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EPS is the first most important ratio in our list. It is very important to understand Earnings per share (EPS) before we study any other ratios, as the value of EPS is also used in various other financial ratios for their calculation.

EPS is basically the net profit that a company has made in a given time period divided by the total outstanding shares of the company. Generally, EPS can be calculated on an Annual basis or Quarterly basis. Preferred shares are not included while calculating EPS.

Earnings Per Share (EPS) = (Net income – Dividends from preferred stock)/(Average outstanding shares)

From the perspective of an investor, it’s always better to invest in a company with higher and growing EPS as it means that the company is generating greater profits. Before investing in any company, you should always check past EPS for the last five years. If the EPS is growing for these years, it’s a good sign and if the EPS is regularly falling, stagnant or erratic, then you should start searching for another company.

The Price to Earnings ratio is one of the most widely used financial ratio analysis among investors for a very long time. A high PE ratio generally shows that the investor is paying more for the share. The PE ratio is calculated using this formula:

Price to Earnings Ratio= (Price Per Share)/( Earnings Per Share)

Now let us look at the components of the PE ratio. It’s easier to find the price of the share which is the current closing stock price. For the earnings per share, we can have either trailing EPS (earnings per share based on the past 12 months) or Forward EPS i.e. Estimated basic earnings per share based on a forward 12-month projection. It’s easier to find the trailing EPS as we already have the result of the past twelve month’s performance of the company.

For example, a company with the current share price of Rs 100 and EPS of Rs 20, will have a PE ratio of 5. As a thumb rule, a low PE ratio is preferred while buying a stock. However, the definition of ‘low’ varies from industries to industries.

Different industries (Ex Automobile, Banks, IT, Pharma, etc) have different PE ratios for the companies in their industry (Also known as Industry PE). Comparing the PE ratio of the company of one sector with the PE ratio of the company of another sector will be insignificant. For example, it’s not much use to compare the PE of an automobile company with the PE of an IT company. However, you can use the PE ratio to compare the companies in the same industry, preferring one with low PE.

Price to Book Ratio (PBV) is calculated by dividing the current price of the stock by the book value per share. Here, Book value can be considered as the net asset value of a company and is calculated as total assets minus intangible assets (patents, goodwill) and liabilities. Here’s the formula for PBV ratio:

Price to Book Ratio = (Price per Share)/( Book Value per Share)

PBV ratio is an indication of how much shareholders are paying for the net assets of a company. Generally, a lower PBV ratio could mean that the stock is undervalued.

However, again the definition of lower varies from industry to industry. There should be an apple to apple comparison while looking into PBV ratio. The price to book value ratio of an IT company should only be compared with PBV of another IT company, not any other industry.

The debt-to-equity ratio measures the relationship between the amount of capital that has been borrowed (i.e. debt) and the amount of capital contributed by shareholders (i.e. equity).

Debt to Equity Ratio =(Total Liabilities)/(Total Shareholder Equity)

Generally, as a firm’s debt-to-equity ratio increases, it becomes riskier as it means that a company is using more leverage and has a weaker equity position. As a thumb of rule, companies with a debt-to-equity ratio of more than one are risky and should be considered carefully before investing.

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders’ equity. ROE measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. In other words, ROE tells you how good a company is at rewarding its shareholders for their investment.

Return on Equity = (Net Income)/(Average Stockholder Equity)

As a thumb rule, always invest in a company with ROE greater than 20% for at least the last 3 years. Year-on-year growth in ROE is also a good sign.

The stock’s price/sales ratio (P/S) ratio measures the price of a company’s stock against its annual sales. P/S ratio is another stock valuation indicator similar to the P/E ratio.

Price to Sales Ratio = (Price per Share)/(Annual Sales Per Share)

The P/S ratio is a great tool because sales figures are considered to be relatively reliable while other income statement items, like earnings, can be easily manipulated by using different accounting rules.

The current ratio is a key financial ratio for evaluating a company’s liquidity. It measures the proportion of current assets available to cover current liabilities. The current ratio can be calculated as:

Current Ratio = (Current Assets)/(Current Liabilities)

This ratio tells the company’s ability to pay its short-term liabilities with its short-term assets. If the ratio is over 1.0, the firm has more short-term assets than short-term debts. But if the current ratio is less than 1.0, the opposite is true and the company could be vulnerable. As a thumb rule, always invest in a company with a current ratio greater than 1.

A stock’s dividend yield is calculated as the company’s annual cash dividend per share divided by the current price of the stock and is expressed in annual percentage. Mathematically, it can be calculated as:

Dividend Yield = (Dividend per Share)/(Price per Share)*100

For Example, If the share price of a company is Rs 100 and it is giving a dividend of Rs 10, then the dividend yield will be 10%.