Stock Market is the attraction of investment for many people. Many people wish to know about stock market. How to invest into it. But they do not know how exactly to start. And interestingly many people invest into stock market, even without knowing some basic ratios. So in this article I wish to address what basic ratios every stock investor should know, especially beginners. Yes ratios give quick overview idea about the particular stock one should invest in. So being the article for newbie I aim to make it as simple as possible to understand. So that even a layman without any finance or stock market background should understand it easily. Okay so let us discuss in detail the ratios
1.PE Ratio or Price Earning Ratio:
Probably many people know about this. They know that there is something called as PE ratio. PE ratio is the ratio of Price of the Stock to Earning Per Share of that stock. This is typical explanation which probably only the person from finance background would understand. Okay so let me make it easy. So basically there are two components of PE ratio that is Price of the Stock. simple. Another thing is Earning Per Share. Now what exactly is Earning Per Share (EPS). Earning is nothing but the Net Profit of the Company. So Earning Per Share is simple i.e. Net Profit After Tax/Number of Shares. So now we got both the things required to calculate the PE Ratio. One Price of the Stock this is simply the market price of the stock. Two Earning Per Share (EPS) as explained above. PE Ratio is simply Price/EPS. Suppose if a person invests in Stock A with market Price of 100 and Earning per share of 20,then the PE ratio is 100/20 i.e. 5. Now if PE ratio is more, it means the person buys at more inflated price. So obviously one should preferably invest in the stocks with lower PE ratio. Of course, PE ratio should not be considered in isolation, and other things about stock should also be researched and studied. To put it simple if there are two companies in the same industry with same profitability, same market cap and same reputation, then one should invest in the company with lower PE ratio, of these two companies.
2.PB Ratio or Price to Book Ratio:
Most of the people know about PE ratio. But many people do not know about PB ratio. This is also very important ratio to find value stocks. It is ratio of Price to Book Value. Price is simply market price of the stock. What exactly is Book Value. Book value is nothing but net worth of the company. Again this is typical finance jargon and difficult to understand for layman. Okay, Book Value is simply Total of Value of the Assets of minus Total value of liabilities. Now it is simple to understand. So Book Value is simply nothing but the excess of assets over liabilities. Now we need to have book value per share. It is calculated as Total Book Value/Number of Shares. So if the price of particular scrip is 100 and book value per share is 50 then the PB ratio is simply 100/50 i.e. 2. Obviously if this ratio is higher then it means one buys the stock at more inflated price. So lower PB ratio is preferable.
3.Return on Equity ROE:
This is also important ratio. Return on Equity is calculated as Net Profit/Shareholders’ Equity. Net Profit is very easy to understand. That is the Net Profit After Taxes. And Shareholders’ Equity is simply share capital and reserves and surplus. It is simply excess of value of Assets over the Liabilities, as explained above. This ratio is very important. Because it calculates the return on the money invested by the shareholders of the company. And ultimately shareholders are only the owners of the company. So if the Net Profit of the Company is 100 and Shareholders Equity is 1000 then ROE is 100/1000 i.e. 10%. If the ROE of the company is not less than the the normal interest rates prevailing in the country, it is not advisable to invest in the stock of that company.
Beta calculates the volatility of the stock as compared to market as a whole. So if the beta of the stock is 1 it means it is equally volatile with market. If the beta is more than 1 it means the stock is more volatile than the market. And if the beta is less than 1 then the stock is less volatile than market. This ratio is very useful to know the volatility of the stock. Many times it is advisable to be cautious while dealing with the more volatile shares. Beta is calculated by comparing historical data of the stock prices and the historical data of benchmark index. Newbies need not know much exactly the beta is calculated. For them this information is readily available for every stock on many finance portals.
5.Operating Profit Margin:
This is also important ratio. Investors should check this ratio also before investing in the stock. It is calculated as Net Operating Profit/Net Sales. This is quite easy to understand. Operating Profit is the profit derived from the operations of the company. And Net Sales is Sales after returns. Obviously, higher the ratio is better. Good idea is to compare this ratio with the Ratio of Return on Equity ROE.
These are the important ratios, every investor should follow before investing in particular stock. Of course there are so many things which need to be studied/researched before investing into particular stock. But these are some of the important ratios which everyone should know. And one more important thing is that these ratios should be checked in totality, and only one or some ratios should not be considered in isolation.
Hope this article helps in your successful journey in equity investing.