5 Key Ratios to Analyze Any Stock

Investing in stocks requires a thorough analysis of fundamentals. This is where financial ratios become essential. They allow you to understand a company’s performance over the years and help you make an informed decision. In this article, we will cover the top financial ratios you need to know for investing in the stock market.

5 Key Ratios for Stock Analysis

Financial ratios are essential for understanding the basics of the stock market. They help you evaluate the fundamentals of a company. Here are five key ratios you should know to analyse a stock.

1. Current Ratio

This is one of the most used ratios. It suggests the company’s ability to pay its short-term liabilities with its short-term assets. It demonstrates the company’s ability to manage its immediate financial obligations effectively. Here is the formula for the same:

Current Ratio = Current Assets / Current Liabilities

The ideal current ratio is typically between 1.5 and 2. For the interpretation, here is what to know:

• Below the range indicates liquidity issues.
• Above the range means the company is not effectively utilising resources.

2. Price-to-Earnings (P/E) Ratio

It shows the price that investors are willing to pay for every rupee a company earns. It helps determine if the share is priced higher or lower than its actual value. The formula for the same is:

P/E Ratio = Current Market Price per Share / Earnings Per Share (EPS)

Once you have the result, it is interpreted as:

• A high P/E ratio means expected strong future growth.
• A low P/E ratio indicates that the company might be undervalued or experiencing difficulties.

3. Debt-to-Equity Ratio

It estimates the company’s financial standing. It reflects the amount of debt a company holds relative to its equity for financing assets and helps assess its financial stability and risk. The formula is as follows:

Debt-to-Equity Ratio = Total Debt / Total Equity

In terms of analysis, here is what you must know:

• A high debt-to-equity ratio means more debt and so more risk.
• A low ratio suggests better financing and, so, safety and stability.

This ratio should always be checked against the industry standard for a better understanding.

4. Return on Equity (ROE)

TIt shows how effectively a company uses shareholders’ funds to generate profits, revealing the profit earned for every rupee of equity invested. The formula for this is:

ROE = Net Income / Shareholders’ Equity

To analyse a company based on ROE, here is what you must know:

• A higher ROE indicates effective use of equity to generate attractive returns.
• A lower ROE can suggest inefficient management and so lower returns.

5. Earnings Per Share (EPS)

This is the amount that a company keeps aside for its outstanding shares. This is taken from the profit. It indicates the profit the company is generating for each share you own. The formula for this is as follows:

EPS = Net Profit ÷ Total Outstanding Shares

The analysis of EPS is as follows:

• A higher EPS indicates stronger profitability, making it more attractive for investors.
• A lower EPS indicates that proper resource utilisation is lacking.

Conclusion

Analysing a company’s numbers gives you the clarity needed to invest with confidence. Financial ratios reveal if a business is strong, stable, and worth your investment. However, always compare the results with industry standards to make an informed decision.

If you wish to learn more about how to analyse stocks, consider taking Upsurge. The club delivers online courses specializing in stock market investing.