Financial Ratios: The Investor's Toolkit

Valuation Ratios

Price-to-Earnings (P/E)

Formula: Share Price ÷ Earnings Per Share

Tells you how much investors are willing to pay for each rupee/dollar of earnings.

• Low P/E (< 15): Potentially undervalued or slow-growing
• High P/E (> 30): High growth expected or overvalued
• Compare within the same industry; a bank's P/E is not comparable to a tech stock's.

Price-to-Book (P/B)

Formula: Share Price ÷ Book Value Per Share

Compares market price to accounting book value.

• P/B < 1: Trading below book value — potential value play (or trouble)
• P/B > 3: Premium to book value

Price-to-Sales (P/S)

Formula: Market Cap ÷ Annual Revenue

Useful for unprofitable growth companies where P/E is meaningless.

PEG Ratio

Formula: P/E ÷ Earnings Growth Rate

A PEG below 1 is often considered attractive — you're paying less for each unit of growth.

Profitability Ratios

Return on Equity (ROE)

Formula: Net Income ÷ Shareholders' Equity

Measures how efficiently a company uses shareholder capital to generate profits. ROE > 15% is generally strong.

Return on Assets (ROA)

Formula: Net Income ÷ Total Assets

Shows profitability relative to total assets.

Operating & Net Margins

• Operating Margin = Operating Income ÷ Revenue
• Net Margin = Net Income ÷ Revenue

Higher margins indicate pricing power and efficiency.

Solvency & Liquidity

Debt-to-Equity (D/E)

Formula: Total Debt ÷ Shareholders' Equity

• D/E < 1: Conservative leverage
• D/E > 2: High leverage — riskier

Current Ratio

Formula: Current Assets ÷ Current Liabilities

Measures short-term liquidity. > 1.5 is generally healthy.

Quick Ratio

Like current ratio but excludes inventory. > 1 indicates strong short-term solvency.

Efficiency Ratios

Inventory Turnover

Revenue ÷ Inventory — how fast inventory is sold.

Asset Turnover

Revenue ÷ Total Assets — how efficiently assets generate revenue.

Putting It Together

No single ratio tells the whole story. A thorough analysis includes:

1. Compare ratios to industry peers.
2. Look at 5-10 years of trends.
3. Combine with qualitative factors (management, moat, industry).
4. Consider macroeconomic context.