2. Liquidity
It is important for investors to look into a company’s liquidity position before
investing.
High Current ratio signal that the company won’t be affected by working capital
issues.
Ideal CR – 1:1
Better check acid test ratio for liquidity, because current assets includes stock and
receivables.
3. P/E ratio
This ratio shows how much investors are paying for each rupee of earnings.
The ideal P/E ratio can be known by comparing current P/E with historical P/E ,
the average industry P/E and market P/E. Although the company is having a
higher P/E as compared to its historical price, it might still be lower than the
industry P/E and market P/E. It is explained below with an example.
Eg. P/E – 15 (expensive as compared to its historical P/E) , industry P/E – 18,
market P/E – 20.
Investors should be smart enough to know company’s tricks. Sometimes,
companies add debts to boost their P/E ratio, which helps in constructing equity
capital.
4. Debt to equity Ratio
It shows how much debt is involved in the business in regard to promoter’s capital
(equity).
A low figure is considered better. But it should not be seen in isolation.
If the company’s returns are higher than its interest cost, the debt will enhance
value. However, if it is not, shareholders will lose.
A company with low debt-to-equity ratio can be assumed to have a lot of scope
for expansion due to more fund-raising options.
5. Operating profit margin
It shows operational efficiency and pricing power.
OPM = operating profit/Net sales
It is compulsory for investors to see if a company’s OPM has been raising over a
period. Investors should also compare OPMs of othercompanies in the same
industry.
6. Return on Equity
ROE = Net income/shareholders equity.
15-20% ROE is considered good.
A rise in debt will also reflect in a higher ROE, mostly in capital intensive business.
7. Interest Coverage Ratio
Formula- EBIT/Interest expense.
It indicates how solvent a business is , and the number of interest payments the
business can serve solely from operation.