{"id":6456,"date":"2022-01-17T16:39:37","date_gmt":"2022-01-17T11:09:37","guid":{"rendered":"https:\/\/www.tickertape.in\/blog\/?p=6456"},"modified":"2022-05-24T11:00:29","modified_gmt":"2022-05-24T05:30:29","slug":"financial-ratios","status":"publish","type":"post","link":"https:\/\/www.tickertape.in\/blog\/financial-ratios\/","title":{"rendered":"5 Important Financial Ratios You Need To Know for Fundamental Analysis"},"content":{"rendered":"\n<p><a href=\"https:\/\/www.tickertape.in\/blog\/what-is-share-market\/?utm_source=blog&amp;utm_medium=article\">Stock markets<\/a> run on a simple principle of buying and selling stocks to generate profits. When you <a href=\"https:\/\/www.tickertape.in\/blog\/why-should-you-prioritise-investing\/\">invest<\/a> in stocks, the idea is to buy at a certain price (generally low) and sell at a higher price. The bigger the gap between the price you buy versus the price you sell, the higher your earnings.&nbsp;<\/p>\n\n\n\n<p>Apart from all these, <a href=\"https:\/\/www.tickertape.in\/blog\/stock-picks-rajesh-kothari\/?utm_source=blog&amp;utm_medium=article\">stocks<\/a> can be an excellent investment avenue for the long term. Using <a href=\"https:\/\/www.tickertape.in\/blog\/a-step-by-step-guide-to-fundamental-analysis\/\">fundamental analysis<\/a>, one can pick potential stocks and profit from their growth later. This can be done with the help of financial ratios. Let\u2019s explore further.<\/p>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_66_1 counter-hierarchy ez-toc-counter ez-toc-custom ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title \" >Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#Why-do-investors-need-financial-ratios\" title=\"Why do investors need financial ratios?\">Why do investors need financial ratios?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#Five-important-financial-ratios-for-fundamental-analysis\" title=\"Five important financial ratios for fundamental analysis\">Five important financial ratios for fundamental analysis<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#PE-ratio\" title=\"P\/E ratio\">P\/E ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#Return-on-equity-ratio\" title=\"Return on equity ratio\">Return on equity ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#Debt-to-equity-ratio\" title=\"Debt to equity ratio\">Debt to equity ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#Price-to-book-ratio\" title=\"Price to book ratio\">Price to book ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#Dividend-yield-ratio\" title=\"Dividend yield ratio\">Dividend yield ratio<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/www.tickertape.in\/blog\/financial-ratios\/#Conclusion\" title=\"Conclusion\">Conclusion<\/a><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\" id=\"why\"><span class=\"ez-toc-section\" id=\"Why-do-investors-need-financial-ratios\"><\/span>Why do investors need financial ratios?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Stock prices are affected by demand and supply, news and a host of other factors that might have nothing to do with the actual financial performance or value of a company. Some stock prices might be inflated purely due to hype. However, at some point, the hype may die out, and the stock price would be guided by the company\u2019s fundamentals.&nbsp;<\/p>\n\n\n\n<p><a href=\"https:\/\/www.tickertape.in\/blog\/fundamental-analysis-of-stocks\/?utm_source=blog&amp;utm_medium=article\">Fundamentals<\/a> are largely the macroeconomic factors that affect the economy, industry, sector and finally, the company. A company that stands strong on its fundamentals i.e. does well in its industry and on growth is touted to make for a great investment. However, sometimes, due to controllable and uncontrollable factors, the stock of such companies may remain ignored and undervalued on the markets. If you succeed in identifying such stocks, you could earn stellar returns.&nbsp;<\/p>\n\n\n\n<p>But, how can you identify when a stock is undervalued or selling at a discount? Well, you use financial ratios to determine a stock\u2019s valuation.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"five\"><span class=\"ez-toc-section\" id=\"Five-important-financial-ratios-for-fundamental-analysis\"><\/span>Five important financial ratios for fundamental analysis<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"PE-ratio\"><\/span>P\/E ratio<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><a href=\"https:\/\/www.tickertape.in\/blog\/pe-ratio\/\">Price to earnings ratio<\/a> is the profit per rupee that an investor derives by investing in a company.&nbsp;It is calculated as :<\/p>\n\n\n\n<p><strong>P\/E ratio = Current share price \/ <a href=\"https:\/\/www.tickertape.in\/blog\/earnings-per-share\/\">Earnings per share<\/a><\/strong><\/p>\n\n\n\n<p>A company\u2019s P\/E ratio holds its earnings against its share price to give investors an idea of whether the stock is undervalued or overvalued.&nbsp;<\/p>\n\n\n\n<p>Let us use a simple example to understand the P\/E ratio. Assume that company ABC ltd has earnings of Rs. 2,00,000. It has 1000 <a href=\"https:\/\/www.tickertape.in\/blog\/shareholders\/\">shareholders<\/a> and a share price of Rs. 100. The earnings per share is Rs. 200, which means that the shareholder pays Rs. 100 for Rs. 200 worth of earnings.&nbsp;<\/p>\n\n\n\n<p>Generally, the lower the P\/E ratio, the more favourable the stock is from a value <a href=\"https:\/\/www.tickertape.in\/blog\/investing-secrets-of-warren-buffett\/?utm_source=blog&amp;utm_medium=article\">investing<\/a> perspective. On the contrary, the higher the P\/E ratio, the more overvalued the stock is. A valuation is arrived at when you compare the P\/E ratio of one stock with peers or the industry average. Note that the healthy P\/E ratio range for every sector is different.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Return-on-equity-ratio\"><\/span>Return on equity ratio<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This is arguably the most important ratio in <a href=\"https:\/\/www.tickertape.in\/blog\/what-is-equity\/\">equity<\/a> analysis. This ratio measures how efficiently the company generates profit per unit equity. Companies with higher ROE are preferred for investments. It is calculated as: <\/p>\n\n\n\n<p><strong>ROE = (Net income\/Profit) \/ Shareholder\u2019s equity<\/strong><\/p>\n\n\n\n<p>However, investors should keep in mind one loophole in <a href=\"https:\/\/www.tickertape.in\/blog\/return-on-equity-ratio\/?utm_source=blog&amp;utm_medium=article\">ROE<\/a>. A company could display a good ROE on account of high debt and low equity. In such a case, if you add its borrowings and equity, its earnings might pale in comparison. You can maintain a clear lens when using ROE by checking the company\u2019s <a href=\"https:\/\/www.tickertape.in\/blog\/difference-between-debt-and-equity\/?utm_source=blog&amp;utm_medium=article\">debt to equity<\/a> structure.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Debt-to-equity-ratio\"><\/span>Debt to equity ratio<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Debt and equity are the two most basic sources of finance. How a company uses one source compared to another defines <a href=\"https:\/\/www.tickertape.in\/blog\/difference-between-debt-and-equity\/?utm_source=blog&amp;utm_medium=article\">debt to equity ratio<\/a>. In other words, the debt to equity ratio can be defined as the ratio at which a company uses debt and equity channels for financing.<\/p>\n\n\n\n<p><strong>Debt to equity ratio = Total debt \/ Total equity<\/strong><\/p>\n\n\n\n<p>Expanding companies will generally have a debt to equity ratio higher than 1 as they typically use debt as a means of finance. However, there is no healthy debt to equity ratio &#8211; it not only differs from one sector to the next but also is more of a support to ROE rather than a standalone metric.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Price-to-book-ratio\"><\/span>Price to book ratio<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>To understand the P\/B ratio, it is important to understand <a href=\"https:\/\/www.tickertape.in\/blog\/book-value-per-share\/?utm_source=blog&amp;utm_medium=article\">book value<\/a>. Book value is derived by deducting borrowings and adding asset value to a company\u2019s present value, and then dividing that figure by 100.&nbsp;<\/p>\n\n\n\n<p>In the same light, the P\/B ratio is calculated as:<\/p>\n\n\n\n<p><strong>P\/B = Market price per share \/ Book value per share<\/strong><\/p>\n\n\n\n<p>Ideally, a lower P\/B ratio makes companies preferable because it means that they are undervalued. However, a negative P\/B ratio might indicate that the company is fundamentally weak or has poor financial health. Like the other ratios on this list, P\/B ratio must account for sector and business environment specifics when making comparisons.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Dividend-yield-ratio\"><\/span>Dividend yield ratio<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This ratio measures the quantum of cash dividends paid out to shareholders per share. It is simply calculated by dividing the annual dividends paid by a company against its stock price. It is given:<\/p>\n\n\n\n<p><strong><a href=\"https:\/\/www.tickertape.in\/blog\/cash-dividend-vs-stock-dividend\/\">Dividend<\/a> yield ratio = Annual <a href=\"https:\/\/www.tickertape.in\/blog\/what-is-dividend\/\">dividend<\/a> per share \/ Price per share<\/strong><\/p>\n\n\n\n<p>If Company A pays a total <a href=\"https:\/\/www.tickertape.in\/blog\/what-is-dividend\/?utm_source=blog&amp;utm_medium=article\">dividend<\/a> of Rs. 100, trading at Rs. 1,500, then the dividend yield ratio is 6.6%. Companies with a higher <a href=\"https:\/\/www.tickertape.in\/blog\/dividend-yield\/?utm_source=blog&amp;utm_medium=article\">dividend yield<\/a> are also seen as preferable because besides stock price appreciation; investors earn by way of dividends.&nbsp;<\/p>\n\n\n\n<p>Investors should proceed with caution when using this ratio because there is no guarantee of dividend payment (or its volume) in the future. Moreover, dividend yield differs largely from one sector to the next.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Conclusion\"><\/span>Conclusion<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Trade with a safe and foolproof strategy instead of guessing, or worse &#8211; getting conned by \u2018insider tips\u2019. Use a combination of financial ratios to time your investment correctly. Understand the markets fully and only then invest. Consult your financial advisor before investing.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Looking to understand the basics of financial ratios? Click here to learn about different types of financial ratios, how they work and use them for fundamental analysis of stocks.<\/p>\n","protected":false},"author":45,"featured_media":6372,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"_lmt_disableupdate":"no","_lmt_disable":"no","footnotes":""},"categories":[9],"tags":[1188,1187],"acf":[],"modified_by":"Anjali Chourasiya","jetpack_featured_media_url":"https:\/\/www.tickertape.in\/blog\/wp-content\/uploads\/2022\/01\/05.png?wsr","_links":{"self":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/6456"}],"collection":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/users\/45"}],"replies":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/comments?post=6456"}],"version-history":[{"count":3,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/6456\/revisions"}],"predecessor-version":[{"id":8598,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/6456\/revisions\/8598"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media\/6372"}],"wp:attachment":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media?parent=6456"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/categories?post=6456"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/tags?post=6456"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}