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Key ratios you must consider before investing in a stock

A high P/E ratio suggests that a company might witness a growth spurt in the future.

July 10, 2021 / 12:33 PM IST

This year, Sitharaman said that apart from tax deduction at source, now details of capital gains and interests from banks and post offices would be pre-filled. Pre-filled forms improve tax compliance and also help tax payers to file their taxes quickly and efficiently as the data is already captured. (Image: Moneycontrol)

This year, Sitharaman said that apart from tax deduction at source, now details of capital gains and interests from banks and post offices would be pre-filled. Pre-filled forms improve tax compliance and also help tax payers to file their taxes quickly and efficiently as the data is already captured. (Image: Moneycontrol)

Before you invest your hard-earned money in the stock market, you need to ensure that the company you’re investing in is worth it. One of the easiest ways of evaluating a company's performance is to study its different financial ratios, which you can easily find on the internet.

Let us take a look at some of the most important financial ratios that you must study before investing in a stocks.

P/E (Price/Earnings) Ratio

This ratio shows how much the investors are paying for each rupee earned from the company. It gives you an idea of whether the market is overvaluing or undervaluing the company you’re interested in.

A high P/E ratio suggests that a company might witness a growth spurt in the future. However, it can sometimes give you the wrong idea as companies might boost this ratio by adding debt. Therefore, it is best to take past P/E ratios into account as well while making the decision.

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Enterprise Value (EV)/EBITDA

The ratio of Enterprise Value (EV) and EBITDA is often used with the P/E ratio for valuing an organization. Since it includes debt as well, it gives a more accurate takeover valuation. It is also the reason why it is better than the P/E ratio, which can often paint an inaccurate picture if the earnings of an organization are driven by debt.

Price/Earnings Growth (PEG) Ratio

This ratio is used to establish the relationship between the price of a stock, earnings per share (EPS), and the organization’s growth. If the PEG ratio is 1, it means that the stock is valued reasonably. If it is less than 1, it means the market is undervaluing the stock.

Return on Equity

There is only one ultimate purpose for investment, and that is to generate returns. ROE indicates the return that shareholders get from the company and overall earnings. It is a great ratio for comparing the profitability of different companies operating in the same domain. The ratio can be used to highlight the capability of management teams of different companies. It is calculated by dividing the total income by shareholder equity.

An ROE in the range of 15-20 percent is generally considered good; however, companies that are growing fast may have higher ROEs.

Current ratio

This ratio can be used to evaluate a company's liquidity status, which means how well a certain company is equipped to meet its short-term obligations with short-term assets. A higher current ratio indicates that a company's workflow will not be affected by working capital issues. However, if the current ratio is less than 1, you shouldn't consider investing in that company, because the company may end up folding if an unprecedented crisis strikes. This ratio is calculated by dividing the current assets by current liabilities.

Even though you can use financial ratios to analyze and assess factors such as profitability, efficiency, and risk, there are several other things that you must consider before you invest your capital in stock. So use these ratios to get a head start but research thoroughly before you invest!

Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
first published: Jul 10, 2021 12:33 pm

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