There was this one instance where he was curious to find out why some chocolate makers get more recognition than the others. His father told him that it is because, like strong structures, successful companies have all the right ingredients, equipment and blueprints to build ‘chocolate factories’. Let us now understand how evaluation of a business should be done.
Key Financial Metrics
1. Earnings Per Share (EPS)
- What is it? EPS shows the profit earned by a company for one share.
- Why it matters: This is useful when comparing businesses irrespective of their sizes.
- Example: In fiscal year 2022, the EPS of Nestle India was ₹250. This suggests that the company earned a profit of ₹250 in respect to every single share held by the shareholder which indicates profitability.
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2. Price-to-Earnings (P/E) Ratio
- What is it? P/E explains the ratio of a stock’s market price and its earnings per share calculated over the last 12 months.
- Why it matters: The price expectancy ratio connotes a comparative valuation of future earnings growth or lack thereof.
- Example: A chocolate manufacturer with a stock selling at INR 2500 and an EPS of INR 250 has a price to earnings ratio of ten. This means investors are willing to pay ₹10 for every ₹1 the company earns.
3. Price-to-Book (P/B) Ratio
- What is it? P/B is the stock price divided by the book value (assets minus liabilities per share).
- Why it matters: A company whose P/B ratio is below 1 is usually perceived to be selling below its actual value.
- Example: A Small-scale Enterprise with a ratio of 0.8 for its price-to-book value may possess assets valued at level ₹1, 000 and be worth ₹800 per share, showing potential value.
4. Debt-to-Equity (D/E) Ratio
- What is it? It is the equity ownership of the company that is in the measure of the overall debts of the company.
- Why it matters: Higher Debt to Equity ratio implies higher finance and business risk.
- Example: If Ramesh owned a chocolate factory and took a loan of ₹100 against the owners’ investment of ₹50, the D/E would be 2. This is risky if sales drop.
5. Return on Equity (ROE)
- What is it? Revenue on Equity or ROE is one of the parameters used to know how profitable a company is in relation to its net worth.
- Why it matters: ROE is an indicator of the effectiveness of the management of a company.
- Example: A company with ₹10,000 in equity and ₹2,000 in profit has an ROE of 20%.
6. Market Capitalization (Market Cap)
- What is it? It means that the value of the market of the firm is arrived at as a product of the price of a single share and the total number of shares.
- Why it matters: It provides the size of a company and the growth which can be expected from it.
- Example: A chocolate company with 1 crore shares at ₹100 each has a market cap of ₹100 crores, making it a mid-cap company.
7. Volume and Trading Activity
- What is it? Volume reads the total number of shares traded every day.
- Why it matters: This is simply to mean that high volume makes it easier to buy and to sell.
- Example: A company with 10 lakh shares traded daily is more liquid than one with only 1,000 shares traded.
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Conclusion
Evaluating a business in advance for investment is like trying to find the best chocolate factory to buy its shares. There are numbers such as EPS, P/E ratio, and ROE, investors think about all the risks and what the market is doing and then make a sensible decision. As Ramesh, it is wise to start it small and learn the aspects gradually building up one’s financial intelligence.
Passionate content writer and savvy blog publisher, Aamir crafts compelling stories and insightful articles that captivate and inform. With a knack for blending creativity and strategy, they bring fresh perspectives to every piece. Dive into their world of words and discover content that resonates.
