๐ The Ultimate Guide to Stock Analysis: Key Ratios You Need to Know Before Buying Your Next Stock.
A Daily Cheat Sheet ๐
If youโre scrolling through your Demat trading app, overwhelmed by numbers and abbreviations like PE, ROE, or Debt/Equity, donโt worryโyouโre not alone. Analyzing stocks may seem intimidating, but itโs actually like solving a puzzle. You just need the right pieces, and Iโm here to help you put them together.
In this post, weโll break down the must-know financial and non-financial ratios to analyze a stockโfrom the basics to advanced metrics. Think of this as your cheat sheet to investing like a pro.
Basic Financial Ratios: Start Here
These are the foundation of any stock analysis.
1. Price-to-Earnings Ratio (P/E)
โข What it means: Tells you how much investors are willing to pay for โน1 of earnings.
โข How to use it: Compare it with the industry average. A high P/E may indicate overvaluation, while a low P/E could mean undervaluation.
โข Example: If Company A has a P/E of 20 and the industry average is 15, ask yourselfโwhat justifies this premium?
2. Earnings Per Share (EPS)
โข What it means: The profit allocated to each share.
โข How to use it: Higher EPS generally means better profitability. Track how this grows over time.
3. Debt-to-Equity Ratio (D/E)
โข What it means: Measures the companyโs leverage.
โข How to use it: A lower D/E ratio is usually safer. For capital-intensive industries like utilities, a higher D/E might be acceptable.
4. Return on Equity (ROE)
โข What it means: How efficiently the company generates profits from shareholdersโ equity.
โข How to use it: A high ROE is a good sign, but only if the company isnโt loaded with debt.
Intermediate Financial Ratios: Digging Deeper
5. Price-to-Book Ratio (P/B)
โข What it means: Compares the stockโs market price to its book value.
โข How to use it: A P/B ratio below 1 might mean the stock is undervalued, but check for any red flags in the companyโs fundamentals.
6. Current Ratio
โข What it means: Assesses the companyโs ability to pay short-term obligations.
โข How to use it: A ratio above 1 is good, but too high might mean the company isnโt efficiently using its assets.
7. Free Cash Flow (FCF)
โข What it means: The cash left after operating expenses and capital expenditures.
โข How to use it: Look for companies with consistent or growing FCFโitโs a sign of strong financial health.
8. Dividend Yield
โข What it means: The return from dividends as a percentage of the stock price.
โข How to use it: Great for income-focused investors. Compare it with government bond yields for context.
Advanced Financial Ratios: Next-Level Analysis
9. PEG Ratio (Price/Earnings-to-Growth)
โข What it means: Adjusts the P/E ratio for earnings growth.
โข How to use it: A PEG below 1 often indicates undervaluation for growth stocks.
10. Enterprise Value to EBITDA (EV/EBITDA)
โข What it means: A valuation metric that accounts for both equity and debt.
โข How to use it: Great for comparing companies with different capital structures. Lower is generally better.
11. Operating Margin
โข What it means: Shows profitability after covering operating expenses.
โข How to use it: A higher margin means better operational efficiency, especially in competitive industries.
12. Interest Coverage Ratio
โข What it means: Measures how easily a company can pay interest on its debt.
โข How to use it: A ratio above 2 is considered safe, but aim for even higher in volatile industries.
Non-Financial Metrics: The Intangibles Matter Too
13. Promoter Holding
โข What it means: Percentage of shares held by the companyโs founders or major stakeholders.
โข How to use it: High promoter holding is a sign of confidence, but look out for any recent declines.
14. Market Share
โข What it means: The companyโs share of the total industry revenue.
โข How to use it: A growing market share in a competitive sector is a major green flag.
15. Management Quality
โข What it means: The track record and reputation of the leadership team.
โข How to use it: Follow earnings calls, read annual reports, and look for transparency in decision-making.
16. Industry Trends
โข What it means: The sectorโs overall health and growth potential.
โข How to use it: Even a great company struggles in a declining industry.
The Big Picture: Putting It All Together
No single ratio tells the whole story. Combine these metrics to get a 360ยฐ view of the stock.
โข Is the company profitable and growing? (EPS, ROE, Operating Margin)
โข Is it reasonably valued? (P/E, PEG, EV/EBITDA)
โข Is it financially sound? (D/E, Interest Coverage)
โข Are there any external or intangible factors to consider? (Industry Trends, Management Quality)
Final Thoughts
Analyzing stocks isnโt about finding the perfect companyโitโs about making informed decisions based on the data. Start with the basics, layer in the advanced metrics, and always keep an eye on the big picture.
Want more tips on stock analysis, market trends, and financial insights? Subscribe to my Substack for fresh ideas delivered straight to your inbox!
Invest smart,
[CA KiranKK]