Some key financial ratios with examples

Financial ratios are essential tools for analyzing a company's performance and making investment decisions. Here are some key financial ratios with examples:

1. Price to Earnings Ratio (P/E Ratio)

• Formula:
  $\text{P/E Ratio} = \frac{\text{Market Price per Share}}{\text{Earnings per Share (EPS)}}$
• Purpose:
  Measures how much investors are willing to pay for each dollar of earnings. A higher P/E ratio can indicate that the stock is overvalued, or it could mean that investors expect future growth.
• Example:
  If a company's stock price is ₹150, and its EPS is ₹10, the P/E ratio is $\frac{150}{10} = 15$. This means investors are willing to pay ₹15 for every ₹1 of earnings.

2. Debt to Equity Ratio (D/E Ratio)

• Formula:
  $\text{D/E Ratio} = \frac{\text{Total Debt}}{\text{Shareholders' Equity}}$
• Purpose:
  Indicates how much debt a company is using to finance its assets relative to equity. A higher ratio means more debt, which could be riskier.
• Example:
  If a company has total debt of ₹500 crores and shareholders' equity of ₹250 crores, the D/E ratio is $\frac{500}{250} = 2$. This suggests the company has ₹2 of debt for every ₹1 of equity.

3. Return on Equity (ROE)

• Formula:
  $\text{ROE} = \frac{\text{Net Income}}{\text{Shareholders' Equity}} \times 100$
• Purpose:
  Measures the profitability of a company in relation to its equity. A higher ROE indicates efficient use of equity capital.
• Example:
  If a company's net income is ₹100 crores and shareholders' equity is ₹500 crores, the ROE is $\frac{100}{500} \times 100 = 20\%$. This means the company generates 20% profit on its equity.

4. Current Ratio

• Formula:
  $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$
• Purpose:
  Indicates a company's ability to pay off its short-term liabilities with its short-term assets. A ratio greater than 1 indicates good liquidity.
• Example:
  If a company has current assets of ₹300 crores and current liabilities of ₹150 crores, the current ratio is $\frac{300}{150} = 2$. This indicates the company can cover its short-term liabilities twice over.

5. Price to Book Ratio (P/B Ratio)

• Formula:
  $\text{P/B Ratio} = \frac{\text{Market Price per Share}}{\text{Book Value per Share}}$
• Purpose:
  Compares a company's market value to its book value. A lower P/B ratio may indicate that the stock is undervalued.
• Example:
  If the market price per share is ₹200 and the book value per share is ₹100, the P/B ratio is $\frac{200}{100} = 2$. This suggests the stock is trading at twice its book value.

6. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) Margin

• Formula:
  $\text{EBITDA Margin} = \frac{\text{EBITDA}}{\text{Revenue}} \times 100$
• Purpose:
  Measures a company's operating profitability as a percentage of total revenue. It shows how much of the revenue is turned into operational profit.
• Example:
  If a company has EBITDA of ₹200 crores and revenue of ₹1,000 crores, the EBITDA margin is $\frac{200}{1000} \times 100 = 20\%$. This indicates 20% of revenue is operating profit.

7. Dividend Yield

• Formula:
  $\text{Dividend Yield} = \frac{\text{Annual Dividends per Share}}{\text{Market Price per Share}} \times 100$
• Purpose:
  Measures the income generated from an investment in the form of dividends. A higher yield could make the stock attractive to income-focused investors.
• Example:
  If a company pays an annual dividend of ₹5 per share, and the stock price is ₹100, the dividend yield is $\frac{5}{100} \times 100 = 5\%$. This means the investor earns 5% of the stock price in dividends.

These ratios are valuable tools for assessing the financial health and valuation of a company. However, they should be used in conjunction with other analyses and industry comparisons to make informed investment decisions.