Top 10 Financial Ratios Every Investor Should Know
Introduction
If you want to become a smarter investor, learning how to read financial ratios is essential. These ratios help you evaluate a company’s performance, profitability, and overall financial health using its financial statements.
Whether you’re a beginner investor or an experienced market participant, here are the top 10 financial ratios every investor should know — explained in simple terms with practical examples.
1. Price-to-Earnings (P/E) Ratio
Formula:
P/E Ratio = Share Price ÷ Earnings Per Share (EPS)
Why It Matters:
The P/E ratio shows how much investors are willing to pay for each dollar of earnings. A high P/E can mean high growth expectations; a low P/E may signal undervaluation.
Example:
If a company’s share price is ₹200 and EPS is ₹10, the P/E = 20. Investors are paying ₹20 for every ₹1 the company earns.
2. Price-to-Book (P/B) Ratio
Formula:
P/B Ratio = Share Price ÷ Book Value Per Share
Why It Matters:
Compares a company’s market value to its book value. A P/B below 1 may indicate an undervalued stock.
3. Debt-to-Equity (D/E) Ratio
Formula:
D/E Ratio = Total Liabilities ÷ Shareholders’ Equity
Why It Matters:
This ratio measures how much debt a company uses to finance its assets. A high D/E means higher financial risk; a low D/E suggests stability.
4. Current Ratio
Formula:
Current Ratio = Current Assets ÷ Current Liabilities
Why It Matters:
Shows a company’s ability to pay short-term obligations. A ratio above 1.5 is generally considered healthy.
5. Return on Equity (ROE)
Formula:
ROE = Net Income ÷ Shareholders’ Equity
Why It Matters:
Measures how efficiently a company generates profit from shareholders’ investments. A consistent ROE above 15% is usually a positive sign.
6. Earnings Per Share (EPS)
Formula:
EPS = (Net Income – Preferred Dividends) ÷ Number of Shares Outstanding
Why It Matters:
EPS shows how much profit is earned per share. It’s one of the key metrics analysts use to judge profitability.
7. Dividend Yield
Formula:
Dividend Yield = (Annual Dividend per Share ÷ Share Price) × 100
Why It Matters:
Shows how much income you earn from dividends relative to the share price — ideal for income-focused investors.
8. Price-to-Sales (P/S) Ratio
Formula:
P/S Ratio = Market Capitalization ÷ Total Revenue (or Share Price ÷ Sales per Share)
Why It Matters:
Useful for analyzing companies with little or no profit. A P/S ratio below 2 may suggest undervaluation.
9. Return on Assets (ROA)
Formula:
ROA = Net Income ÷ Total Assets
Why It Matters:
Indicates how effectively a company uses its assets to generate profit. Higher ROA = better efficiency.
10. Quick Ratio (Acid-Test Ratio)
Formula:
Quick Ratio = (Current Assets – Inventory) ÷ Current Liabilities
Why It Matters:
A stricter liquidity measure than the current ratio. A quick ratio above 1 means the company can meet short-term debts without selling inventory.
Bonus Tip: How to Use These Ratios Together
No single ratio tells the full story. Combine profitability ratios (like ROE, EPS) with valuation ratios (like P/E, P/B) and liquidity ratios (like Current and Quick Ratio) to get a complete picture of a company’s health.
Conclusion
Understanding these top 10 financial ratios will give you a strong foundation for making smarter investment decisions. Before you buy any stock, always compare these ratios with industry peers.
Remember: The numbers tell a story — and as an investor, your job is to read it.
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