Are you looking to become a stock market investor? Then, remember, it is more than just picking stocks based on impulses or tips! Instead, it is about making informed decisions based on various techniques.
Learning fundamental ratios and using them appropriately is integral to stock investment. However, which fundamental ratios should you, as an Indian investor, know and use?
As providers of one of the top 10 best online share market courses, we consider this a crucial question. So, here is the answer to it.
5 Types of Fundamental Ratios Investors Must Learn and Use
From Price to Earnings to Debt-to-Equity ratio, here are the ratios to consider.
1. Price to Earnings (P/E) Ratio
It is the ratio of the current share price to the earnings of the company per share.
The ratio tells you if the company is undervalued or overvalued in the market.
For instance, a company’s overall earning is Rs. 3000, and it has 300 shares trading in the market. Thus, its earning per share is Rs. 10.
Next, let’s say the company’s shares are trading at Rs. 300 per share. Thus, the P/E ratio is,
P/E = 300/30 = 10
In simple words, you are paying Rs. 10 for earning Rs. 1 from the company’s earnings. Thus, you can confidently say that establishments with a higher P/E ratio are much overvalued.
Now, what should be the ideal P/E ratio? There’s no specific answer. While calculating the ratio, you must consider the industry benchmarks and assess the valuation.
2. Dividend Yield
This one is crucial if you are looking for regular income.
It signifies the yearly dividend payout as the current stock price’s percentage.
The formula is annual dividend per share/market price per share X 100.
It will show you the return you earn through dividends on your investment.
Let’s say you buy a stock at a market price of Rs. 10. A year or two later, you see the stock price hasn’t changed at all. So, are such stocks good to invest in?
A quick look will reveal they aren’t, as you’ve earned a zero percent return.
But have you considered the dividend before making a decision?
Usually, you would go for companies with high dividends. However, it might also signify a declining stock price or shaky payout ratio.
The key to making the right choice? Analyzing the company’s dividend history and the ability to maintain future payouts.
Decode P/E, P/B, and D/E Like a Wall Street Analysis – We’ll Teach You How
3. Price-to-Book (P/B) Ratio
This ratio compares a company’s market capitalization to its book value. It helps you determine if you are paying a reasonable price for the company’s net assets.
So, how do you calculate the P/B ratio?
P/B Ratio = Market Price Per Share / Book Value Per Share.
Suppose a company’s value is Rs. 100. It decides to close shop and gets Rs. 100. But out of this amount, it must pay Rs. 50 as a loan repayment. On the other hand, the company has some assets worth Rs. 20. Thus, the company’s total book value is 100-50 + 20 = Rs. 70
Now, let’s say the total number of outstanding shares was 35.
So, the firm’s book value per share is 70/35 = Rs. 2.
As for the P/B ratio, let’s say the company’s market share price is Rs. 30. Thus, the P/B ratio will be 30/2 = 15. Companies with a low P/B ratio are considered undervalued. Those with a higher one are overvalued.
4. Current Ratio
Although profitable, companies that cannot repay their short-term debts can face financial issues. Hence, calculating the current ratio is crucial. The formula is,
Current Ratio= Current Assets / Current Liabilities
A ratio greater than 1.0 means the company can meet its short-term liabilities with short-term assets. But a ratio above 1.0 might indicate that the company is accumulating money and not using it efficiently. A ratio below 1.0 signifies risk. It indicates that the company might struggle to cover its debts.
5. Debt-to-Equity (D/E) Ratio
Profits are one part. But what about debts?
That’s where the D/E ratio comes into play.
Debt-to-Equity Ratio = Total Debt / Shareholders’ Equity.
Too much debt can pose a risk.
The ratio shows you how much debt a company is carrying for every rupee of equity.
A high ratio shows that a company is more leveraged, resulting in a financial risk.
Want to Master Fundamental Ratios?
Although not the only one, the fundamental ratio is an important technique that helps you make informed investment decisions. But you must champion them with the right training. So, whether you are looking for share trading or futures and options classes in Pune, FinEarn Share Market Academy has got you covered. We are a reputed institute with a proven track record and successful alumni.
Want to discover more? Call us at +91 95618 61818.