LISTED Share Research: 3 Essential Ratios
Financial Ratios are a great tool for investors to conduct listed shares research. Financial Ratios decode financial data and give insight into a company's efficiency, profitability, and growth. Below are a few essential Financial Ratios that every investor should look at when trying to ascertain the viability of an investment:
1. Price to earnings (P/E Ratio):
Price to earnings ratio= (Price Per Share)/ (Earnings Per Share)
PE Ratio is one of the most widely used financial ratios among investors. It compares the Share Price of a company relative to its Earnings. A high PE ratio means that the Share Price of the company is far outperforming its Earnings. This could be a signal of concern since it means that the market is overvaluing the current earnings of the company. However, it could also be
a positive signal if taken to mean that the market is expecting high growth in the Company. Similarly, a low PE could be both a positive indicator indicating that a company is undervalued, or it could be a negative indicator raising doubt about the company’s growth potential. The PE ratio varies widely from industry to industry, therefore it is important to know the industry average to benchmark a company’s PE ratio. For example, the FMCG sector in India has a very high PE (~40) as compared to the Utility sector (~15).
Example: Godrej Consumer Products and ITC are two major players in the FMCG sector. Godrej's PE ratio is 58 and ITC’s PE ratio is 22. Therefore, we can say that ITC is relatively undervalued compared to its peers.
2. Return on Equity(RoE) Ratio:
Return on Equity= (Net Income)/(Average Stockholder Equity)
Return on Equity is the amount of net income returned as a percentage of shareholders' equity. RoE ratio measures a company’s profitability by revealing how much profit a company generates with the money shareholders have invested in it. Like PE ratios, RoE ratios vary from sector to sector making it important to the industry average ROE. Moreover, it is important to look at the company’s capital structure. A company might have a high RoE ratio because it might have taken on a lot of debt and its equity investment is low.
Example: Vedanta and National Mineral Development Corporation(NMDC) are the two major players in the Metal and Mining sector. Vedanta’s RoE ratio is 14.36% and NMDC’s RoE ratio is 21.83%. This says that NMDC having the highest RoE ratio has taken a lot of debt and its equity investment is also low.
3. Debt-to-Equity(D/E)Ratio:
Debt to Equity Ratio= (Total Liabilities)/ (Total Shareholders Equity)
Debt-to-Equity Ratio measures the relationship between the amount of capital that has been borrowed (debt) and the amount of capital contributed by shareholders (equity). If a firm's DE ratio increases, then it becomes riskier whereas a lower DE ratio means that the company is using less leverage and has a strong equity position. For example, if a company has Rs 10 Lakh worth of loans and has shareholders' equity of Rs 50 Lakh, the DE ratio of the company works out to be a modest and acceptable 0.25. Usually, DE ratio higher than 1 is a cause for concern.
Example: HEG and Graphite India are two major companies in the Electrodes and Graphite sector. HEG has a DE ratio of 0.17 and Graphite India has a DE of 0.09. While both companies have low leverage (DE ratio < 0.25), Graphite is even less levered than HEG and therefore may be more attractive to an investor.
Thus we see that Financial Ratios help investors to conduct listed shares research. We need to remember that a company cannot be evaluated just by using a single ratio, it is very crucial to research a variety of ratios that explore all aspects of a company’s finances for more confident investment decision-making. To get the latest financial ratios for listed companies visit www.stockknocks.com.