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Fundamental analysis involves evaluating a company’s financial health and performance using various ratios. These ratios help investors make informed decisions about buying, holding, or selling stocks. Understanding key ratios is essential for beginners to analyze companies effectively.
Profitability Ratios
Profitability ratios measure a company’s ability to generate profit relative to sales, assets, or equity. They are crucial indicators of financial health.
- Gross Profit Margin: (Gross Profit / Revenue) x 100
- Net Profit Margin: (Net Income / Revenue) x 100
- Return on Equity (ROE): (Net Income / Shareholders’ Equity) x 100
- Return on Assets (ROA): (Net Income / Total Assets) x 100
Liquidity Ratios
Liquidity ratios assess a company’s ability to meet short-term obligations. They indicate financial stability in the near term.
- Current Ratio: Current Assets / Current Liabilities
- Quick Ratio: (Current Assets – Inventory) / Current Liabilities
- Cash Ratio: Cash and Cash Equivalents / Current Liabilities
Valuation Ratios
Valuation ratios help determine if a stock is overvalued or undervalued based on market prices and financial metrics.
- Price-to-Earnings (P/E) Ratio: Market Price per Share / Earnings per Share
- Price-to-Book (P/B) Ratio: Market Price per Share / Book Value per Share
- Dividend Yield: Annual Dividends per Share / Market Price per Share
Leverage Ratios
Leverage ratios evaluate the level of debt used by a company and its ability to meet debt obligations.
- Debt-to-Equity Ratio: Total Debt / Shareholders’ Equity
- Interest Coverage Ratio: Earnings Before Interest and Taxes (EBIT) / Interest Expenses
- Debt Ratio: Total Debt / Total Assets