Understanding these 6 key stock market ratios can help investors make informed decisions. Learn how to evaluate stocks using P/E ratio, P/B ratio, ROE, debt-to-equity, dividend yield, and PEG ratio.
Why Are Market Ratios Important for Stock Investors?
Stock market investing requires a clear understanding of financial statements and market data. Market ratios help investors assess a company's valuation, financial health, and investment potential.
Before investing, every investor should understand these 6 essential market ratios to make well-informed decisions.
1. Price-to-Earnings Ratio (P/E Ratio)
Why It Matters?
The P/E ratio indicates whether a stock is overvalued or undervalued.
Example: If a company's stock price is ₹100 and its Earnings Per Share (EPS) is ₹4.5, then its P/E Ratio = 100 / 4.5 = 22.22.
For Indian companies, a P/E ratio between 15-25 is considered reasonable.
How to Interpret It?
Low P/E ratio (below 15) → The stock might be undervalued, but it could also indicate weak growth potential.
High P/E ratio (above 25) → Investors expect high future growth, but the stock could be overvalued.
2. Price-to-Book Ratio (P/B Ratio)
Why It Matters?
The P/B ratio compares a company's stock price to its book value.
If the P/B ratio is below 1, the stock may be undervalued and a good investment opportunity.
How to Interpret It?
P/B ratio below 1 → The stock is trading below its book value, making it attractive.
P/B ratio above 1 → The stock may be overvalued, but investors expect strong growth potential.
3. Return on Equity (ROE - Profitability Indicator)
Why It Matters?
ROE measures how efficiently a company generates profit for shareholders.
A company is considered good for investment if its ROE is equal to or higher than the industry average.
How to Interpret It?
Higher ROE → The company is profitable and effectively utilizing shareholder funds.
Lower ROE → Indicates low profitability or inefficient management.
4. Debt-to-Equity Ratio (D/E Ratio - Financial Stability Indicator)
Why It Matters?
This ratio shows the proportion of a company's funding through debt versus shareholder equity.
A high debt-to-equity ratio means a company relies heavily on debt, which can be risky.
How to Interpret It?
D/E ratio below 1 → The company is financially stable with low debt.
D/E ratio above 1 → The company has high debt levels, which can increase financial risk.
5. Dividend Yield (Income Indicator for Investors)
Why It Matters?
Dividend yield shows how much of a company’s profit is returned to investors as dividends.
It is a key ratio for investors seeking regular income from their investments.
How to Interpret It?
High dividend yield → The company is returning a good share of its profit to investors.
However, be cautious: Sometimes, a high dividend yield is due to a falling stock price, which may indicate financial trouble.
6. Price/Earnings-to-Growth Ratio (PEG Ratio - Growth & Valuation Balance)
Why It Matters?
The PEG ratio links stock price, earnings per share (EPS), and expected earnings growth to help investors determine a stock’s fair value.
A PEG ratio below 1 suggests the stock is undervalued.
How to Interpret It?
PEG ratio below 1 → The stock is attractively valued compared to its growth potential.
PEG ratio above 1 → The stock may be overvalued compared to its earnings growth.
Conclusion: Why Market Ratios Matter for Investors?
Analyzing market ratios helps investors make better stock investment decisions.
P/E Ratio → Is the stock overvalued or undervalued?
P/B Ratio → How does the stock price compare to its book value?
ROE → How profitable is the company?
D/E Ratio → How much debt does the company have?
Dividend Yield → How much return does the stock provide as dividends?
PEG Ratio → Is the stock priced fairly based on expected growth?
By using these ratios, investors can identify strong stocks and minimize risks.
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By Team Atharva Examwise #atharvaexamwise
