Financial ratios are ready-made tools to interpret what’s happening in a company. Most financial ratios can be derived from the three major financial statements: balance sheet, profit-and-loss statement and cash-flow statement.
In order to put a company’s ratios in perspective, compare them with the industry trend and peers’ ratios. Again, good analysis goes beyond ratios, and you shouldn’t make your investment decision just in terms of ratios.
Earnings per share : EPS tells you the profit of a company per share. It helps determine valuations when seen in conjunction with price. The resulting metric is called the price-to-earnings ratio.
Debt to equity : Companies take debt to run their business operations. Their shareholders also put money, called equity, in the business. The debt-to-equity ratio tells us about this balance. A high deb-to-equity is not desirable. But to know what is ideal, you must see the industry-wide trend. As a rule of thumb, avoid companies where the debt-equity ratio exceeds one.
Return on net worth : Also called the return on equity (ROE), this ratio tells us what returns a company is generating on its equity part. A high RONW is desirable. Good companies have more RONW than their peers.
Operating margin: Tells us how much a company makes from its core operations. It is derived by dividing the operating profit by the total revenues. A high operating margin is a good sign, but do see the industry trend.
Revenue growth: indicates how fast a company is growing its revenues over a period of time. A high revenue growth is a positive sign and shows that the company is expanding.
EPS growth: This is a tool related to EPS and tells us the growth of EPS over a period of time. For instance, if the EPS of a company this year has gone up from Rs.10 to Rs.12, the EPS growth is 20 per cent. Good companies show higher earnings growth than their peers in a sector. A shrinking EPS, on the other hand, should ring an alarm.
