6 key financial ratios
These ratios are like readymade tools to interpret what's happening in a company
By Research Desk | Mar 18, 2019
If you are not one who likes to dig deep into a company's financial statements but still wants to make sense of its financials, financial ratios come to your rescue. They are readymade 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.
Here is a summary of the major financial ratios and what they mean. You can find these (and more) for any Indian listed company on the Value Research website. Just type in a company's name in the search bar. On the company page, click on the Financials - Annual tab and scroll down. You will find the 'Key Ratios' section, as shown in the GIF below.
Earnings per share (EPS): 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 (RONW): 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: This ratio 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: This ratio 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.