Here I will discuss investing in those companies which are listed on the stock exchanges. The listing in the stock exchanges makes the investing process easy as one can get the relevant information about any listed company from the website of the stock exchange.
There are certain financial ratios which analyze the health of the company and help in taking the investment decision wisely.
The important financial ratios that an every investor must know are as follows:
(1) The Price to Earning (P/E) ratio
It is the ratio of market price of the stock to the earning per share of the company. It can be represented as:
If you take EPS from the last 12 months, then it is called trailing P/E ratio and if the projected EPS is taken for the next year, then it is called forward or projected P/E ratio. One should compare P/E ratios of the companies of the same industry. The companies which have negative income do not have the P/E ratio.
(2) The Price-earnings to Growth (PEG) ratio
The PEG ratio is next layer of analysis after looking at the P/E ratio of the company. This ratio helps in shortlisting the undervalued company. It can be represented as:
For example, the PE ratio of company XYZ Ltd is 12 and its realistic growth rate is 16%, the PEG ratio of the company is 12/16 = 0.75 < 1 (the company is assumed undervalued; hence a good investment choice.
(3) The Price to Book value (P/B) ratio
This ratio is a good indicator, showing the willingness of the investors to pay for each rupee of the company's tangible assets. rupee of the company’s tangible assets.
It is the ratio of the market price of the share to its net assets excluding any intangibles like goodwill
(4) The Price to Free cash flow (P/FCF) ratio
It is the ratio of the market price of the share to free cash flow per share. The cash flow remaining after deducting the capital expenditure from the operating income is called free cash flow; the company can use this free cash for expansion, acquisitions or support its operations during bad market conditions.
Free cash flow = Operating cash flow – Capital expenditure
P/FCF ratio = Market price of the share / free cash flow per share
You can get the value of free cash flow per share by dividing the free cash flow by the number of shares outstanding. You can find number of shares outstanding from any finance website like www.moneycontrol.com or www.yahoofinance.com
(5) The Debt-Equity (D/E) ratio
It indicates the proportion of the debt and the equity a company is using to run its operations and the assets.
(6) The Return on capital employed (ROCE)
It indicates the profitability of any company and it is a strict measure of the performance than return on equity as it takes into account the debt part of the company. It is represented as follows:
It is useful in the capital intensive sectors like telecoms, utilities companies
(7) The Inventory turnover ratio
It is a good indicator, which shows the number of times the company's inventory is sold in a year's time. It indicates the efficiency of the management.
(8) The Current ratio
This ratio measures the liquidity of the company as to what extent the company is able to meet it's short term and the long term liabilities. It is ratio of total current assets the the total current liabilities.
Although, the above mentioned ratios are the good indicators for the investors to gauge the performance of the company. But the few points have to be kept in mind while using these ratios like: