#Stock-Market  #Fundamental-Analysis  #Finance 

📋 Topics Covered

  • General Terms Used in Financial Ratios
  • Profitability Ratios (PAT, EBIT, EBITDA Margins)
  • Return Ratios (ROE, ROCE, ROA)
  • Leverage Ratios (D/E, Interest Coverage)
  • Valuation Ratios (P/E, P/B, PEG)

📊 Financial Ratios

📖 General Terms Used

  • Total Equity = Shareholders’ Equity

    • Equity Share Capital + Preferred Equity + Reserves
    • Also known as the Book Value (BV).

  • Capital = Total Equity + Debt

  • Book Value Per Share

    • Used to calculate the Price to Book Ratio (P/B).

  • Net Sales = Topline = Total Revenue

    • The total amount of sales made by the company.

  • Capital Raising (2 Ways):

    • Equity Capital: Shareholders become part-owners and share the company’s profitability.
    • Debt Capital: Borrowed money (can be Short-term or Long-term).

  • Debt = Borrowings + Other financial liabilities.

  • Earnings Per Share (EPS)

    • Net Profit / Number of Equity Shares
    • It changes during events like Bonus Issues, New Share Issues, or Stock Splits.

💰 Profitability Ratios

PAT Margin

  • Profit After Tax (PAT) or Net Profit
    • The actual profit left after paying all taxes.
  • PAT Margin = Profit percentage in terms of Total Revenue.
PAT = PBT - TAX
PAT Margin = PAT / Topline

EBIT Margin

  • Earnings Before Interest and Tax (EBIT) or Operating Profit
    • Profit before taxes and interest expenses are subtracted.
EBIT = PAT + Taxes + Finance Cost  OR
EBIT = PBT + Finance Cost
EBIT Margin = EBIT / Net Sales

EBITDA Margin or OPM

  • Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
  • Also termed the Operating Profit Margin (OPM).
  • Shows how much operating profit a company is generating, which reflects its Operational Efficiency.
EBITDA = PAT + Taxes + Finance Cost + Depreciation
EBITDA Margin = EBITDA / Net Sales

🔄 Return Ratios

Return on Equity (ROE)

  • ROE is most useful for Debt-Free Companies (e.g., FMCG companies like HUL, ITC).
  • Highly leveraged companies can take advantage of debt to artificially inflate ROE.
ROE = PAT / Shareholders' Equity
ROE = PAT FY20 / Avg Shareholders' Equity of FY19 and FY20
Example: ROE = [ 2,496 / { (15,197 + 12,927) / 2 } ] * 100 = 17.75%

Return on Capital Employed (ROCE)

  • ROCE is most useful for Companies with Debt (e.g., Infrastructure, Telecom Sectors).
Capital Employed = Shareholders' Equity + Debt Capital
ROCE = (EBIT / Avg Capital Employed) * 100
Example: ROCE = (3,455 / 15,664.5) * 100 = 22.01%

Return on Assets (ROA)

  • In the Banking Sector, ROA is considered instead of ROCE because Loans are treated as Bank Assets.

⚠️ Important Note on Returns:

  • For a debt-free company, ROE != ROCE because PAT is used for ROE, whereas EBIT is used for ROCE.
  • Manipulating ROE:
    • If a company has high debt and lower equity, ROE is HIGH when earnings from debt are good.
    • However, ROE is LOW when earnings from debt are low, but the interest payout is high.
  • Manipulating ROCE & ROE:
    • If a high dividend is paid out, the Reserves & Surplus will not increase. This can artificially inflate ROCE and ROE.

⚖️ Leverage Ratios

Debt to Equity Ratio (D/E)

D/E = Total Debt / Shareholders' Equity

D/E < 1 --> Debt Capital < Shareholders' Equity
D/E > 1 --> Debt Capital > Shareholders' Equity
D/E = 1 --> Debt Capital = Shareholders' Equity
  • Ideally, it should be D/E < 1 (except for Banks and NBFCs).
  • Always compare within the same sector.
  • A max ratio of D:E = 2:1 is generally considered acceptable.

Interest Coverage Ratio

  • Measures if the firm can comfortably pay interest on its outstanding debt.
  • A higher ratio is better.
  • Ideally, the ratio > 2.4.
Interest Coverage Ratio = EBIT / Interest Expense
Interest Coverage Ratio = (PBT + Finance Cost) / Finance Cost

🏷️ Valuation Ratios

Price to Earnings (P/E or PE) Ratio

  • Tells us how much price an investor pays for Re 1 of earnings of the company.
PE Ratio = Market Price per Share (MP) / Earnings per Share (EPS)
PE Ratio = Market Cap / PAT

Example: PE Ratio = MP / EPS = 100 / 10 = 10
(An investor is ready to pay 10 times the earnings of the share)
  • Types:
    • TTM PE (Trailing 12-Month PE)
    • Forward PE
  • Indices PE:
    • PE ~16: Undervalued Zone
    • PE ~21: Overvalued Zone

Price to Book Ratio (P/B or PB)

  • Book Value is the amount that would be left if the company liquidated all of its assets and repaid all of its liabilities.
  • PB tells us the multiple of price an investor pays for the net assets.
Book Value (BV) = Assets - Liabilities = Common Shareholders' Equity
BV per Share = BV / Total Shares  --> (Say 50 / 10 = 5)

P/B = Market Price per Share (MP) / BV per Share  --> (20 / 5 = 4)
(Investors are ready to pay 4 times the Net Assets)
  • PB is often more stable than PE.
    • In difficult times like COVID-19, PB is a more reliable metric.
  • PB is not useful for less capital-intensive industries (e.g., IT Companies).

Price/Earnings-to-Growth (PEG) Ratio

  • The PEG ratio relates a company’s P/E to its expected earnings growth rate (usually CAGR over the last 5 years).
PEG = PE / Growth in PAT
 
PEG < 1 --> Company is Undervalued
PEG > 1 --> Company is Overvalued
PEG = 1 --> Company is Fairly Valued
  • Better PEG calculation:
    • Calculate the Average Growth of PAT, Revenue, & EBITDA over the last 5 years.
    • Calculate PEG = PE / Avg Growth.
    • This considers three parameters instead of only PAT for a more robust valuation. Always compare with peers within the exact industry.

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