Best and Effective Ways Of Doing Financial Ratio Analysis in 5 Minutes

Ratio Analysis: How to pick up a share of a company using financial ratios. How to take buy, sell and hold decisions. Know the major objectives of various ratios like Liquidity ratios, performance ratios, and profitability ratios. Ratio analysis enables the users of financial statements to make prompt decisions.




Table of Content

Meaning and objectives of Ratio Analysis

11 Important Financial Ratio

Conclusion


Meaning and objectives of Ratio Analysis


Ratio analysis refers to the study of the relationship between various variables of a financial statement for the purpose of decision making. Ratio analysis is used by shareholders because it shows the financial position of the company and how the company is utilizing its capital and assets to generate revenue. The major objective of the liquidity ratios is to measure the short-term solvency of the firm. performance ratios measure the efficiency of asset and profitability ratios measures the profit margin and earnings. 



  11 Important Financial Ratio

Earning per share (EPS) = Net profit available to equity shareholders/number of equity shares. Let us suppose, ABC ltd has RS 10,00,000 net profit available to equity shareholders and only 1,000 equity shares. Then EPS is RS 1000. The higher the EPS, the higher the profitability for the equity shareholders. so, always pick up those stocks having high EPS.

Dividend per share(DPS) = Total profit distributed to Equity shareholder/number of equity shares. Let us suppose, ABC ltd has distributed only RS 8,00,000 profit to its equity shareholders and the total number of equity shares is 1,000. Then DPS is RS 800. so, it is preferred to choose those stocks having high DPS.

Dividend Rate = Dividend per share(DPS) / Face value per share. ABC ltd has a DPS of RS 800 and let's assume face value or paid-up value per share is RS 1,000. Then dividend rate is 80% and a higher dividend rate is better for the investor. If you have 100 units of share of ABC ltd then you will get 100*800 = RS 80,000 as dividend from ABC ltd.

Dividend Yield = Dividend per share (DPS) / Market price per share (MPS). Let us suppose the MPS of ABC ltd is RS 2,000. Then dividend yield is 40% and a higher dividend yield is better for the investors.

Earning yield = Earning per share (EPS) / Market price per share (MPS). ABC ltd has earning yield of 50% which is a better one. Investors shall always focus on a stock having a high earning yield.

Dividend Payout Ratio = Dividend per share (DPS) / Earning per share (EPS). ABC ltd has a dividend payout ratio of RS 80%. It means ABC ltd distributes 80% of its earnings to its shareholders and retains 20% as a reserve. 

Retention Ratio (Plough back ratio) = 1- DP ratio. ABC ltd has a retention ratio of 20%. It means RS 2,00,000 is reinvested in the business for further scaling.

Price to Earnings Ratio (P/E Ratio) = Market Price per Share (MPS) / Earning per Share (EPS).  Let's understand the concept of the P/E ratio from the point of view of existing shareholders and potential investors. from the point of view of existing shareholders, a higher P/E ratio means better wealth maximization. An excessive P/E ratio may mean that share is overvalued and hence investor may consider it as a time to sell his share. But From the point of view of new potential investors, Investors may look for shares with a lower P/E ratio as a low P/E ratio may mean that the stock is undervalued. But low P/E sometimes indicates very low growth potentials, low business reputations, high business risk. The investor should consider all these factors before making an investment decision. ABC ltd has a P/E ratio of 2 which indicates that it's time to pick up the stock of ABC ltd as it seems undervalued.

Book Value = Total equity shareholder fund which includes all share capital, reserve, and surplus less accumulated losses.

Book Value per share = Total Book Value / Total number of equity shares. let's assume ABC ltd has a book value of RS 30,00,000. The book value per share of ABC ltd is RS 3,000. It means that if ABC ltd gets dissolved on today's date then shareholders will get RS 3000 for one share held. Higher book value per share is better. 

Price to Book Ratio(P/B) = MPS / Book Value per share. The price-to-book (P/B) ratio has been favored by value investors for decades and is widely used by market analysts. P/B ratio less than 1 is better as it creates a margin of safety for a value investor. However, value investor often considers stock with a P/B value under 3. In our case, ABC ltd has a book value per share of 0.67(it is in times). so it is time to pick up the stock of ABC ltd as much as you can because it is undervalued.

Conclusion

 All the above-mentioned ratios shall be analyzed by the investors before buying any stocks from the stock market. Investors shall always take a time to do research on the fundamental analysis and management analysis of the company. Before buying a mobile phone you check the feature of the mobile phone like RAM, battery, camera, display. similarly, before purchasing the share you should check the financial statement of the company like balance sheet, cash flow statement, statement of profit and loss account, and other key ratios. Investors shall buy the share when undervalued, sell the share when overvalued, and hold the share when correctly valued. so, I recommend you to go thoroughly and read the report of the company and evaluate and analyze the important ratios that I mentioned above prior to investment.

(If you have any queries, please feel free to comment down below)


Have a great time

Keep learnings, Keep Investing.


 Thank You.




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