher DE ratio indicates that the company is in high debt. But having a lot of debt is not always counterproductive. There is also a possibility that the company will be able to repay the loan on time and use the loan properly.