5 Most Important Ratios Every Investor and Traders Must Know

To cash in gains from stocks, you have to understand that even though there is no direct way to analyze any stock but you can use some fundamental metric measures to your advantage.

Hence, there are some metrics that are extremely essential for trading online. These fundamentals include a company’s financial as well as operational data. Knowing the financial figures helps you understand the company’s financial health and growth prospects.

Some metrics that are more important than the others and here’s five of them.

Price-to-Earnings Ratio:

One of the most valuable metrics, P/E or price-to-earnings ratio divides the stock’s price by the earnings per share to arrive at the value that lets you know how much investors are willing to spend against every rupee of a company’s earnings.
The importance of this measure is that it provides a measuring stick for traders to compare valuations. For example any stock with a low P/E ratio costs less per share than one with a higher P/E. P/E ratios however work best while compared within a single industrial sector. 

Price-to-Book Ratio:

P/B ratio is an equally good metric like the P/E ratio. It divides the stock’s share price by its net assets. In case of the P/B ratio, all the intangibles are taken out which means that investors get to know what they are paying for real tangible assets.

However certain companies have important intangibles, the P/B ratio would be misleading to say the least. It is conservative metric but handy in most occasions.

Debt Equity:

It is essential that as a trader, you should know how a company can finance any of its assets. The Debt/Equity ratio indicates the amount of financing any company has received from debt and equity.

However when an industry is facing a tough time, debt/equity numbers will show that a company is getting over its head in debt.

Free Cash Flow:

A company’s earnings is never equal to the amount of cash it generates. The reason why this happens is because companies normally report their financials using accounting principles like GAAP or IFRS and not a financial statement of their corporate checking account.

It might so happen that a company has reported huge profits for this quarter, however their coffers are empty. Free cash flow indicates how much cash the company has after capital investments. This is a great metric to use during tough times.

PEG Ratio:

The PEG Ratio, or the price/earnings to growth ratio is an evolved version of the good old P/E ratio. As a trader you can use this ratio to find undervalued companies on an upward growth path, which could gain some attention later on.

However when you are using the PEG ratio, needless to say, that it varies from industry to industry like the P/E ratio and it should be used to compare between companies belonging to the same industry.

Conclusion:

Investing is much more than just analyzing the numbers. Sometimes quantitative metrics like low or high stock valuations may not tell the real story. In many cases qualitative metrics are better in evaluating a stock. Just because a stock seems to be cheap does not mean it will increase in value or deserves to increase in value.

There can’t be a right or wrong analysis with a single metric, it can be right at times, it can also be wrong. So as a trader, all you can do is keep working on your fundamental analysis skills, these metrics will only help you to sharpen your skills.

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