STOCK MARKET : 5 IMPORTANT FINANCIAL RATIOS TO KNOW BEFORE INVESTING

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  • Post last modified:20/09/2021

Financial Ratios Are Very Important For Analyzing Any Stock Or Company, The First Thing Anyone Will Do Is To Compare The Financial Ratios Such As EPS, PE Or ROE With Other Companies Which Are In the Same Sector.

So That They Can Get a Good Idea On How Efficiently The Company Is Performing And Will Get An Idea To Choose A Company For Investment.

In This Article, You Are Going To Learn About 5 Important Financial Ratios Which Are Very Useful For analyzing The Companies Performance And Efficiency Within The Same Sector.

What Is EPS Ratio?

EPS Stands For Earnings Per Share. By Knowing The Full Form We Can Understand EPS Is Nothing But Earnings OF The Company For Each Share.

EPS = Total Profits After Tax / Total No Of Shares ( Total Profits Divided By Total No Of Shares ).

If You See EPS In Any Website It Will Be Present As EPS ( TTM ), Here TTM Means Trailing Twelve Months.

Trailing Twelve Months Means We Need To Consider The Profit For Past Twelve Months.

How To Calculate EPS Ratio

For Example, The Total Shares Of A Company Is 1 Lakh And The Total Profit For the Past Twelve Months Is 10 Thousand.

Now EPS = 1 Lakh / 10 Thousand ( 1 Lakh Divided By 10 Thousand )

= 10, So Earnings Per Share For This Company Is 10. For Every One Share The Company Generated 10Rs Profit.

From Above Example, If You Have 100 Shares Of The Company, Means The Company Generated 10Rs Profit For Every Share You Hold.

Uses Of EPS Ratio

One Can Use EPS Financial Ratio To Judge A Company, Do Note That EPS Is Only One Factor And We Need To Consider Many Other Factors To Judge A Company.

Higher The EPS, Better The Company. Use EPS While Comparing Companies Of the Same Sector.

If The EPS Is Higher Means The Company Is Making Good Profits.

So While Choosing A Stock Compare The EPS With The Companies In The Same Sector.

What Is PE Ratio ?

PE Stands For Price To Earnings, PE Ratio Is Nothing But How Much We Are Paying To The Company For Every 1 Rupee Of Profit The Company Is Making.

PE = Current Market Price Of The Share/EPS.

In The Above Example Used In EPS, The EPS Is 10, Which Means The Company Is Earning 10 RS For Every share.

For Example, If The Share Price Is 200 Rupees, By Using PE Formula.

PE = 200/10 = 20. Means We Are Investing 20 Times More Money Than What The Company Is Making In Profit.

If The PE Is 20 Means We Are Investing 20 Rupees For One Rupee Of Profit Made By The Company.

To Understand Clearly Let Us Take Another Example.

From Above The EPS Is 10 And The Share Price Is 200, EPS Is Nothing But Earnings Per Share Means The Company Is Earning 10 Rupees Per Share, Here Share Price Is 200 Rupees.

So The Company Is Earning 10 Rupees Profit For 200 Rupees, Which Is 20 Times Low Then Share Price ( 20 x 10 = 200, Here 10 Is EPS, 20 Is PE And 200 Is Share Price ). That Is Nothing But PE.

Uses Of PE Ratio

PE Can Be Used To Know If The Stock Price Is Expensive Of Cheap.

High Value Of PE Means The Stock Is Trading At Expensive Valuations And Low Value Of PE Means The Stock Is Trading At Low Valuations.

We Can Use The PE To Compare The Companies In The Same Sector.

PE Is Just One Factor To Compare A Company If All The Other Factors Are Good For Any Companies And Then Choose A Company With Low PE Value.

Do Note PE Alone Doesn’t Define A Company, We Need To Consider Lot Of Other Factors Also.

What Is ROCE Ratio?

ROCE Stands For Return On Capital Employed. Let Us Understand ROCE In Detail By Taking A Simple Example.

Capital Employed Is Nothing But The Total Capital Of The Company Raised From Both Equity And Debt.

For Example, If You Want To Set Up A Company And You Need 100 Crores To Set Up That Company, So Now You Raised 50 Crores From Equity ( Some Big Investors Liked Your Idea And Invested In Your Company ).

For Another 50 Crores, You Raised From Debt. So In Total, You Raised Enough Capital For Your Company.

After One Year Your Company Made 20 Crores Profit (Profit Before Tax And Interest ) In Total.

Now ROCE = Total Profit/Capital Employed x 100 ( Total Profit Before Tax And Interest Divided By Total Capital Employed ).

= 20 Crores/100 Crores x 100 = 20%, ROCE = 20%.

Uses Of ROCE Ratio

ROCE Can Be Used To Compare The Companies Within The Same Sector. Do Note Don’t Use ROCE To Compare companies Within Different Sectors!

For Example, If You Want To Compare the ROCE Of TCS Then Compare Only With IT Companies Like WIPRO, HCL, INFOSYS. But Not With The Companies In Other Sectors.

High ROCE Is Positive For The Company.

ROCE Is Can Be Better Used In Sectors Like Telecom, Power Because The Debts Of The Companies Are Higher In Those Sectors.

What Is ROE Ratio?

ROE Stands For Return On Equity.

The Difference Between ROE And ROCE Is, In The ROCE We Considered Both Equity And Debt, But In ROE We Consider Equity Only And In ROCE We Have Taken Profit Before Tax And Interest But In ROE We Need To Take Profit After Tax ( Net Profit ).

ROE = Net Profit / Total Equity

Uses Of ROE Ratio

ROE Can Be Used To Compare The Companies Within In The Same Sector.

High ROE Is Positive For Company. ROE Measures The Efficiency Of The Company On How The Company Using The Funds.

So Higher The ROE, Better The Efficiency Of The Company On How The Company Using The Funds.

If The Companies You Are Comparing Have Huge Debts Then ROE Doesn’t Matter, Because ROE Does Not Consider The Debts.

So While Comparing The Companies With Debts Use ROCE Rather Then ROE.

In Simple Words Use Both ROE And ROCE, But If The Debts Are Significant Then ROCE Will Be Better To Compare With Other Companies.

What Is ROA Ratio ?

ROA Stands For Return On Assets. Assets Are Properties Of A Company Like Machinery, Property, Inventory, Patents, Buildings All These Are Company Assets.

For ROA We Need To Consider The Profit After Tax And Interest.

ROA = Net Profit / Total Assets.

Uses Of ROA Ratio

We Can Use The ROA To Compare How Efficiently The Company Is Using Its Assets Like Machinery, Inventory Or Properties.

High ROA Is Positive For The Company. Means The Company Is Efficiently Using Its Assets To Gain Profits.

This Is All About The 5 Important Financial Ratios. One Can Use These Financial Ratios To Analyze The Companies Within The Same Sector.

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