key Financial Ratios.

Investing in stocks requires a careful analysis of financial data to find out the actual worth of the company. The simplest way to make a viable investment decision is to look for the favorability of various ratios which are easily available. This approach is less cumbersome and less time consuming than examining the actual figures of the balance sheet, income statement and cash flows.

Though this is not a foolproof method, it is a good way to run a fast check on a company's health.

"Ratio analysis is crucial for investment decisions. It not only helps in knowing how the company has been performing but also makes it easy for investors to compare companies in the same industry and zero in on the best investment option.

In this article, we will be sharing with you some of the key ratios one should look for before investing. 

1. Price- earning ratio or P/E ratio:

The price-to-earnings or P/E ratio shows how much stock investors are paying for each rupee of earnings. It shows if the market is overvaluing or undervaluing the company.

One can know the ideal P/E ratio by comparing the current P/E with the company's historical P/E, the average industry P/E and the market P/E. For instance, a company with a P/E of 15 may seem expensive when compared to its historical P/E, but maybe a good buy if the industry P/E is 18 and the market average is 20. P/E ratio is usually used to value mature and stable companies that earn profits. A high PE indicates that the stock is either overvalued (with respect to history and/or peers) or the company's earnings are expected to grow at a fast pace.

A high P/E may indicate the stock is overpriced and a low P/E may mean the stock has a great potential for rising. 

2. Price- to- book value ratio or P/BV ratio:

The price to book value ratio is used to compare a company's market price to its book value. Book value simple means value that remains after liquidating assets and repaying all its liabilities. 

P/BV ratio values shares of companies with large tangible assets on their balance sheets. A P/BV ratio of less than one shows the stock is undervalued (value of assets on the company's books is more than the value the market is assigning to the company). It indicates a company's inherent value and is useful in valuing companies whose assets are mostly liquid, for instance, banks and financial institutions.

3. Debt- to -equity ratio or D/E ratio:

The debt-equity ratio of a company is calculated by dividing total liabilities by its share holder's equity. This ratio is used to evaluate the company's financial leverage. This ratio measures the degree at which the operations of the company are financed by the borrowed debt versus owners capital. More specifically, it reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn.

Given that the debt-to-equity ratio measures a company’s debt relative to the value of its net assets, it is most often used to gauge the extent to which a company is taking on debt as a means of leveraging its assets. A high debt/equity ratio is often associated with high risk; it means that a company has been aggressive in financing its growth with debt.

4. OPERATING PROFIT MARGIN (OPM)

The OPM shows operational efficiency and pricing power. It is calculated by dividing operating profit by net sales.

Aggarwal of SMC says, "Higher OPM shows efficiency in procuring raw materials and converting them into finished products."

It measures the proportion of revenue that is left after meeting variable costs such as raw materials and wages. The higher the margin, the better it is for investors.

While analyzing a company, one must see whether its OPM has been rising over a period. Investors should also compare OPMs of other companies in the same industry.

5. Return on Equity: 

The ultimate aim for any investment returns. Return on equity measures the return that shareholders get from the business and overall business.

ROE is considered a measure of how effectively management is using a company’s assets to create profits. ROE is expressed as a percentage and can be calculated for any company if net income and equity are both positive numbers. Net income is calculated before dividends paid to common shareholders and after dividends to preferred shareholders and interest to lenders.

Though investing in equities is a complex task, which includes digging into various factors as such balance sheet, income states and other financial but this tedious work can be cut short if you know how to read these ratios. These ratios are useful while analyzing a company. However, these aren't the only parameter for choosing the right investment. Everyone has a diffrenet style and purpose of investing, thus their way of analyzing may differ as well.