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HomeFinancial ValuationTop 5 Essential Ratios for Evaluating Companies

Top 5 Essential Ratios for Evaluating Companies

Investing in stocks can be a great way to grow your wealth over time. However, it’s important to do your analysis and research before you invest in any company. One of the best ways to assess a company’s financial health is to look at its financial ratios.

Here are five key ratios or metrics to check before investing in a company: 

  1. Price-to-earnings ratio (P/E ratio) 

The P/E ratio is one of the most widely used stock valuation metrics. It compares a company’s current share price to its earnings per share (EPS). A high P/E ratio can indicate that a company is overvalued, while a low P/E ratio can indicate that a company is undervalued.

Read: Understanding Earning Yields and P/E Ratio

  1. Price-to-sales ratio (P/S ratio) 

The P/S ratio compares a company’s current share price to its sales per share (SPS). A high P/S ratio can indicate that a company is overvalued, while a low P/S ratio can indicate that a company is undervalued.

  1. Debt-to-equity ratio (D/E ratio) 

The D/E ratio compares a company’s total debt to its total equity. A high D/E ratio can indicate that a company is highly leveraged and therefore riskier. A low D/E ratio can indicate that a company is less leveraged and therefore less risky. Normally it should be less than one.

  1. Return on equity (ROE) 

The ROE is a measure of a company’s profitability. It compares a company’s net income to its average shareholder’s equity. A high ROE can indicate that a company uses its shareholder’s equity efficiently. A low ROE can indicate that a company is not using its shareholder’s equity efficiently.

Read: ROE Vs ROCE

  1. Gross margin 

The gross margin is a measure of a company’s profitability. It compares a company’s gross profit to its net sales. A high gross margin can indicate that a company is able to generate a lot of profit from its sales. A low gross margin can indicate that a company cannot generate a lot of profit from its sales.

It’s important to note that no single ratio or metric can tell you everything you need to know about a company. You should always consider multiple ratios and metrics when evaluating a company’s financial health.

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