Essential Mathematics Commonly Used in Stock Market Investing

Understanding stock market investing isn't just about following market trends or expert opinions—it's about interpreting numbers effectively. Basic mathematical concepts can empower retail investors to evaluate stocks, manage risk, and optimise returns. From calculating returns to understanding ratios and risk metrics, these numbers serve as the foundation of sound investment analysis. This article explores essential mathematical concepts and tools every investor should know and how they apply in real-world investing scenarios.

Mathematics plays a central role in analysing stock performance, making portfolio decisions, and managing financial risk. These calculations allow investors to assess profitability, compare investment options, determine valuations, and make predictions based on historical performance.

Without a grasp of fundamental math, investors may find it difficult to judge whether a stock is undervalued, overvalued, or appropriately priced.

Start with the building blocks—how to measure what you gain or lose from an investment:

Absolute Return

This measures the total return over a period, irrespective of time.

Formula:

• Absolute Return = ((Final Value - Initial Value) / Initial Value) × 100

Example: If you buy a stock at ₹100 and sell at ₹130,
Absolute Return = ((130 - 100)/100) × 100 = 30%

Annualised Return (CAGR)

Compound Annual Growth Rate (CAGR) measures the mean annual growth rate of an investment over a time period longer than one year.

Formula:

• CAGR = [(Final Value / Initial Value) ^ (1 / Number of Years)] - 1

This standardises returns across different timeframes.

XIRR (Extended Internal Rate of Return)

Used when SIPs or multiple cash flows occur over time. It calculates the return on each installment by considering its specific investment date. XIRR is useful for comparing returns on mutual funds or SIPs.

Risk assessment is a crucial part of investing, and certain mathematical tools help investors manage it better:

Standard Deviation

It measures the volatility of stock returns. Higher standard deviation means higher risk.

Beta

Beta compares a stock’s volatility with the overall market.

• Beta > 1: Stock is more volatile than the market
  

• Beta < 1: Stock is less volatile
  

• Beta = 1: Stock moves with the market
  

Sharpe Ratio

Used to evaluate the return of an investment compared to its risk.

Formula:
Sharpe Ratio = (Portfolio Return - Risk-Free Rate) / Standard Deviation

A higher Sharpe ratio indicates better risk-adjusted returns.

Valuation ratios help determine whether a stock is priced fairly based on its earnings, book value, or sales.

Price to Earnings Ratio (P/E)

Formula:

• P/E = Market Price per Share / Earnings per Share (EPS)

This shows how much investors are willing to pay per rupee of earnings.

Price to Book Ratio (P/B)

Formula:

• P/B = Market Price per Share / Book Value per Share

It helps assess whether a stock is over or undervalued relative to its net assets.

Earnings Per Share (EPS)

Formula:

• EPS = (Net Profit - Preferred Dividends) / Number of Equity Shares

EPS is a measure of a company’s profitability per share.

Dividends can contribute to the total return of an investment. Understanding these metrics is vital:

Dividend Yield

Formula:

• Dividend Yield = (Annual Dividend per Share / Market Price per Share) × 100

It shows how much income you earn on your investment via dividends.

Dividend Payout Ratio

Formula:

• Payout Ratio = (Dividend per Share / EPS) × 100

This reflects how much of the earnings are being returned to shareholders.

Time value of money (TVM) concepts help investors understand the future value of investments or the present value of expected returns.

Future Value (FV)

Formula:
FV = PV × (1 + r)^n
Where:

• PV = Present Value
  

• r = Rate of return
  

• n = Number of years
  

Present Value (PV)

Formula:

• PV = FV / (1 + r)^n

These calculations are essential when comparing investments or projecting long-term goals.

Systematic Investment Plans (SIPs) have their own set of formulas to estimate future wealth.

SIP Future Value

Formula:

• FV = P × {[(1 + r)^n - 1] / r} × (1 + r)

Where:

• P = SIP amount
  

• r = Rate of return per period
  

• n = Number of periods
  

This formula estimates the potential value of a SIP over time.

Understanding tax implications is crucial when investing:

Short-Term Capital Gains (STCG)

For listed equity shares sold within 12 months, taxed at 15%.

Long-Term Capital Gains (LTCG)

For shares held longer than 12 months, gains above ₹1 lakh are taxed at 10% without indexation.

Capital Gain Formula:

• Capital Gain = Sale Price - Purchase Price - Expenses

These formulas illustrate how capital gains and taxes are calculated.

Mathematics also assists in building and maintaining a well-balanced investment portfolio:

Portfolio Weight

Formula:

• Weight of Asset = (Value of Asset / Total Portfolio Value) × 100

Rebalancing is done by adjusting these weights to maintain your desired allocation, especially after market movements.

Correlation Coefficient

Used to understand how two assets move in relation to each other. Helps in diversifying the portfolio to reduce overall risk.

Mathematics may seem intimidating to some investors, but it provides a powerful toolkit for understanding financial products, evaluating stock investments, and measuring portfolio performance. From simple return calculations to complex risk metrics, these tools help investors make informed and data-backed decisions. When understood and used wisely, essential math concepts can turn into a framework for understanding risk, return, and long-term performance.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.