Financial Ratios are the most pivotal part of the fundamental analysis of any stock of a company. These are numerical values collected from the financial statements of a company. They provide insight into the key financial factors like earnings, valuation, dividends, profitability and many more.
We are happy to present a very easy-to-understand series on various financial ratios for our readers.
Earnings per share (EPS) is calculated as a company's net profit divided by the outstanding shares of its common stock. By looking at a company’s EPS you can figure out how much it is earning against each of its outstanding stocks. EPS is an important metric for estimating the corporate value of an enterprise.
A higher EPS indicates the company is more profitable. For investors, it indicates that the company is generating higher profits with respect to its share price. Investors may be willing to pay more to acquire such shares, with the hope of raking in the profit.
Like other financial metrics, the EPS of a company gives a clearer picture when compared to that of other companies in the industry, and across a time span.
The price-to-earnings ratio measures the ratio between the current share price of a company with respect to its EPS. The P/E ratio is also sometimes known as the price multiple or the earnings multiple.
A share with a high P/E ratio could mean that it is overvalued, or that there is an expectation in the market that it will deliver high growth in future. A loss-making company or a company without earnings will not have any P/E ratio as there is no EPS. P/E can be a trailing or backwards-looking P/E, or a forward P/E as an estimation or projection.
A P/E ratio helps an analyst to estimate if the stock is overvalued or undervalued and compare the company with the P/E of competitors, the industry or against benchmarks like Nifty.
The book value of a company is the value of its business as per its financial statements. Mathematically, the book value of a company is,
Total assets − Total liabilities
Total assets cover all types of financial assets, including cash, short-term investments, and accounts receivable. It also includes physical assets, such as inventory, property, plant, and equipment. Intangible assets, like brand names and intellectual property, if appearing in financial statements, can be a part of total assets.
Total liabilities include items like debt obligations, accounts payable, and deferred taxes. Both total assets and total liabilities are on the company's balance sheet in annual and quarterly reports.
Theoretically, book value is what the investors would receive after all the company's assets are sold and all its debts and obligations are paid. Book value and market value comparison indicate if a stock is overvalued or under-valued.
The price per book value is the comparison of the company’s market capitalization to its book value. It is a numerical way of measuring the value offered by a firm's shares. The price-to-book (P/B) ratio compares the market value and book value of the company with the formula,
P/B Ratio = Market Price of the share/Book Value per share.
The P/B ratio can indicate several things. For instance, a low P/B ratio may mean that the company is undervalued. It can, however, also mean that the fundamentals of the company are wrong. The P/B ratio indicates how much investors stand to get if all the assets of the company are liquidated, and all liabilities are paid off. The P/B ratio should be seen along with the Return on Equity number. High P/B with low ROE is a cause of concern.
The price-to-book ratio is another name for the price per book value.
The dividend yield, expressed as a percentage, is a financial ratio (dividend/price) that shows how much a company pays out in dividends each year relative to its stock price. By looking at this ratio an investor can find out how much dividend income can be made and has been made from an investment in the stock.
Investors need to keep in mind that higher dividend yields do not always indicate attractive investment opportunities. The dividend yield of stock would be high even in case of a declining market price of the stock.
Calculating the Dividend Yield
Dividend Yield (%) = (Annual Dividend Per Share / Price per share) *100