Stock Market Tips: Whether a stock is cheap or expensive or whether one should invest in a particular company, it can be known through a ratio.
Stock Market Tips: When you invest directly in the stock market, the first thing to do is to choose the best stock. A lot of care has to be taken while choosing stocks so that you can get great profits. Sometimes you must have read in the news that if the stock of this company is expensive then it is not right to take it. In such a situation, the question must have arisen in your mind whether a stock is cheap or expensive, how does it know whether the price of a stock is right or not. Its calculation is shown by the particular financial ratio. Apart from this, the health of the company is also estimated from these ratios. Let us know about some of these special ratios which can help in choosing a stock.
Price to Earnings (P/E) Ratio
Price to Earnings Ratio is the ratio of a company’s current share price and Earnings Per Share (EPS) of a company. This shows the overvalued or undervalued share price of a company. It is written in the form of multiples such as 15x, 20x, 23x and through this a comparison can be made between two companies of the same industry, then the historical record of the same company can be tested. Its high means that there are high expectations about future growth or it is overvalued, while on the other hand, it means that the company does not have high expectations about the growth or it may outperform i.e. undervalued.
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Return on Equity (R/E) Ratio
It is a measure of the financial health of a company by dividing net income by total equity. This shows the return on investment in the shares of a company, that is, it gives an idea to the investors that how much capital can be increased on investment in it. It is a measure of the profitability of the company that how well the company is generating profit.
Price to Book (P/B) Ratio
It is used to compare the market capitalization of a company with its book value. Its value is calculated by dividing the current share price of the company by the book value per share. Book value means the value recorded in the balance sheet. It is commonly used by long term investors. If its value is less than one, then less than one is considered better, but value investors consider even 3 better. Lower this ratio means the share is at a discount.
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Dividend Yield (Dividend-Price Ratio)
This shows how much dividend the company is paying in comparison to its share price. It is shown as a percentage and its value is calculated by dividing the dividend by the share price. However, its high value does not mean that a stock is better for investment as its value can be high even if the share price is low.
Debt-to-Equity (D/E) Ratio
It is the ratio of the total debt and equity of the company. This is a very important ratio which shows how much leverage the company is using i.e. how much debt the company is taking for its business as compared to its (shareholder’s) money. Higher this ratio means more risk. However, higher ratio for long term investors means different as compared to short term investors as liabilities in long term are different from short term. Generally a debt-equity ratio of 2-2.5 is considered good.
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