Decoding key financial ratios

The financial ratios of a company mirror the financial health of a company. But is essential to understand and interpret some of the key financial ratios to accurately gauge the financial health of the company before investing in the stock. Here are some of the key financial ratios that every investor must look at before investing:

Earnings per share (EPS): This ratio depicts the profit of the company for the year on a per share basis, so if the entire profit of the company for the year were to be distributed among the investors, they would get the EPS amount for every share held by them. EPS denotes the earnings of the company as compared to the face value (FV) of the share. So, if the FV is Rs 10 and the earnings per share is Rs 25, the company’s profitability can be said to be high.

Return on Equity (ROE): This ratio, also called the Return on Net Woth (RONW), indicates the return generated by the company on its equity capital. The higher the ROE, the more profitable is the company.

Return on Capital Employed (ROCE): This ratio indicates the return generated by the company on the equity capital and the outstanding debt (in the form of loans and bonds) of the company. As with shareholders’ equity capital, loans and bonds are liabilities of the company and the company has to meet its obligations of interest payments and repayments of loans and bonds. Therefore, ROCE provides an indication of the company’s profitability and a barometer of its financial health and capability of meeting its financial obligations.

Debt-Equity Ratio (DER): The DER shows the extent to which the company is leveraged. The higher the DER, the higher the leverage, and lower the DER, lower the leverage. Higher leverage means higher interest outgo, which can be a burden on the profits of the company. So, a company with lower DER or debt-free status is always better than a company with higher DER.