Individual stocks can be a beneficial choice for investors seeking to make investments outside of diversified mutual funds or exchange-traded funds (ETFs). But, you’ll need to understand how to evaluate the underlying companies of various stocks through the stock market ratios before you begin purchasing them. A company’s Securities and Exchange Commission filings are a smart place to start. A wealth of information, including the latest year’s financial statements, will be available from these filings. Stock market ratios can then be computed to help you better understand the company and potential future direction of the stock price.In this article, we will understand the various stock market ratios;
Stock market ratios
In quantitative analysis, stock market ratios are essential. The price-to-earnings (P/E), price-to-book (P/B), debt-to-equity, and other profitability ratios are examples of common ratios. These ratios provide information about solvency, liquidity, profitability, and valuation. Investors, analysts, and other stakeholders can assess a company’s performance over an extended period of time by comparing it to that of its industry or peers using financial ratio analysis. It entails evaluating several components of a company’s financial statements using a variety of ratios. The financial ratio aids in scale reduction and facilitates comparison with other businesses. Financial ratio analysis assesses businesses with robust financial indicators in order to help find possible investment opportunities.
Types of stock market ratios
There are the following types of stock market ratios;
- Liquidity ratio
- Profitability ratio
- Solvency ratio
- Efficiency ratio
- Valuation ratio
Liquidity ratio
Liquidity ratios show a company’s liquidity and financial flexibility. It evaluates its capacity to fulfill short-term obligations. Companies with robust liquidity ratios are better equipped to manage unforeseen costs and weather economic downturns. Liquidity ratios evaluate a company’s capacity to manage unforeseen expenses or business downturns without having to turn to outside finance sources. Financial stability is aided by having a healthy liquidity position.
Types of liquidity ratio
There are the following types of liquidity ratio;
Current Ratio: This ratio assesses how well a business can use its short-term assets to cover its short-term liabilities. A ratio greater than one suggests that the business can pay its debts. A ratio of 1.5 to 3, which represents a sound balance between assets and liabilities, is frequently preferred by investors. Current Assets / Current Liabilities equals the current ratio.
Quick Ratio (Acid-Test Ratio): This ratio is derived by deducting inventory from current assets, assesses how well a business can use its most liquid assets to cover short-term obligations. With inventory excluded, it offers a more cautious perspective. It is a demanding test of liquidity that indicates the short-term financial health of an organization. Formula of quick ratio: (Current Assets – Inventory) / Current Liabilities is the quick ratio.
Profitability ratio
The ability of a business to turn a profit in relation to its expenses and other pertinent factors is assessed using profitability ratios. Investors rely on profitability measurements to determine how well a business uses its resources to turn a profit. Businesses with strong profitability ratios are frequently seen as desirable places to invest.
Types of profitability ratio
There are the following types of profitability ratio;
Gross profit margin: The percentage of revenue that surpasses the cost of products sold is disclosed by the gross profit margin ratio. It is used to assess a company’s profitability. A higher gross margin is a sign of pricing power or more effective production methods.
Net Profit Margin: This shows the portion of income that is turned into profits following the deduction of all costs, such as interest and taxes. An increased net profit margin is indicative of improved operational efficiency and cost control. By dividing net income by revenue, it is computed.
Return on equity: It means how efficiently a company uses the money of their shareholders.
Always buy a share of a company who has a high ROE ratio.
Solvency ratio
Financial indicators called solvency ratios are employed to evaluate a company’s capacity to fulfill its long-term financial commitments. These ratios assess how much a company’s assets surpass its liabilities. It shows how long it can continue to operate. When interest rates are rising or the economy is struggling, having a lot of debt may make things riskier. Investors can determine whether companies are better positioned for long-term financial stability and debt management by comparing solvency ratios within an industry or against competitors.
Types of solvency ratio
There are the following types of solvency ratio;
Debt-to-Equity Ratio: Indicates how much equity and debt were utilized to finance the assets of a business. Greater indebtedness and possibly greater danger are indicated by higher ratios. A reduced danger of debt obligations to a company’s financial viability is indicated by a low debt-to-equity ratio.
Efficiency ratio
They are crucial in figuring out how productive and efficient a business is, and they frequently look to these ratios for insightful information. Efficiency ratios and a company’s cash flow performance are related. Improved cash flow can result from a business operating more profitably through better inventory management, quicker receivables collection, asset utilization, and operational cycle optimization.
Valuation ratio
The desirability of a company’s stock with respect to its market price, earnings, book value, or other fundamental indicators is assessed using valuation ratios, which are financial measurements. These statistics shed light on whether a company is appropriately priced in the market or is overvalued or undervalued. Different viewpoints on a company’s financial health, growth potential, and market sentiment are offered by valuation ratios. To make well-informed investment selections, investors are recommended to utilize a combination of these measures, qualitative analysis, industry benchmarks, and market conditions.
Types of valuation ratio
There are following types of valuation ratio;
Price to earning ratio or PE ration: Cost-to-The current stock price of a corporation is compared to its earnings per share (EPS) using the earnings ratio. An expensive stock may be indicated by a high P/E ratio, and an undervalued stock may be suggested by a low ratio. Purchasing stocks with low price-to-earnings ratios could be beneficial.
Price to book ratio: The market price per share and book value per share of a corporation are compared using the P/B ratio.
This valuation tool determines the relative undervaluation and overvaluation of a stock based on its accounting value. If the ratio is less than 1, it can suggest that the stock is cheap in relation to its assets. The conduct of investors determines P/B preference. Value investors may be drawn to low P/B ratios because they perceive them as possible values, whereas growth investors may be more drawn to higher P/B ratios because they anticipate more growth.
Dividend yield: A financial ratio called dividend yield compares a company’s stock’s yearly dividend income to its current market value. It shows the percentage return on investment that an investor gets from dividends. A high dividend yield is indicative of either an inexpensive stock or a business that gives its shareholders a sizable amount of its earnings. When comparing the income prospects of several firms within the same industry or across sectors, investors consider dividend yield. It assists in locating stocks with enticing dividend payment records. Variations in stock prices and market conditions might affect dividend yields. Not every increased yield brought on by a declining stock price is a sign of a strong investing opportunity.
FAQs
What is a good PE ratio?
Ans. A good PE ratio should be between 20-25.
What is a good roe ratio?
Ans. A good roe ratio should be between 10-15%.
What is good debt to equity ratio?
Ans. A good debt to equity ratio should be below 2.
What is a good pb ratio?
Ans. A good pb ratio should be below 3.
