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Explore the essential financial ratios that help investors evaluate the value and performance of a stock.
Key financial ratios for stock valuation include the P/E ratio (Price-to-Earnings), PEG ratio (Price/Earnings to Growth), P/B ratio (Price-to-Book), P/S ratio (Price-to-Sales), and D/E ratio (Debt-to-Equity), which assess valuation, growth, and financial leverage.
Financial ratios are standardised metrics derived from a company’s income statement, balance sheet, and cash flow statement. They allow investors to compare companies, assess financial health, and make informed decisions about stock prices and potential growth.
Ratios help remove the complexity of raw financial data and translate it into comparative indicators of performance and valuation.
By using ratios, investors can reduce guesswork and analyse businesses on solid financial grounds.
Reason |
Explanation |
|---|---|
Simplifies decision-making |
Converts financial data into easy-to-read metrics |
Enables comparison |
Facilitates peer and industry comparison |
Identifies strengths and risks |
Reveals a company’s financial efficiency, profitability, and stability |
Assists in valuation |
Helps judge whether a stock is undervalued or overvalued |
Valuation ratios offer a quick way to compare stock price to earnings, assets, sales, or dividends.
Shows how much investors are willing to pay for ₹1 of the company’s earnings.
Formula:
P/E Ratio = Market Price per Share ÷ Earnings per Share (EPS)
A high P/E may indicate growth expectations, while a low P/E may signal undervaluation or weak growth.
Compares a company’s market price to its book value (net asset value).
Formula:
P/B Ratio = Market Price per Share ÷ Book Value per Share
Useful for assessing stocks in capital-intensive sectors like banking and manufacturing.
Evaluates how much investors are paying per rupee of the company’s sales.
Formula:
P/S Ratio = Market Capitalisation ÷ Total Sales
Helps when a company is not profitable yet but has significant revenue growth potential.
Indicates the income return from a stock relative to its price.
Formula:
Dividend Yield = (Annual Dividend per Share ÷ Price per Share) × 100
Used by income-focused investors to evaluate dividend returns.
To assess how well a company turns its revenues and assets into profits, investors often rely on key profitability ratios.
Measures a company’s efficiency in generating profits from shareholders’ equity.
Formula:
RoE = (Net Income ÷ Shareholder’s Equity) × 100
A higher RoE indicates effective capital utilisation and operational efficiency.
Shows how much of the company’s revenue is left as profit after expenses.
Formula:
Net Profit Margin = (Net Profit ÷ Revenue) × 100
Used to assess profitability in relation to total sales.
Evaluates how well a company uses its assets to generate earnings.
Formula:
RoA = (Net Income ÷ Total Assets) × 100
Higher RoA suggests better asset utilisation and operational strength.
Efficiency ratios help evaluate how well a company utilizes its assets and resources in daily operations.
Indicates how effectively the company uses its assets to generate revenue.
Formula:
Asset Turnover = Revenue ÷ Average Total Assets
Useful in assessing operational efficiency.
Measures how often inventory is sold and replaced over a period.
Formula:
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
Higher turnover indicates strong sales and efficient inventory management.
To assess a company’s ability to meet both short-term and long-term obligations, solvency and liquidity ratios are essential tools.
Indicates the proportion of a company’s financing from debt versus equity.
Formula:
D/E Ratio = Total Liabilities ÷ Shareholder’s Equity
A lower ratio is generally preferred, showing financial stability and lower risk.
Measures a company’s ability to meet short-term requirements.
Formula:
Current Ratio = Current Assets ÷ Current Liabilities
A ratio above 1 indicates good short-term financial health.
Shows the company’s ability to pay interest on outstanding debt.
Formula:
Interest Coverage = EBIT ÷ Interest Expenses
A higher ratio implies strong debt-servicing capacity.
While ratios are helpful, context is essential:
Compare ratios with industry peers
Track trends over several quarters or years
Consider macroeconomic conditions
Combine quantitative ratios with qualitative analysis
Using multiple ratios together provides a more complete picture of a stock’s valuation.
Being mindful of limitations improves the accuracy of your investment analysis.
Mistake |
Why It Matters |
|---|---|
Looking at ratios in isolation |
One metric doesn't capture the full story |
Ignoring industry benchmarks |
What’s “good” varies by sector |
Over-relying on historical data |
Past performance doesn’t always predict future outcomes |
Not accounting for one-time events |
Temporary earnings or losses can distort ratios |
Understanding and using financial ratios is a vital part of evaluating a company’s true market value. These ratios act as tools that help decode a company’s financial health, efficiency, and profitability. When used correctly and in combination, they help investors interpret financial data more effectively. Whether you're analysing blue-chip stocks or emerging businesses, these key ratios will serve as a solid foundation for your stock valuation strategy.
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.
Common ratios for stock valuation include the Price-to-Earnings (P/E) ratio, Price-to-Book (P/B) ratio, Dividend Yield, and Return on Equity (ROE). These help investors assess valuation, profitability, and returns relative to a company’s financial performance.
Stocks with relatively lower P/E or P/B ratios and higher ROE compared to peers may appear undervalued, though this must be validated through detailed fundamental analysis.
Not necessarily. Benchmark ratios vary by industry. For example, capital-intensive industries may have different D/E ratios than tech firms.
Financial ratios are typically reviewed quarterly when companies release financial results, and annually for long-term trend analysis.
No. Ratios are a helpful starting point but should be combined with business fundamentals, qualitative factors, and macroeconomic trends.
Financial ratios help evaluate a company’s performance by measuring aspects like profitability, liquidity, efficiency, and leverage. They provide investors with standardised metrics to compare companies and assess financial health before making informed investment decisions.
The debt-to-equity (D/E) ratio evaluates a company’s leverage by comparing its total borrowings with shareholders’ equity. A higher ratio reflects greater dependence on debt, which may raise financial risk during periods of market volatility.
The price-to-earnings (P/E) ratio compares a company’s current share price to its earnings per share. It helps assess valuation by indicating how much investors are willing to pay for each unit of earnings, relative to peers.
The quick ratio, also called the acid-test ratio, measures a company’s ability to meet short-term liabilities using liquid assets like cash, marketable securities, and receivables. It excludes inventory, offering a stricter view of liquidity strength.
Earnings per share (EPS) is calculated by dividing a company’s net profit available to equity shareholders by the total number of outstanding shares. It indicates profitability on a per-share basis, often used in valuation comparisons.
Profitability ratios, such as net profit margin and return on equity (ROE), measure how efficiently a company generates profits relative to sales, assets, or equity. Analysts use them to evaluate operational performance and long-term value creation.
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