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5 Must Know Financial Ratios to Pick a Stock - Stocks for Beginners | EP 02 | Groww - YouTube
Channel: Groww
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So today's video is going to be very important for you
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Because this video will be a learning video and I will exaplain to you with an example
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Which ratio is important, where and how much
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So if I tell you a little about today's video
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So in today's video I am going to tell you about five fundamental ratios
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Using which
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You can choose a quality stock
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These ratios are very important to conduct fundamental analysis
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Apart from this, if you don't conduct fundamental analysis
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This can give you a slight overview
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How the company is performing compared to its competitors
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And how it can perform in the coming time
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I, Jagdeep Singh, welcome you to the Groww channel
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Today we are going to talk about five important ratios
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Looking at which, you can choose a good company
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Which can help a lot for you to make good invesments
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Let us go to the first ratio, and this is used very commonly
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Almost every investor likes to look at this ratio very carefully
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And the name of this is P/E ratio
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Which we also call P/E ratio
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So what does P/E ratio say, and what is the definition for it
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So if I talk about the definition of P/E ratio, like it is in the name, price to earning ratio
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So price if the price of the sahre right now
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And the earning in the denominator
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That tells us what the earning of the company is per share
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Consider there is one company whose earning is Rs 100 overall
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In total, 10 of its shares trade
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Per share earning of it is Rs 10
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Now consider that the share price of the company is Rs 100 currently
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Now that P/E ratio of it comes out to be Rs 10
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So P/E ratio says that on an earning of Rs 1
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What is the price the company is getting
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Normally it is considered that higher the P/E ratio
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That much is the stock overvalued
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But now I cannot tell you
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That if the company is higher than 10 then you shouldn't invest it in
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Because only by looking at P/E ratio
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You can never make a good investment
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P/E ratio is just a fact check
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And you can never compare the absolute value
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You should always compare it across industries
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Like I will give you an example to explain it to you
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In any industry, having a P/E ratio of 50-60 is considered normal
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And many companies are there
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Where the normal P/E ratio is 10
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So if I give you the example of an industry where the normal P/E ratio is 40-50
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That is FMCG industry
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So if I talk about a company, Hindustan Unilever ltd, HUL
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Its P/E ratio is more than 70
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If I talk about another company, Britannia
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Even its P/E ratio is around 50
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So in this industry it is considered normal to have a P/E ratio of 40-50
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Now I will go to such an industry
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Where the P/E ratio is around 10
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If I talk about such an industry
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The name of this industry is Paper industry
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So in the paper industry, many companies have a P/E ratio less than 10
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I will give you an example and try to explain to you, there is a company in the paper industry, JK paper
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The P/E ratio of JK paper
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That is around 4
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Now you will think that if you compare this 4 to 40 or 50
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Then 50 company is highly overvalued
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Now I will tell you that the company with P/E ratio of 50
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That was a company in the FMCG sector
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For them, P/E ratio of 50 is normal
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JK paper, which belongs in the paper industry
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Its P/E ratio is 4
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So here it is very important for you to compare the company's P/E ratio to the industry's P/E ratio
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Like if I talk about the average P/E ratio of the FMCG sector
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That is 40+
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There if I talk about the paper industry
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The normal P/E average
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That will be around 7, 8 or 9
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There a P/E ratio of 4 or 5 is normal
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And this varies from industry to industry
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Let us move onto the next ratio and before that I want to tell you a little about the company
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Whenever someone sets up a company, or a promoter sets up a company
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While setting up the company, they put in a little of their money
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Which we call Equity investment
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So they keep some money for ownership which we call equity investment
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The money that the owner puts in the company
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Then some amount of money comes from tax, the company that takes loans to expand itself
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The second ratio is very connected with equity financing
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Now consider that you are a promoter of a company that you have invested in
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Consider that you contributed Rs 100 in equity
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The total value of the company had an equity of Rs 100
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Now in equity
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The income that the company generated is very important
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Consider that one company had an equity of Rs 100
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They generate an income only of Rs 20
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And there is another company which generates an income of Rs 40 at the same equity
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So the company that generates higher returns is considered better
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In the same set of equity capital
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This ratio is called ROE
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This is called Return on Equity
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Return on equity tells us that on an equity investment
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How much profit that company gave
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If I talk about its formula
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The formula for ROE is
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Net income/Total equity
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How much net income the company gave on the total income
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Like I told you in the previous video
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What is net income
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When we remove other expenses from the total revenue
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We get the net income
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So ROE is very important for any company
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And this also tells us
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How efficiently a company and its management used its equity
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It is possible that the company uses Rs 200
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And gives a return of Rs 20
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There, another company gives you a Rs 20 return on an investment of Rs 100
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One company's ROE is 10%
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And the second company's ROE is 20%
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The second company becomes very efficient
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So if I give you the example of two companies whose ROE is very high
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A company that you must have heard about many times, Coal India
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The ROE of coal India in the past year
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That is more than 70%
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There is another company, HEG
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Whose ROE is more than 100%
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So don't invest in these companies just by looking at the ROE
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I would like to give you an example and explain
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How ROE works
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But you can never invest by looking at one parameter
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And ROE is very important for you to look at sector to sector
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And after that you should see that the company's structure
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How the company's financing structure is
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Because it is possible for a company to have a very high ROE
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Because that company had taken a lot of debt
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Its equity investment is low
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So you have to see the entire structure, look at the equity structure
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And then think about ROE
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Let us talk about the third ratio which we call price to book value, P/B ratio
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So P/B ratio tells us what the company price is in comparison to its book value
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Price means, share price
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Now what is book value
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Now consider that the value of a company is Rs 100
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And the company thought to sell its entire business
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They are going to shut down their business
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So out of that Rs 100, the company said that they have to pay a debt of Rs 40
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After paying off the debt, the value of the company became Rs 60
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After that, the company sold all its assets
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After selling those assets the company gets Rs 20 more
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The total book value of the company is Rs 80
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Now consider that the total number of shares of the company was 10
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The book value of the company per share is Rs 8
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Now consider that the share price of the company is Rs 80
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The company's P/B ratio becomes Rs 10
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80 divided by 8
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The P/B ratio of the company is Rs 10
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80, which is the share price of the company
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8 which is the book value of the company per share
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So it tells us that if one company stops all its business today
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If it pays off all its liabilities
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Sells all its assets
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What will the per share value be of the company
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Which we call book value
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And P/B value, normally value investors
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They see if the P/B value is low to see whether the company is fundamentally strong
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But I want to tell you another word of caution here
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You cannot tell how a company is just by looking at its P/B value
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Because there are some companies whose P/B ratio is lesser than 1
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Which means that it is trading at its book value
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This is not a good thing, because in cases like these
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If you see that the P/B is low and you will invest
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There will be many panic stocks
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Which are fundamentally very weak
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Their P/B ratio will be very low
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So you should see the P/B ratio from industry to industry
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This is just a fact check
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Only on the basis of this, you cannot judge a company
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I will try to explain this with a small example
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Yes bank has a P/B ratio of 1.14
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But as you know, this bank was in a lot of trouble in the recent past
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So this number cannot tell you how this company is
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This is a very small number
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There is another company, D-mart
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Whose P/B value is 22
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But that company is considered fundamentally strong
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So the P/B ratio
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It is a good ratio which can give you the idea
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It can give you an indicator
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But it cannot be the prime reason for your investment
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So using this value, you can get a little idea
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But don't base your entire investment decision on this parameter
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Now let us talk about the fourth ratio, but before I go to that
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I will make you think whether that investment was good or not
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Now consider that you invested in a company
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Its share price a year ago today was Rs 100
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At the same point today
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The share price of the company is still Rs 100
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How do you think the invest was? Good or bad?
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If you look at the share appreciation, you got a 0% return
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Maybe you would think that you did not make a good investment
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But here there is another source of return when you invest in any stock
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That source of return is dividend
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So the company directly given an investor dividend income
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The company that gives it shareholders one share from its profits
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Now consider that one company had a profit of Rs 100
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They felt that they should keep Rs 60 for their expansion
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But they should distribute Rs 40 directly to their distributors
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Now consider that in the Rs 40, there were 100 shares
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Every shareholder, gets a dividend of 40 paise
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So dividend becomes a second source of income on your share appreciation
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Which becomes very important in some investment cases
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Like the example I gave you now, there was Rs 100 share
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Even now it is Rs 100
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You will feel that your investment is not good
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But now consider that in the past year, that company gave a Rs 20 dividend
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You get a direct 20% return
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Even if its share price did not increase
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So there is a ratio which tells you that in any stock
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What the dividend was in the recent time
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And this ratio is very important when you invest
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Because there are many stocks whose price appreciation is not that much
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But their dividend income is very good
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From today, whenever you invest
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You should pay attention to this well
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And the name of this ratio is dividend yield
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Dividend yield tells you
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How much dividend a company gave on the share price
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So the higher this is, the higher is your dividend income
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So whenever you calculate the net return of any company
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You should see your dividend income on that as well
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So if I tell you the names of two three stocks like these
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Which give a lot of dividend, whose dividend yield is very high
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The examples of those are Coal India
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Vedanta
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NTPC, apart from this there are many PSUs that give a lot of dividend yield
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And you can consider dividend yield in the coming time
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When you think about a stable income
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So I will talk about the last ratio which is very important for the company's structure
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According to the company's finances
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And the name of this is Debt to equity ratio
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Debt to equity ratio tells you
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The overall structure of the company
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How much of that is debt and how much is equity
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Normally it is considered that when a company has a lot of debt
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It is impossible for the company to pay its debt back
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Because for debt, you always have to pay interest
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And when a company pays interest, its profit and loss statement is directly or indirectly affected a lot
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Because of which its net income reduces
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Because of the net income reducing, the cash flow also reduces
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People see interest in a very negative way
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And they want to see that the company they are going to invest in
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Does that company have a lot of debt
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This ratio can be very helpful for you guys
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Using this ratio
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You can find out that the company you're going to invest in
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How much debt do they have
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So debt equity ratio says that the company you are going to invest in
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How much is the debt and the equity
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And normally, higher the ratio
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Higher the debt is for that company
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Now there is no cutoff value for this
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You don't have to invest in more than 5 companies
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Because many times, the debt that we look at in a negative way
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Many times, debt can be seen in a positive way as well
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Because there are many companies that take the right amount of debt
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Pay it back at the right time
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And grew a lot
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So you can't decide whether the company is good by looking at this ratio
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But this can help if you want to take a selective approach
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You don't want to invest in those companies who have a lot of debt
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This ratio can be very helpful for you
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So this video was purely for educational purposes
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So that you can get an idea about the ratio
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Using which we can get a factcheck, and glance through information
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You can judge your investment
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And these ratios are such
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Which aren't stable
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The ratios I told you about aren't stable ratios
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They change quarterly or after every annual result
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And many ratios change with price like P/E ratio
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P/B ratio
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Because price is directly used in them
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So if you want to invest
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So keep checking these results after every quarter
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So that you can find out whether these ratios are going out of your quarterly result
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So if you liked this video, press the like button
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You can comment and ask us anything
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Apart from that, if you haven't yet subscribed to our channel
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Then please subscribe to the Groww channel
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Because we put up 3-4 videos every week on this channel for educational purposes
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Which can help a lot for you to become a good and intelligent investor
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Happy investing!
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