06 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses

These ratios are like readymade tools to interpret what's happening in a company

Earnings per share (EPS): EPS tells you the profit of a company per share. It helps determine valuations when seen in conjunction with price. The resulting metric is called the price-to-earnings ratio.

Debt to equity: Companies take debt to run their business operations. Their shareholders also put money, called equity, in the business. The debt-to-equity ratio tells us about this balance. A high deb-to-equity is not desirable. But to know what is ideal, you must see the industry-wide trend. As a rule of thumb, avoid companies where the debt-equity ratio exceeds one.

Return on net worth (RONW): Also called the return on equity (ROE), this ratio tells us what returns a company is generating on its equity part. A high RONW is desirable. Good companies have more RONW than their peers.

Operating margin: This ratio tells us how much a company makes from its core operations. It is derived by dividing the operating profit by the total revenues. A high operating margin is a good sign, but do see the industry trend.

Revenue growth: This ratio indicates how fast a company is growing its revenues over a period of time. A high revenue growth is a positive sign and shows that the company is expanding.

EPS growth: This is a tool related to EPS and tells us the growth of EPS over a period of time. For instance, if the EPS of a company this year has gone up from Rs 10 to Rs 12, the EPS growth is 20 per cent. Good companies show higher earnings growth than their peers in a sector. A shrinking EPS, on the other hand, should ring an alarm.

Share: