Our Products
Loans
Cards
Insurance
Investment
Stock Market
Electronics Mall
CIBIL Score
Knowledge Centre
Calculators
Our Services
My Account
Do not call
En
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 help investors compare companies, evaluate financial health, and understand how well a business is performing within its sector. By translating raw financial data into simple indicators, such as liquidity ratios for short-term stability or profitability ratios for earnings efficiency, these metrics assist in assessing whether a stock price is undervalued, overvalued, or fairly priced.
In essence, financial ratios remove much of the uncertainty from stock analysis. By converting complex numbers into meaningful insights, they offer a structured way to review performance metrics, evaluate risk exposure, and understand financial outcomes within the market environment.
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.
Understanding profitability ratios helps investors evaluate how effectively a company converts its revenue, assets, and equity into actual earnings. These ratios reveal whether a business is managing costs well, generating healthy margins, and using its resources efficiently; all of which are important indicators when analysing long-term performance and valuation.
Below are the key profitability ratios used in stock analysis, each with a clear explanation, formula, and interpretation.
RoE measures how efficiently a company generates profits from the money invested by its shareholders. It reflects the company’s ability to reinvest profits and grow its value over time.
Formula:
RoE = (Net Income ÷ Shareholder’s Equity) × 100
How to interpret it: A higher RoE indicates stronger capital utilisation and effective management capability. It suggests the company is generating meaningful returns without relying heavily on debt.
Net Profit Margin shows what percentage of a company's total revenue remains as profit after all expenses, including operating costs, taxes, and interest, are deducted. It measures how much revenue is converted into net earnings.
Formula:
Net Profit Margin = (Net Profit ÷ Revenue) × 100
How to interpret it: A higher margin means the company is good at controlling costs and converting sales into profit. It also allows for fair comparison of profitability between companies of different sizes within the same industry.
RoA evaluates how well a company uses its total assets to generate earnings. It shows whether the business is making productive use of its investments in infrastructure, inventory, and other assets.
Formula:
RoA = (Net Income ÷ Total Assets) × 100
How to interpret it: Higher RoA values indicate efficient asset management and stronger operational capability. It is especially useful for assessing companies that operate with large asset bases.
By analysing these profitability ratios, investors gain a clearer understanding of how effectively a company generates earnings from its revenue, equity, and asset base; helping them judge both performance and long-term sustainability.
Efficiency ratios help evaluate how well a company utilises its assets and resources in daily operations. These ratios provide insight into operational effectiveness and asset management, indicating how productively a company turns its resources into revenue.
Below are key efficiency ratios commonly used in financial analysis, along with their formulas and interpretations.
The Asset Turnover Ratio indicates how efficiently a company uses its assets to generate revenue. It reflects the company’s ability to maximise sales from its asset base.
Formula:
Asset Turnover = Revenue ÷ Average Total Assets
How to interpret it:
A higher asset turnover ratio suggests efficient utilisation of assets in generating sales, pointing to operational efficiency. Comparisons between companies in the same sector can reveal relative effectiveness in asset management.
Inventory Turnover Ratio measures how often a company sells and replaces its inventory over a specific period. It reflects inventory management effectiveness and sales strength.
Formula:
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
How to interpret it:
Higher inventory turnover implies strong sales performance and efficient inventory control, reducing holding costs. Conversely, a low ratio may indicate overstocking or sluggish sales.
Solvency and liquidity ratios assess a company’s ability to meet its financial obligations in both the short and long term. These ratios highlight financial stability and risk, important for understanding a company’s capacity to sustain operations.
Following are the solvency and liquidity ratios, with explanations and formulas.
The Debt-to-Equity Ratio indicates the proportion of a company’s financing that comes from debt compared to shareholders’ equity. It measures financial leverage and risk exposure.
Formula:
D/E Ratio = Total Liabilities ÷ Shareholder’s Equity
How to interpret it:
A lower debt-to-equity ratio generally signals conservative financing, indicating financial stability and reduced risk. Higher ratios may suggest greater reliance on debt, which could increase vulnerability during downturns.
The Current Ratio measures a company’s ability to cover its short-term liabilities with its short-term assets. It reflects liquidity and operational efficiency.
Formula:
Current Ratio = Current Assets ÷ Current Liabilities
How to interpret it:
A current ratio above 1 indicates sufficient short-term assets to cover liabilities, signifying good short-term financial health. Ratios too high may also indicate inefficient use of assets..
The Interest Coverage Ratio shows how well a company can meet interest payments on its outstanding debt from earnings before interest and taxes (EBIT).
Formula:
Interest Coverage = EBIT ÷ Interest Expenses
How to interpret it:
A higher interest coverage ratio implies a strong ability to service debt, reducing the risk of default. Low ratios indicate potential difficulties in meeting interest obligations.
Financial ratios support stock valuation by offering a structured view of company performance. However, their usefulness depends on comparison across time periods, industry benchmarks, and peer companies to understand the context behind the numbers.
Why Context Matters When Using Ratios
Ratios gain clarity when they are observed alongside industry benchmarks rather than in isolation
Tracking how these numbers evolve across quarters or years reveals patterns that a single data point cannot
Broader economic conditions, such as inflation, interest rates, or market cycles, often influence how ratios should be read
Quantitative ratios become more reliable when paired with qualitative factors like business model strength, management decisions, and market positioning
A combination of multiple ratios generally provides a more balanced picture of valuation than any single metric
By interpreting financial ratios within their broader context and pairing them with qualitative insights, investors get a clearer and more grounded view of a stock’s valuation and long-term potential.
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 performance |
Not accounting for one-time events |
Temporary earnings or losses can distort ratios and lead to misleading conclusions |
Understanding and using financial ratios can assist in evaluating a company’s valuation and financial position. 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 are analysing blue-chip stocks or emerging businesses, these key ratios will contribute to a more structured evaluation in equity analysis.
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 represents the proportion of a company’s total debt to its shareholders’ equity. It indicates the balance between financing through borrowed funds and owner investment.
The price-to-earnings (P/E) ratio measures a company’s current share price divided by its earnings per share. It indicates the amount investors pay for each unit of a company's earnings compared to others.
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.
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.
Academy 
