Ratio Analysis & Valuations - Video Series

HomeRatio Analysis & Valuations – Video Series

Profitability Ratio – Operating & Net Profit Margin Ratio

Operating and Net Profit Margin Ratios measure in percentage terms, the profit being generated for each rupee of sales which the company makes. Operating Profit Margin measures the return being generated by the business purely from its operations while the Net Profit Margin indicates what is left for the owners (i.e. shareholder) after accounting for all other costs associated with conducting the business, such as depreciation, taxes etc.

 Efficiency Ratio – Return on Capital Employed & Return on Equity

Return on Capital Employed (ROCE) and Return on Equity (ROE) or Return on Net Worth (RONW) are used to measure the profitability of a company based on the funds with which the company conducts its business. While each ratio is a metric to measure returns, ROCE measures the overall return and ROE measures the return attributable only to the shareholders.

 Current Ratio

Current Ratio indicates in percentage terms the working capital (i.e. current assets – current liabilities) with which the company conducts its business operations. Current assets include cash and liquid assets that can be readily converted to cash such as accounts receivable, inventory, marketable securities, prepaid expenses etc. Similarly current liabilities are obligations of a company which are due within one year and include short term debt, accounts payable, accrued liabilities and other debts of similar nature.

 Long Term Debt to Equity Ratio

Long Term Debt to Equity Ratio indicates the extent to which a company relies on external debt financing to meet its capital requirements. If a company can employ more debt and generate higher earnings than the amount needed to service the debt (i.e. interest charges), it improves the return to the shareholders as more earnings become available for distribution after payment of interest charges.

 Interest Coverage Ratio

Interest Coverage Ratio measures a company’s operating profit (i.e. earnings before other income, interest, tax, depreciation and amortization) relative to the amount of interest charges which the company pays. It indicates the extent to which earnings are available to meet the interest expenses. A Higher Interest Coverage Ratio indicates that the company can easily meet the interest expense pertaining to its debt obligations and vice versa.

Quantitative Analysis: Key Things to keep in mind when using financial ratios

Ratio analysis is the process of mathematically interpreting financial statements in order to understand the performance and financial position of a business. Ratios are a great tool for assessing the efficiency of management by looking at financial trends in light of the progress and opportunities in the business. Financial ratios serve as a great tool in assessing if management’s strategies are realistic and if such strategies are achieving desired results over a given period of time.

Price to Book Value Ratio

Price/ Book Value Ratio (P/B ratio) is used to compare the market price of the share to its book value and is calculated by dividing the Market Price per share by Book Value per share. P/B ratio usually works well only for companies which have large assets on their books such as, infrastructure and real estate companies, or companies in other manufacturing sectors – steel, automobiles etc.

Price – Earning Ratio

Price Earnings Ratio (P/E Ratio) is the most commonly used method of valuing companies. It is arrived at by dividing the current market price of the equity share by its EPS. P/E Ratio can be calculated by dividing the current share price by the trailing 12 months EPS i.e. reported EPS of the last 4 quarters. A high P/E ratio indicates that the investors are expecting the earnings (and accordingly the price of the company’s shares) to grow at a faster rate and vice versa.

Discounted Cash Flow Analysis

Discounted Cash flow (“DCF”) Analysis is a widely used model for determining the fairness of stock prices. The goal is to estimate the amounts and dates of expected cash receipts which the company is likely to generate in future and then arriving at the present value of (the sum of) all future cash flows using an appropriate discount rate.

 Fundamental Analysis of Stocks

Fundamental analysis of stocks involves a study of the overall financial health of the economy and industry and an examination of business’s financial statements, management quality, its competitive advantages and future prospects. The key to fundamental analysis is in-depth RESEARH of both quantitative and qualitative factors.


Role of Corporate Governance in Investing

Assessing management integrity and background is no doubt an important aspect that every investor must look prior to investing. However, when it comes to the role of corporate governance in investing decisions, the trouble is how to find information about management.There are 2 very distinct points on the role of corporate governance: Integrity and Competence.

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.