Chapter 5 of 5

Financial ratios that matter

8 min read

Ratios turn financial statements into comparable numbers. No ratio is a verdict, but a handful, used together, give a quick and honest picture.

Valuation ratios

Price-to-earnings (illustrative)

A share trades at ₹195 and its EPS is ₹9.75.
P/E is 195 ÷ 9.75 = 20: investors pay ₹20 for each ₹1 of yearly profit.
A higher P/E means higher expectations, not a better company.

Price-to-book (P/B): price relative to net assets, often used for banks.
Dividend yield: annual dividend as a percentage of price.

Profitability ratios

Return on equity (illustrative)

Profit after tax is ₹97.5 crore on equity of ₹600 crore.
ROE is 97.5 ÷ 600 = 16.25%: each rupee of shareholders' money earned about 16 paise.
High ROE built on heavy debt is riskier than the same ROE with little debt.

Operating and net margin: how much of each rupee of sales is kept.
Return on capital employed (ROCE): profit relative to all capital used, debt included.

Safety ratios

Debt-to-equity: how leveraged the company is.
Interest coverage: operating profit divided by interest cost; below about 2 deserves a close look.

Using ratios fairly

Compare a company with its own history and with direct peers.
Look at several years, not one.
Never rely on one ratio. A low P/E may signal a cheap stock or a business in trouble.

Key takeaways

P/E, ROE, debt-to-equity and margins form a useful core.
Compare within an industry and across years.
A ratio tells you where to look, not what to do.

This content is for education only and is not investment or tax advice. Mutual fund investments are subject to market risks; read all scheme-related documents carefully.