Investing in the stock market can be both exciting and frightening. There are so many stocks to select from that having a plan so that sense can be made of the whole process is important.
So, it becomes essential for you to have a strategy for selecting the right ones. This guide will help you in understanding key financial metrics that can help you make informed decisions, even if you’re new to investing.
1. Price-to-Book (P/B) Ratio
The P/B ratio compares a company’s market value to its book value. Imagine you buy a stock for ₹100, but the company’s book value (total assets minus liabilities) per share is ₹120. This means you’re buying it for less than its actual worth, which could signal a good deal.
Example: If Company A has a market price per share of ₹50 and a book value per share of ₹100, its P/B ratio is 0.5. A P/B ratio below 1 typically suggests the stock is undervalued.
It is usually advised to have a P/B ratio below 1, so that investors can get good returns. However, you can compare the P/B ratio with other stocks of the same sector or its competitors.
2. Price-to-Earnings (P/E) Ratio
The P/E ratio shows how much investors are willing to pay per rupee of earnings. A lower P/E ratio might mean the stock is undervalued, while a higher P/E ratio could indicate overvaluation.
Example: If Company B has a share price of ₹150 and an EPS (earnings per share) of ₹15, the P/E ratio is 10. This means investors are willing to pay ₹10 for every rupee of earnings.
3. Net Profit
Net profit is the company’s total earnings after all expenses. Consistently rising net profit indicates good management and a potentially strong investment.
Example: If Company C’s net profit has grown from ₹10 crore to ₹15 crore over the past three years, it shows a healthy growth trend.
4. Revenue
Revenue is the total income from sales. It’s crucial to look at revenue trends to understand a company’s growth potential.
Example: If Company D’s revenue increases from ₹200 crore to ₹250 crore in a year, it’s a positive sign of business expansion.
5. Earnings Per Share (EPS)
EPS is the portion of a company’s profit allocated to each share. Higher EPS indicates greater profitability.
Example: If Company E has a net profit of ₹30 crore and has 10 crore shares outstanding, the EPS is ₹3. An increasing EPS over time suggests improving profitability.
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6. Return on Capital (ROC)
ROC measures the profit generated from the capital invested in the business. A higher ROC indicates efficient use of capital.
Example: If Company F invests ₹100 crore and generates ₹20 crore in profit, the ROC is 20%. This means the company makes 20% on its investments.
7. Return on Equity (ROE)
ROE indicates how well a company uses shareholders’ equity to generate profit. A high ROE means efficient management and profitability.
Example: If Company G has a net profit of ₹50 crore and shareholders’ equity of ₹250 crore, the ROE is 20%. This is a sign of effective use of equity.
8. Operating Income
Operating income is the profit from a company’s core business activities. It excludes non-operating income and expenses, providing a clear picture of operational efficiency.
Example: If Company’s operating income is steadily increasing, it shows the core business is growing strong.
9. Order Book
The order book shows the orders received but not yet fulfilled. A robust order book indicates strong future revenue potential.
Example: If Company I has a large order book, it suggests high demand for its products or services, which is a good sign for future growth.
10. Cash Flow
Cash flow shows the amount of cash generated by the company. Positive cash flow means the company can easily pay its bills and invest in growth.
Example: If Company J consistently shows positive cash flow, it’s financially healthy and can sustain operations and growth.
11. EBITDA
EBITDA measures overall financial performance, excluding interest, taxes, depreciation, and amortization. It shows operational profitability.
Example: If Company K has an EBITDA margin of 30%, it indicates good operational efficiency and profitability before accounting for non-operational expenses.
Conclusion
As a beginner, Selecting stocks for you requires dedicated time. It involves analyzing various financial metrics to assess a company’s health and growth potential. By understanding P/B, P/E, net profit, revenue, EPS, ROC, ROE, operating income, order book, cash flow, and EBITDA, you can make informed investment decisions.
Remember, there’s no one-size-fits-all approach—consider a mix of these metrics to get a comprehensive view of the company’s performance.
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