Investing in stocks require a lot of research. One of the easy ways to ascertain the financial health of a company is by looking at the financial ratios of the company. Looking at the ratios you can not only analyse the company's historic performance but also make a comparison with the company's peers. However, following list is not exhaustive but these are the key ratios.
Price to earning
It is the ratio of the company's current market price to the company's earnings per share. The ratio signifies how much investors are willing to pay for the single rupee of earnings of the company. The higher the ratio means the investors are willing to pay more while lower the ratio investors are willing to pay less for the earnings of the company. Ideally, one should compare the PE ratio of the company with its historic PE ratio or with its peers. So, if the company's PE is higher than peers and its own historic value that means the company is currently overvalued or else it is undervalued.
Price to book value
Book value of the company indicates the value of the assets of the company after retiring its liabilities. And book value per share is calculated by dividing the assets of the company with the number of shares. Price to book value is calculated by dividing the current market price with the book value per share of the company. The ratio indicates what will be left for the shareholders after the company goes bankrupt.
A PB ratio of less than one shows the stock is undervalue (value of assets on the company's books is more than the value the market is assigning to the company) and vice versa.
Debt to equity
It shows how leveraged is the company. The ratio is calculated by dividing total liabilities of the company by the equity shareholders capital of the company. The lower debt to equity ratio the better it is. However, the ratio may vary from industry to industry as capital intensive companies may have a higher debt to equity ratio compared to companies where capital requirement is less. Therefore, comparison should be made within the same industry.
Return on equity
For an investor what matters most is the returns from the company. The ratio measure how much return the company is giving to its shareholders and shows the ability of the management to generate profits. It is calculated by dividing the net income that is profit after tax by equity shareholders capital. The higher the ratio the better it is.
It is calculated by dividing the annual dividend per share of the company with the share price of the company. The ratio indicates how much the company pays out dividend to its shareholders per year. The higher the ratio, the better it is. Those investors who require cash flows prefer investing in companies which pay high dividends regularly. In the absence of capital gains, dividend yields is a good way of return from the stock. During volatile times investors prefer investing in high dividend yielding stocks as such companies are good for risk averse investors