Before investing in a company’s stock, the financial parameters must be carefully looked at to find out what its real value is. Before you buy shares, you should think about the eleven financial ratios we give you.
Before investing in a company’s stock, the financial facts must be carefully looked at to find out what its real value is. This is usually done by looking at the balance sheet, cash flow statement, and profit and loss account of the company. This can be hard and take a long time. It’s easier to learn about a company’s performance by looking at its financial ratios, most of which can be found online for free.
This is a good way to quickly figure out how healthy a company is, but it is not a foolproof method.
You should think about these eleven financial ratios before you buy a stock.
P/E Ratio
The price-to-earnings ratio, or P/E, shows how much investors are willing to pay for each rupee of earnings. It shows whether the market is putting too much or too little value on the company.
The best P/E ratio can be found by comparing the current P/E to the past P/E of the company, the average P/E of the industry, and the P/E of the market. A company with a P/E of 15 may seem expensive when compared to its historical P/E, but if the industry P/E is 18 and the market average is 20, it may be a good investment.
If the P/E ratio is high, the price of the stock may be high. A stock with a low price-to-earnings ratio may have more room to go up. P/E ratios should be used along with other financial ratios to help people make good decisions.
PRICE-TO-BOOK Ratio
The price-to-book value (P/BV) ratio compares the market price and book value of a company. Book value is simply the amount left over after a company sells all of its assets and pays off all of its debts.
The P/BV ratio is used to figure out the value of a company’s shares if it has a lot of real assets on its balance sheet. If the P/BV ratio is less than 1, the stock is undervalued because the value of the company’s assets is higher than what the market is putting on the stock. It shows what a company is really worth and helps figure out the value of businesses with mostly liquid assets, like banks and financial institutions.
DEBT TO EQUITY Ratio
It shows how leveraged a company is, or how much debt it has compared to the amount of money its founders put into the business (equity). Most of the time, a low number is better. But it can’t be looked at by itself.
The debt will be worth more if the company makes more money than it spends on interest. But if it isn’t, shareholders will lose.
A business with a low debt-to-equity ratio may be expected to have a lot of room to grow because it has more ways to get money.
But it’s not that simple. It varies by industry, with higher numbers in industries that need a lot of capital, like manufacturing and the car business. A high debt-to-equity ratio could be a sign to the market that the company has invested in a lot of high-NPV projects, but it could also mean that the company has a lot of debt and, therefore, a higher risk of credit default.
A stock may be overpriced if its P/E ratio is high. A stock with a low price-to-earnings ratio may have more room to go up. P/E ratios should be used along with other financial factors to help make good decisions.
OPERATING PROFIT MARGIN (OPM)
The OPM is good at setting prices and running its business well. It is found by dividing the operational profit by the net sales. A higher OPM shows that it is efficient to get raw materials and turn them into finished goods.
It figures out how much money is left over after paying for variable costs like salaries and raw materials. The margin is bigger the better it is for investors.
When analysing a company, check to see if its OPM has been going up over time. Investors should compare the OPMs of different companies in the same business sector.
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