Many investors buy stocks based on tips, news, social media or short-term price movements. But before investing your money, one question matters: What do the numbers say about the company?
According to Sushil Alewa, SEBI Registered Research Analyst (INH100009433), MBA and CFP, investors should look beyond market tips and understand a company’s financial strength, valuation, profitability and risk.
Financial ratios make this easier by converting financial-statement numbers into simple, comparable measures. They help investors judge whether a stock looks expensive, assess business profitability, and understand debt and liquidity.
If you want to learn the basics of financial markets before going deeper into analysis, explore ISFM’s Stock Market Course.
1. P/E Ratio — Price-to-Earnings
- Formula: P/E = Market Price per Share ÷ EPS
- P/E tells you how much investors are paying for every ₹1 of earnings.
- A high P/E can indicate strong growth expectations or an expensive valuation. A low P/E may indicate an opportunity—or problems with the business.
Tip: Compare P/E with industry peers and the company’s historical average.
2. P/B Ratio — Price-to-Book
- Formula: P/B = Market Price per Share ÷ Book Value per Share
- P/B compares the market value of a company with its net assets. It is particularly useful for banks, financial companies and asset-heavy businesses.
A low P/B isn’t automatically cheap; it can also reflect poor asset quality or weak profitability.
3. PEG Ratio
- Formula: PEG = P/E ÷ Annual EPS Growth Rate (%)
- PEG combines valuation with earnings growth.
- A company with a high P/E may still be reasonably valued if its earnings are growing rapidly. A PEG around 1 is often used as a reference point, but investors should consider the quality and sustainability of growth.
4. ROE — Return on Equity
- Formula: ROE = Net Profit ÷ Shareholders’ Equity × 100
- ROE measures how efficiently a company generates profits from shareholders’ capital.
- A consistently strong ROE can indicate an efficient business. However, check several years of data because high debt can sometimes inflate ROE.
5. ROCE — Return on Capital Employed
- Formula: ROCE = EBIT ÷ Capital Employed × 100
- ROCE shows how efficiently a company generates operating returns from the capital invested in the business.
- A consistently strong ROCE is generally positive, particularly when returns remain above the company’s cost of capital.
For a deeper understanding of company financials, profitability and valuation, explore ISFM’s Fundamental Analysis Course.
6. Net Profit Margin
- Formula: Net Profit Margin = Net Profit ÷ Revenue × 100
- This tells you how much profit a company retains from every ₹100 of sales.
- Stable or improving margins can indicate strong pricing power and cost control. Falling margins may indicate rising costs, competition or pricing pressure.
7. Debt-to-Equity Ratio
- Formula: D/E = Total Debt ÷ Shareholders’ Equity
- D/E shows how much debt a company uses relative to shareholders’ equity.
- Lower debt is generally less risky, but there is no universal ideal ratio. Compare companies with similar businesses and capital structures.
8. Interest Coverage Ratio
- Formula: Interest Coverage = EBIT ÷ Interest Expense
- This measures how comfortably a company can pay interest on its borrowings.
- A higher ratio generally means greater debt-servicing ability. A low or declining ratio can be a warning sign.
9. Current Ratio
- Formula: Current Ratio = Current Assets ÷ Current Liabilities
- The current ratio measures a company’s ability to meet short-term obligations.
- A ratio above 1 generally indicates that current assets exceed current liabilities, but the appropriate level varies by industry.
10. Quick Ratio
- Formula: Quick Ratio = (Current Assets − Inventory) ÷ Current Liabilities
- The quick ratio provides a stricter liquidity test because it excludes inventory.
- A ratio around or above 1 is often considered comfortable, but business context remains important.
How to Use These 10 Ratios Together
Never judge a stock using just one ratio. Use a simple framework:
- Valuation: Check P/E, P/B and PEG.
- Profitability: Check ROE, ROCE and Net Profit Margin.
- Debt: Check D/E and Interest Coverage.
- Liquidity: Check Current and Quick Ratios.
Most importantly, examine 5–10 years of financial data, not just the latest quarter.
Once you understand fundamental analysis, technical analysis can help you study price trends, support and resistance, momentum and potential entry and exit levels. Learn more through ISFM’s Technical Analysis Course.
Investors interested in derivatives can also explore the Options Trading Course to understand options strategies, Greeks, volatility and risk management.
For a more comprehensive learning path covering fundamental analysis, technical analysis, derivatives and other market concepts, consider ISFM’s Chartered Stock Trading Expert (CSTX) Course.
Common Mistakes Investors Make
Avoid these mistakes:
- Relying on a single ratio such as P/E.
- Comparing companies from different industries.
- Ignoring long-term trends.
- Ignoring one-time gains or losses.
- Assuming a low P/E automatically means a stock is cheap.
- Treating past performance as a guarantee of future returns.
Financial ratios should always be combined with business quality, management, competitive position, cash flows and industry conditions.
Conclusion
These 10 financial ratios every investor must know provide a practical framework for evaluating a company’s valuation, profitability, debt and liquidity.
There is no magic ratio that guarantees a successful investment. Instead, compare the company’s numbers with its peers, historical performance and business fundamentals.
Before buying a stock, ask yourself one simple question:
“Do the numbers support the story?”
If they do, you are investing with your eyes open—not simply following a tip.
