Fundamental analysis looks at a company’s business, financials and valuation to judge its long-term worth. These metrics are best compared against the company’s own history and against peers in the same sector, since “good” values vary a lot between industries (a bank and an FMCG company can’t be judged by the same yardstick).
1. Valuation Ratios (Is the stock cheap or expensive?)
- P/E Ratio (Price to Earnings): Share price divided by earnings per share. Shows how much investors pay for every ₹1 of profit. A high P/E may reflect growth expectations; a low P/E may signal undervaluation or underlying problems.
- PEG Ratio: P/E divided by the earnings growth rate. Adjusts P/E for growth; a value around 1 is often considered fairly valued, though this is a rough guide.
- P/B Ratio (Price to Book): Share price relative to book value (net assets) per share. Most useful for asset-heavy businesses like banks and NBFCs.
- EV/EBITDA: Enterprise value (market cap + debt − cash) divided by operating earnings. Allows fairer comparison between companies with different debt levels.
- Price to Sales (P/S): Market cap divided by revenue. Helpful for companies that aren’t yet profitable or have volatile earnings.
- Dividend Yield: Annual dividend per share as a percentage of share price. Relevant for income-focused investors.
2. Profitability Ratios (How well does the company make money?)
- ROE (Return on Equity): Net profit as a percentage of shareholders’ equity. Shows how efficiently shareholders’ money is being used. Consistently high ROE is generally a positive, but check that it isn’t inflated by heavy debt.
- ROCE (Return on Capital Employed): Operating profit as a percentage of total capital (equity + debt). A broader measure than ROE and widely used in India to judge capital efficiency. Ideally it should comfortably exceed the cost of borrowing.
- Operating Profit Margin (OPM / EBITDA Margin): Operating profit as a percentage of revenue. Reflects pricing power and cost control in the core business.
- Net Profit Margin: Net profit as a percentage of revenue. Shows how much of each ₹1 of sales ends up as profit after all expenses and taxes.
- EPS (Earnings Per Share): Net profit divided by number of shares. The trend over several years matters more than any single figure.
3. Financial Health and Leverage (Can the company survive tough times?)
- Debt to Equity (D/E): Total debt relative to shareholders’ equity. Lower is generally safer, though acceptable levels vary by sector (capital-intensive industries typically carry more debt).
- Interest Coverage Ratio: Operating profit divided by interest expense. Shows how comfortably the company can service its debt; a low figure is a warning sign.
- Current Ratio: Current assets divided by current liabilities. Measures ability to meet short-term obligations; a value above 1 indicates more short-term assets than liabilities.
- Quick Ratio: Like the current ratio but excludes inventory, giving a stricter view of liquidity.
4. Efficiency Ratios (How well are assets and working capital managed?)
- Asset Turnover: Revenue divided by total assets. Shows how effectively assets generate sales.
- Inventory Turnover / Inventory Days: How quickly inventory is sold. Rising inventory days can signal slowing demand.
- Debtor Days (Receivable Days): Average time taken to collect payment from customers. A steady rise may mean the company is extending easy credit to push sales.
- Cash Conversion Cycle: Inventory days + debtor days − payable days. A shorter cycle means cash is tied up for less time.
5. Growth Metrics (Is the business expanding?)
- Revenue Growth (CAGR): Compounded annual growth in sales over 3, 5 or 10 years. Consistency matters as much as the rate.
- Profit Growth (CAGR): Growth in net profit over time. Profit growing faster than revenue suggests improving margins.
- EPS Growth: Growth in per-share earnings, which also captures the effect of share dilution or buybacks.
6. Cash Flow Indicators (Are profits turning into real cash?)
- Operating Cash Flow (CFO): Cash generated from core operations. Over the long run it should broadly track net profit; a persistent gap is a red flag.
- Free Cash Flow (FCF): Operating cash flow minus capital expenditure. The cash genuinely available for dividends, buybacks, debt repayment or growth.
- CFO to PAT Ratio: Operating cash flow divided by profit after tax. A ratio consistently close to or above 1 indicates good earnings quality.
7. Shareholding and Governance (Particularly relevant in Indian markets)
- Promoter Holding: Percentage of shares held by the founders or controlling group. Stable or rising holding is often read as confidence; sharp falls deserve a closer look.
- Promoter Pledge: Share of promoter holding pledged as collateral for loans. High pledging is a risk, since falling prices can trigger forced selling.
- FII / DII Holding: Stakes held by foreign and domestic institutional investors. Changes over successive quarters can indicate shifting institutional interest.
- Dividend Payout Ratio: Proportion of profit paid out as dividends. Indicates the balance between rewarding shareholders and reinvesting in the business.
Points to Keep in Mind
- No single ratio tells the whole story. Look at several together and over multiple years.
- Always compare within the same sector. A D/E of 2 may be normal for an infrastructure company and alarming for an IT services firm.
- Banks and NBFCs use their own set of metrics (NIM, GNPA/NNPA, CASA ratio, capital adequacy) that standard ratios don’t capture well. That could be a separate post.
- Numbers explain the “what”; annual reports, management commentary and concall transcripts help explain the “why.”
- Qualitative factors such as management quality, competitive advantage (moat), industry outlook and corporate governance matter as much as the ratios.
Disclaimer: This post is for educational purposes only and is not investment advice or a recommendation to buy or sell any security. Please do your own research or consult a SEBI-registered advisor before making investment decisions.