Main Ratios of Company Fundamentals
Understanding key financial ratios is essential for evaluating a company's fundamentals. These ratios provide insights into profitability, liquidity, efficiency, and solvency. Here are the main ratios to focus on:
1. Price-to-Earnings (P/E) Ratio
The P/E ratio compares a company's current share price to its earnings per share (EPS). It indicates whether a stock is overvalued or undervalued relative to its earnings. A higher P/E might suggest growth expectations, while a lower P/E could indicate undervaluation.
2. Return on Equity (ROE)
ROE measures how effectively a company uses shareholders' equity to generate profit. Calculated as net income divided by shareholders' equity, a higher ROE signifies better profitability and efficient use of capital.
3. Debt-to-Equity (D/E) Ratio
This ratio compares a company’s total debt to its shareholders' equity, reflecting its leverage. A lower D/E ratio suggests a company relies less on debt, indicating financial stability, while a high ratio may signal higher risk.
4. Current Ratio
The current ratio assesses a company’s ability to pay short-term liabilities with short-term assets. Calculated as current assets divided by current liabilities, a ratio above 1 indicates good liquidity.
5. Quick Ratio
Also known as the acid-test ratio, it measures a company's ability to meet short-term obligations with its most liquid assets (excluding inventory). A quick ratio above 1 is generally a positive sign of financial health.
6. Price-to-Book (P/B) Ratio
The P/B ratio compares a company’s market value to its book value. A P/B ratio below 1 might suggest the stock is undervalued, while a higher ratio could indicate overvaluation or strong market confidence.
7. Gross Margin
This ratio shows the percentage of revenue remaining after deducting the cost of goods sold. A higher gross margin indicates better efficiency in production and pricing strategies.
Importance
These ratios help investors assess a company’s financial health, compare it with peers, and make informed investment decisions. Regular analysis of these metrics can reveal trends and potential red flags over time.
