Financial Ratios: Make Investing Easy By Understanding These Numbers

Financial Ratios: Make Investing Decisions Easy By Understanding These Numbers
Let us consider we have two vehicles. You fill both vehicles with 1 liter of fuel. You have the data of how much Distance it has traveled and what Time it has took. You can divide Distance by Time to get Speed. You can divide Distance by Fuel Used to determine the Mileage. Financial Ratios are nothing but similar to Speed and Mileage, which you can determine with the help of available information. You can use the various Financial Ratios to determine the best out of a list of Stocks and also use to Rank them to find the right one for Investments. We will know how to find the Financial Numbers and how to determine the Ratios which in turn will help us for taking better decisions.

Role of Financial Ratios in Investing/Trading

The first step for a Smart Investor is knowing the Numbers of the Company he/she interested in. I've mentioned Numbers which can be extracted from a Company's public available information either from Company websites, Annual Reports or even from Newspapers (Official Circulars). Naturally I have love towards Numbers (I got distinction in all 4 mathematics papers in my Engineering course).

Any investor interested in stock analysis should be able to calculate financial ratios. The basic source of these ratios is the company’s profit & loss account and balance sheet that contain all kinds of important information about that company. The ratios really help to bring those details to light and identify the financial strengths and weaknesses of the company. When assessing ratios, it is important that the results are compared with other companies in the same industry and not to be taken in isolation. What may seem like a poor ratio at first glance may well be normal for that industry and, of course, the reverse applies, in that what may seem a good ratio on its own, could be below average for that industry.

Financial ratios indirectly tells us information about a company's Financial Strength, Management Effectiveness, Efficiency and Profitability.

It helps us to identify:

  • The Current Financial Position of the Company
  • Where the Company stands among its peers 
  • If the Stock is correctly priced by the market
  • It helps you to decide if a particular Company is eligible for investing

Financial Ratio Analysis is also called Fundamental Analysis. Many investors use fundamental analysis alone or in combination with other tools to evaluate Stocks for investment purposes. The ultimate goal is to determine the current worth of the Company and, more importantly, how the market values the Company's Stock.

The below listed Financial Ratios are the important one's and which might help identify the potential opportunities in a stock. You can click the links to read them in detail and know how to calculate them for any given stock and also how to interpret the ratios.

  1. Earnings Per Share or EPS
  2. Price To Earnings Ratio or P/E Ratio
  3. Market Capitalization
  4. Price To Sales Ratio or P/S Ratio
  5. Price To Book Ratio or P/B Ratio
  6. Dividend Payout Ratio and Retention
  7. Dividend Yield and Earnings Yield
  8. Book Value
  9. Return On Equity (ROE) and ROCE
  10. Interest Coverage Ratio
  11. Evaluating Debt: Current and Quick Ratios
  12. PEG Ratio (P/E by Projected Growth Ratio)

Hope you enjoy this series of Financial Ratios. Do let me know whether any more details are required or need clarifications about. Will consider to add them.