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» 9 Important ratios that help you earn profit in stock investment..!
9 Important ratios that help you earn profit in stock investment..!
The stock market is one of the most important investments in today's times, offering returns higher than the rate of inflation and paying less income tax on profits. Although some people call this investment gambling, it is an investment game. It is necessary to observe 9 important Financial Ratios to win this game and earn more income. Let's look at them in detail one by one.These ratios tell investors about the quality of the company's underlying business, performance and earnings performance of the stock.
(1) Earnings per share..!
Earnings per share (EPS) is the amount of money a company earns per share over a period of time . Earnings per share is the company's net profit divided by the total number of shares outstanding. It is calculated on quarterly or annual basis. It is profitable to have more.
A company's net profit is Rs. Let's say 1,000. The total number of shares traded in that company is 100. Here the return per share is 1000/100= Rs.10.
Formula: Earnings per share = Net profit of the company / Total number of shares
(2) P/E Ratio:
Renowned investor and author of Warren Buffett , Benjamin Graham , has said that the P/E ratio must be observed in stock selection. This is the most important ratio in stock investing.
The ratio of the market price of the stock to the earnings per share (EPS) is called Price to Earnings Ratio (P/E Ratio). Generally, a ratio below 25 is profitable.
A company's P/E ratio should be compared with the average P/E ratio of the sector to which the company belongs. Better if the P/E ratio of the company is lower than the average P/E ratio of the sector. Also, it should be compared with the P/E ratio of the competing companies. A stock with a low P/E ratio is likely to give higher returns in the future.
At the same time, the P/E ratio of the fastest growing companies can be as high as 40, 50 even. P/E ratio will be very high as many investors will come forward to pay premium price i.e. higher price when the company is estimated to grow well in the future. Paying attention to this and investing will be profitable.
If the current P/E ratio is lower than the average of the last 3, 5 and 10 year P/E ratio, the future growth of the company is better; It can be concluded that the share price will also increase.
Total number of shares traded in a company is 100. Assuming earnings per share is Rs.10 then P/E ratio is 100/10=10. That is, if the stock's P/E ratio is 10, to buy a share from the stock market, one needs to spend 10 times the earnings of the share. Simply put, this means that an investor pays Rs.10 to get Rs.1 in the company's earnings.
Formula: P/E ratio= Current share price/ Earnings per share
(3) P/EG ratio
This is also the proportion Benjamin Graham tells us to observe. Based on this ratio it can be decided whether the company's future growth is priced at a discount or a premium. That means it can measure whether the stock is undervalued or overvalued.
P/E Ratio / Earnings Growth Rate - PEG Ratio is obtained by dividing the P/E ratio by the company's expected earnings growth rate . This ratio should be calculated based on the expected revenue growth rate over various time periods. It is best to calculate on a long-term basis. Calculation based on next five year growth rate would be correct. A revenue growth rate of at least 25% is good. If this P/EG ratio is less than 1, it means that the share price is undervalued.
A company stock with a P/E ratio of 25 and earnings growth of 25% has a P/EG ratio of 25/25=1.
Formula: P/EG Ratio = P/E Ratio/ Company's Expected Earnings Growth
(4) P/B ratio:
The Price To Book Value Ratio ( P/BV Ratio) describes how much an investor is paying for every rupee of assets owned by the company . It is the ratio between share price and book value. Book value refers to how much a company would receive per share if it were sold for some reason.
A company's P/P ratio should be compared with the average P/P ratio of the sector in which the company belongs . Better if the ratio of the company is lower than the average P/P ratio of the sector. Also, the P/P ratio of competing companies should be compared. Investing in stocks with a P/P ratio of less than 1.5 is likely to yield good long-term returns.
Assuming the market price of a company share is Rs.100 and the book value of a share is Rs.150 then 100/150= 0.66. As the P/P ratio is less than 1.5, this company stock can be invested.
Formula: P/PV ratio = Market price of share/ Book value of a share
(5) Debt / Equity Ratio :
The ratio of a company's total debt to its shareholders' equity is called Debt / Equity Ratio . Better if this ratio is less than 1.
If a company has too much debt it is likely to become a big problem in difficult times. For example, during the Covid-19 crisis, companies with high debt and high interest rates were hit hard.
When making an investment, you need to look at what a company is borrowing for. For expansion work, you can invest in that company stock. If you want to pay off the debt, you will continue to be a company with debt anyway, so you have to think carefully and take the decision.
Also note the amount of interest on the loan. If the interest rate is very high then it is better to avoid investing in that company stock. Also, it is better to compare the debt/equity ratio of other companies in the sector and invest in the company stock with a lower ratio.
If a company's debt is Rs.50 crore and its share capital is Rs.100 then debt/share capital = 50/100= 0.5. As it is less than 1 you can invest in this company stock.
Formula: Total debt of the company / Total share capital of the company
(6) Income from share capital..!
Return On Equity (ROE ) indicates whether a company is getting good returns by investing the equity capital raised from its shareholders . This ratio is the company's net income divided by its share capital. Through this one can know the financial management skills of the management.
The higher the ratio, the better. The higher the number, the more profitable the stock investment will be. Generally, anything above 20 percent is profitable.
A company's net income is Rs. 50 and its share capital is Rs.200. Return on Equity = (50/200)100= 25%. As it is more than 20% you can invest in this company stock.
Formula: ( Net Income / Share Capital)* 100
(7) Income from assets..!
This also helps in knowing the financial management of a company. A company's net income divided by the value of total assets is Return On Assets (ROA) .
The higher the ratio, the better. The higher the ratio, the higher the company's income; That may resonate with stock investing as well. Generally a couple of percentage points higher than the inflation rate is better.
If the net income of a company is Rs.15 and the value of assets is Rs.100 then the return on assets is (15/100)100= 15%.
Formula: ( Net Income / Value of Total Assets)*100
(8) Dividend Yield:
Often profitable companies will continue to pay high dividends. This would be such percentage of the face value of the company share. If a company share has a face value of Rs 1, then the company pays a dividend of Rs 1 per share which is 100 percent. Let us assume that the face value of another company's share is Rs.10. If the company pays a dividend of Rs.1 it is 10%.
In that way, rather than looking at the dividend percentage, you should look at how much in rupee terms.
Specifically, look at the ratio of the share price to the amount of dividend paid in a year. If it is 4-5% then it can be concluded that it is a good company.
Let us assume that the net profit of a company is Rs.1000. The company keeps Rs.500 out of it for future use. The remaining Rs.500 is distributed to equity investors. The company has a total of 100 shares. A dividend of Rs.5 per share is available. If share price is Rs.100 then dividend yield=(5/100)100 = 5%.
The higher the dividend yield, the higher the profit for the investor.
Real estate companies like Raid and Invit are paying high dividends. Investors who focus on dividend income may consider these for investment.
Formula: Dividend Yield = (Annual Dividend per Share) / Share Price)*100
(9) Net Profit Ratio..!
Increasing the sales of a company is the best thing. However, if the cost also increases significantly, the profit will not be as much as it can be said. In that sense it is important to observe the profitability ratio of a company.
There are many types of profit ratio, to find the company's profit ratio, divide the company's profit by its sales. Gross profit is the result of subtracting the cost of sales from the company's sales . A company's profit after paying interest and income tax is the net profit . It should continue to increase. Should be 15-20%. This ratio is much higher in manufacturing companies. Investment decision should be made by comparing the net profit ratio of other companies in the particular industry sector.
Most experts will tell you to analyze the fundamentals of that particular company before choosing a stock to invest in . Accordingly how many people can scrutinize the company's financial documents and take a decision. Choosing the right stock can be done by analyzing some specific financial ratios. The financial ratios mentioned here help to understand the true value of a company. Also, the financial strength of the company can be known. Finding these ratios is no big deal; As these ratios are available to everyone on the internet, one can easily analyze them and make stock investments.
If you analyze the above ratios and invest based on them, you can expect good returns from equity investment in the long term.
Beyond strong financial ratios…!
We looked at key financial ratios that help us evaluate an individual company and its stock. Apart from these, the share price changes due to various factors. The stock price may fall due to various factors such as crude oil prices prevailing in the international market, war between countries, virus like Covid-19, financial crisis, economic recession etc. In the case of a good company stock, in such situations, if the stock price falls, additional investment will be profitable in the long run.
(1)- Coal India is mainly engaged in mining and production of coal. Company has delivered good profit growth of 31.9% CAGR over last 5 years
(2)- Diamines and Chemicals Ltd has been sole manufacturer of Ethyleneamines in india. Company has delivered good profit growth of 38.8% CAGR over last 5 years
(3)- SKM Egg Products Export Ltd is manufacture and sale of egg powder and liquid egg with varieties of blends used in food industry and health sector.Company has delivered good profit growth of 127% CAGR over last 5 years.
(4)- Coromandel international Ltd is agri solutions provider for the farming value chain. It specialises in fertilizers , crop protein, bio pesticides, speciality nutrients, organic fertilizers,etc. Company has delivered good profit growth of 38.8% CAGR over last 5 years
(5)- Expleo Solutions Ltd is an Indian based software service provider primarily delivering software validation and verification services to the BFSI industry worldwide. Company has delivered good profit growth of 33% CAGR over last 5 years
Formula: Company Profit Ratio = (Company Profit / Sales)100
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