Investing is a great way to grow your wealth. In fact, some people see investment as a potential future income resource.
People invest in stock market and scoop revenue according to the type of investment made.
People who frequently visit stock market know that there are different vehicles of investment.
Some of them like to trade in stocks, some like to invest in mutual fund and some like to invest in bonds. There are multiple options available, and we get to choose according to our preferences.
These investments are made in shares of companies present in market. The companies provide some kind of services or are manufacturing something to keep their feet in the market.
A firm doesn’t only have the role of manufacturing services and goods but also, there are multiple aspects to its functioning. Share market is one of them.
What we invest becomes their liability. The firm has to pay back these investments as revenue or in form of dividend to the investors.
Companies use our investment to grow their services which will incur more profit. This profit is shared by the shareholders of the company.
Considering this situation, investors should be wary of the companies they are investing in. A slow pacing company can drown your investment or a company on the verge of going bankrupt can seize all your hopes of high returns or revenue at all.
But there are many companies present in the market, how do I know which one is safe to invest in?
Well, the stock market is always full of risks. So, unexpected things keep on happening here. However, we can predict which company won’t drown and has good reputation in the market. So, that you can start investing.
Also Read: Ways to Get Freedom from Your Money Problems
What is a financial ratio?
Financial ratios are tools used by Business managers and investors to analyse a company’s performance in the present, how it is going to be in the future and the past reputation as well.
A company’s market value, profitability and solvency is determined based on financial ratio.
By the data collected from balance sheet, cashflow and income statement of a firm, financial ratios are calculated and a reputation is built up for a company.
It not only benefits the investors but the company as well. They can draw a frame about the company’s performance. It is easy to compare with other firms operating in the same field.
It is accessible to gauge the company’s debt and revenue and how the company will carry on in the near future as well.
There are 15 types of financial ratios. However, these are classified based on liquidity, efficiency, solvency, coverage, profitability and market value.
However, there are 5 financial ratios that an investor would like to learn about before beginning their investment journey.
Earnings per share
It is the ratio of the company’s net profit and outstanding shares of common stocks.
It is used to determine share price of a company in the market.
Likewise, it is used to measure a firm’s profit making ability.
High EPS means investors are willing to pay more for share price and there is good return as well.
Price to earning ratio
This ratio is used to analyse about investors’ behavior towards the company’s stock. Investors’ attitude change towards the stock as per change in the profits.
This ratio shows their willingness to spend their money in the company’s stock at profit incurred from each rupee invested.
A high Price to earning ratio suggests that investors are expecting high returns from the company’s stock in the future.
It is calculated by dividing market price per share of the company by earning per share.
Price to book ratio
This ratio is also known as price to equity ratio. Book value of a company means all its tangible net asset.
It is used to measure the company’s market value to its book value.
Investors use this ratio to know whether the company is a potential investment opportunity.
Undervalued stock will signify a warning that the company might not incur good returns in the future.
Overvalued stock signifies expectations of high returns in the future. It is calculated as market price per share by book value per share.
Return on equity
Return on equity is a financial analysis tool that helps investors understand a company’s efficiency.
It shows how good a company is at using shareholder’s investment and generating profit from it.
By this, investors can gauge if a company will give good returns to the future and how effectively it will perform.
It is calculated by dividing net income of the company by average shareholder’s equity.
Debt to equity
A company needs to make more profit than the amount of debt it owns.
If the company is unable to cover up its debts than the shareholders will face a revenue crisis and may even lose a good amount of money.
Debt to equity ratio is a tool used to compare company’s liabilities to its shareholder’s equity.
This gives a good idea of how the company is using its leverage.
It is calculated as a ratio of total liabilities by total shareholder’s equity.
The bottom line
An investor should compare and evaluate the market effectively and to invest in a company’s stock.
Market value, solvency, liquidity, profitability, and efficiency are important aspects of a company which determines its efficiency in the long term.
An investor should be skepticle about all the financial tools and make wise investments.