Corporate Ratio Analysis: A Must For Winning Stock Market
As a newbie enters the securities market, he wonders how to proceed with the investments? How should he evaluate the companies for investment? The basic knowledge required is the corporate ratio analysis.
If someone is from non-financial background enters the market, it would be hardest for him/her to understand things. Success in a securities market investment comes only with the knowledge. The knowledge about the market. You have to learn about the key technical points and corporate ratio analysis. So that you can make winnable stock market trading strategies.
Points of Corporate Ratio Analysis
1. P/E Ratio:
It stands for Price/Earnings Ratio. It is derived from dividing the current market price of the stock by its earnings per share.
P/E= Market Price/Earnings per Share (EPS).
It indicates the valuation of a stock in the market as against its earnings. A higher PE ratio suggests that the participants are bullish on the stock and it has high growth potential. Inversely, a lower PE ratio indicates its bearish phenomenon and has low earning prospects.
But there is also a different theory works for PE ratio. A higher PE ratio means the stock is overpriced and has low growth potential in comparison to a stock with lower PE ratio.
So, a single PE ratio alone cannot give a proper knowledge about the stock growth potentiality. We can compare the ratio of the current period to the corresponding previous period and peer companies within the industry. A fair comparison of PE ratios let you predict how the stock will perform in the future.
2. P/B Ratio:
It stands for Price to Book Value Ratio. Means
P/B= Market Price of the Stock/Book Value of the Share.
Where Book Value per share= (Assets-Liabilities)/Total Number of Outstanding Shares.
When P/B Ratio is below one tells either of the two things. One the book value of the share is overvalued than the market believes it should be or secondly the company is earning a poor return on its assets. If the first case is true, it would be advisable to avoid such stock. Because it tends to face strong correction in the future and the investor would run into losses. But in the second case, the chances of positive returns on the stock investment are very high.
3. Debt-Equity Ratio:
It indicates that how much debt the company is using to finance its assets equivalent to the shareholder’s equity. The formula is:
Debt-Equity Ratio= Total Liabilities/ Equity.
This ratio is used for assessing the financial leverage and financial soundness of the firm. It also indicates that how much debt/liability can be satisfied by using equity shareholders contribution at the time of liquidation of the company. A low debt-equity means less risky in times of increase in interest rate and favourable from an investor’s point of view. In simple terms, interest on debts will not be a hindrance to the growth of a company.
4. Operating Profit Margin:
Operating Profit Margin ratio indicates how well a company’s operations contribute to its profitability. We can find operating margin in the following way:
Operating Margin= Operating Profit/Net Sales.
Operating Profit is the profit before interest and tax, left on the income statement, after all operating costs and overheads. Overhead includes the cost of goods sold, administrative expenses and selling costs. The more one’s operating margin is, the better his financial positions would be.
5. Interest Coverage Ratio:
This is the ratio that shows how capable the company is to pay the interest on debt when they are due. We can work out the ratio in the following way:
Interest Coverage Ratio= Earning Before Interests and Taxes/Interest Expenses.
The ratio measures how many times the interest on debt can be paid out of the profit of the Company. It also determines the solvency of the Company, which impacts the creditworthiness of the Company. The higher the company’s Interest Coverage Ratio is, the better the company’s growth prospects would be.
6. Return on Equity:
This is a vital number, one should check before investing in a company’s equity shares. It shows how much profit the company can generate with the money invested by the shareholders.
Return on Equity (ROE) = Net Profit/ Shareholder’s Equity.
Net Profit is calculated after interest and taxes and preferential dividend but before equity dividend.
An increase in ROE from the previous period shows how well the company is increasing its ability to generate profit without needing any extra capital. We use ROE especially for comparing the performance of companies in the same industry.
7. Asset Turnover Ratio:
This is a ratio between the company’s turnover and the value of the average assets of the company. The formula is:
Asset Turnover Ratio= Net Sales/ Average Total Assets.
Average total assets are derived from the value of assets at the beginning and at the end of the year divided by 2.
This ratio is a determinant of the company’s performance. This is an indicator how efficiently the company is deploying its assets to generate revenue. This ratio is comparable from period to period basis. A lower Asset Turnover Ratio than the previous year indicates problems with surplus production capacity, poor inventory management etc.
8. Dividend Yield:
Dividend Yield is the percentage of dividends paid out to the shareholders relative to the market value of the share. We can calculate Dividend Yield in the following way:
Dividend Yield= Annual Dividend per Share/Market Price per Share X 100.
A company with high dividend yield pays a substantial amount of profit to its shareholders as dividends. It also shows the consistency of the company in paying the dividend to its shareholders, in the absence of any capital gain.
9. Price/Earning to Growth Ratio:
PEG Ratio establishes a relationship between the market price of the share, earning per share and the company’s growth rate. The formula is:
PEG Ratio= P/E Ratio/Annual EPS Growth Rate.
P/E Ratio achieved by dividing the Market Price of Stock by Earning per Share.
Annual EPS Growth Rate= (Current Year EPS-Previous EPS)/Previous Year EPS*100.
PEG ratio takes our analysis beyond P/E Ratio. It determines the value of a stock while taking company’s earning growth rate into account. It is a way to understand whether the stock is undervalued or overvalued after taking into consideration the earning growth rate of the Company.
10. Current Ratio:
Current Ratio shows the liquidity position of the company. It means how prepared is the company to pay its short-term liabilities with short-term assets. We can calculate it in the following way:
Current Ratio= Current Assets/ Current Liabilities.
Current Assets include inventories, receivables and other assets meant for short term purposes say less than a year. And Current Liabilities include short-term loans, overdrafts, creditors and other liabilities due within one year.
Current assets and liabilities are the issues related to the day to day businesses of the company. If the Current ratio above one, it indicates us that the working capital issues will not affect the company’s day to day businesses. This is very important for the growth of the company.
Brokerage firms provide various advisory services to their clients. You can invest in accordance with them. But, corporate ratio analysis, helps an investor to acquire in-depth knowledge about a stock. And guide him/her in taking investment decisions by own self.