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What are the Important Ratios you must know before Investing?

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Before you invest your hard-earned money in the stock market, make sure the firm you're selecting for the investment is worthwhile. One of the simplest methods to assess a company's performance is to look at its various financial ratios, which are freely accessible on the internet.

Most stock market professionals would recommend that you undertake fundamental research on a firm before picking stocks. This implies that you must examine the company's financial records to see whether its stocks are currently worth investing in.

However, not everyone is a finance expert and knows what to look for when evaluating a company's stock. As a result, you must pay close attention to a few key factors in order to determine the investment's sustainability.

Financial ratios can help you analyse a stock and make an informed selection in this situation. Let's take a look at these ratios and what they mean in terms of a stock's viability.

P/E (Price/Earnings) Ratio

This ratio indicates how much investors are willing to pay for each rupee made by the company. It tells you whether a company's stock is overvalued or undervalued in the market.

A high P/E ratio indicates that a company is likely to experience future growth. However, it can occasionally give you a false impression because corporations may use debt to increase this percentage. So, make sure you select the company with proper research.

Earnings per Share (EPS)

When you purchase a stock, you are investing in the company's future profits (or risk of loss). The earnings per share formula are very simple yet easy to implement. It is a measurement of a company's net income divided by the number of shares outstanding. Analysts divide the company's net income by the weighted average number of outstanding common shares for the year.

Earnings per share will be zero or negative if a corporation has no or negative earnings (i.e. a loss).

Return on Equity (ROE)

Common shareholders are interested in knowing how profitable the enterprises in which they invest and for that, they need to calculate the return the equity ratio. The return on equity formula is computed by dividing the company's net earnings (after taxes) by common equity dollars.

Consider $1.3 million in net earnings and $300,000 in preferred dividends. Divide that by $8 million in common equity. This results in a return on investment (ROI) of 12.5%. The greater the return on investment (ROI), the more profitable the company is.

Debt-Equity Ratio

What if your potential investment target borrows excessively? This might diminish the safety margins behind what it owes, raise fixed expenses, reduce earnings available for dividends to shareholders like you, and ultimately precipitate a financial crisis.

The debt-to-equity ratio (D/E) is determined by multiplying the total amount of long and short-term debt by the book value of shareholders' equity. Assume that ABC has $3.1 million in loans and $13.3 million in shareholders' equity. This equates to a low ratio of 0.23, which is acceptable in most situations. The measure, like all other ratios, must be evaluated in light of industry standards and company-specific criteria.

Current Ratio

This ratio can be used to assess a company's liquidity situation, which refers to how well it is able to meet short-term obligations with short-term assets. A greater current ratio indicates that working capital concerns will not disrupt a company's operations. If the current ratio is less than one, however, you should avoid investing in that company because it may collapse if an unprecedented catastrophe occurs. The current ratio formula is computed by dividing current assets by current liabilities.

PEG (Price/Earnings Growth) Ratio

This ratio is used to determine how the price of a stock, earnings per share (EPS), and the company's growth are related. When the PEG ratio is 1, the stock is considered to be fairly valued. If the number is less than one, the stock is considered undervalued by the market.

Wrap Up!

While a complete fundamental study of a firm is required, these ratios can assist you to analyse the financial position of companies. It's also vital to keep in mind that these ratios inherently are dynamic. Therefore, it is very significant to calculate them again after every 6 months or after the announcement of quarterly financial results. It is always advisable to learn the skills first and then implement them to avoid any major loss.

And, if you want to understand these ratios in detail then, StockDaddy is one of the prestigious platforms where you can learn everything about the stock market.

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