Investing in stocks is a riskier way of earning profit. Large profits can be made if the decision is made correctly. This risk can be minimized by making good estimates about the stocks. For making these estimates financial statements and the earnings are not enough, as financial statements are not easy to interpret and earnings shown can be controlled by various accounting techniques. In this situation, financial ratios can prove to be very handy and optimum profit from stocks is only possible through analyzing them correctly. Financial ratios give in-depth understanding of the financial statements and the true financial position of the company, which in return makes the decision making easier for the investors. Following are the 5 most important financial ratios for the stock investors.
Dividend yield ratio
Dividend yield ratio is the ratio of dividend paid by the company annually to its share price. It actually shows that how much cash flow you can get for each dollar invested in the equity. It can also be termed as investors’ return. Investors can use this ratio in two ways. First they can check which stock is better to invest as sound companies have higher dividend yield ratio while progressing companies have comparatively lower ratio. Secondly investors can get information about the returns they are getting on the stocks they have invested in.
Price earning ratio
Price to earning ratio is the ratio of market price of the share to its earning. Earning per share (EPS) used in this ratio is calculated in different ways. Mostly it is calculated from the last four quarters. This ratio shows the expectation of the investors about the stock, the higher the PE ratio the higher the expectation for the stock to be profitable. This ratio alone is almost meaningless, unless it is compared with the PE ratio of the other companies of the same industry. Investors can analyze by comparing the PE ratios of the companies of any industry. And they can make profitable decision by investing in the stocks with higher price earning ratio. PE ratio of a company can also be compared with the historical PE ratio of the same company. It would show the progress of the stocks of that company in the exchange. If the ratio is increasing by time, it means that expectation and willingness of the investors to invest in the stock are increasing with the passage of time.
Earning per share ratio
This ratio can be calculated by dividing net income earned in the given period of time by the total number of shares outstanding in the same period. Usually weighted average of the number of shares outstanding is used in the formula. This ratio is the profitability of the company per unit of the ownership of the shareholder. While analyzing investors should keep in mind that earnings shown by the company could be doubtful, due to accounting changings. If the earnings are not real then this ratio is not a good measure.
Dividend payout ratio
It is the percentage of the earnings which are paid by the company to its investors in the form of dividend. This ratio is in real the measure that how much the company is paying back to its stockholders. Dividend payout ratio is more useful for the investors, who are willing to do a long term investment in stocks. Mature and stable companies have higher payout ratio as compared to other companies of the industry.
Debt to equity ratio
Debt to equity ratio is calculated by dividing liabilities by the equity of shareholders. This ratio shows that how much equity the company is investing for its assets. Higher ratio shows that the company is investing largely for the long term plans and it has sound future prospects.
My Name is Ammad Hafeez and I’m writing for last 5 years for different newspapers and websites on variety of subjects i.e. Finance, Investments, Business, Politics and Sports