Top 5 Financial Ratios Every Stock Market Investor Should Know
Introduction
When investing in the stock market, financial ratios act like a health report for a company. These key ratios help investors assess a company’s profitability, stability, and valuation. Whether you’re new to investing or brushing up your knowledge, these five ratios are non-negotiable tools for smarter decisions.
1. Price to Earnings Ratio (P/E Ratio)
- Formula: Share Price ÷ Earnings Per Share (EPS)
- What it means: Tells you how much investors are willing to pay for every ₹1 of earnings.
- Use: Compare valuation between companies in the same industry.
- Ideal Range: Varies by sector – lower may indicate undervaluation.
2. Return on Equity (ROE)
- Formula: Net Income ÷ Shareholders’ Equity
- What it means: Measures a company’s efficiency in generating profits from shareholder money.
- Use: Indicates how well the company uses investor funds to generate growth.
- Ideal Range: ROE > 15% is generally considered good.
3. Debt-to-Equity Ratio (D/E Ratio)
- Formula: Total Liabilities ÷ Shareholders’ Equity
- What it means: Shows how much debt a company is using to finance its operations.
- Use: Helps assess the company’s financial risk.
- Ideal Range: Below 1 is typically safe, especially in non-capital intensive sectors
4. Current Ratio
- Formula: Current Assets ÷ Current Liabilities
- What it means: Measures a company’s ability to pay short-term obligations.
- Use: Checks liquidity and short-term financial health.
- Ideal Range: 1.5 to 2 is considered healthy.
5. Earnings Per Share (EPS)
- Formula: Net Income ÷ Outstanding Shares
- What it means: Indicates the portion of a company’s profit allocated to each share.
- Use: Helps measure profitability on a per-share basis.
- Ideal: Higher EPS generally means better profitability.
Summary Table
Ratio | What It Measures | Good Indicator |
|---|---|---|
| P/E Ratio | Valuation | Low (if company is strong) |
| ROE | Profitability | 15% or higher |
| D/E Ratio | Leverage/Risk | Less than 1 |
| Current Ratio | Liquidity | 1.5 to 2 |
| EPS | Per Share Profitability | Higher is better |
Pro Tip:
Always compare financial ratios with industry averages and historical data. A good ratio in one sector might be bad in another.
