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Fundamental Ratios for Stock Analysis - Part 2
Book value per share –
Book value per share indicates how much net asset are backing each share. Book value is net worth of the company. It is the net after you take out every liability from the asset base. The book value, however, doesn’t have much relevance for many companies (especially in the knowledge sector firms) as the asset base is very less. The major value lies in intangibles such as brand, knowledge, and IP driven processes and products. Nevertheless, book value is a still followed by many analysts to get a fair idea about the valuation of stock.
To take the same example of HUL and ITC, their book value per share is Rs 12.19 and Rs 20.51. In such cases, even looking at book value per share will be meaningless. Book value is important in analysing banks and financial institutions. Typically, a higher book value is better and preferable.
Return on Net worth (RONW) –
Return on net worth indicates the returns that investors get on the shareholders’ funds or equity. This is calculated by dividing the net earnings by shareholders’ equity or net worth or book value. This is also known as Return on Equity or ROE. RONW or ROE is the most important parameters for investors from returns perspective unlike PE ratio which is the most important from valuation perspective.
Taking the example of HUL and ITC again, the values are as 87.57% and 31.36% for the year 2010-2011. Certainly HUL gave better returns than ITC in the year 2010-2011.
Profitability –
Profitability is a measure of operational efficiency of the company. A higher margin is certainly better and it adds to shareholders’ net worth. Profitability can be measured as EBITDA margin or net profit margin. EBITDA margin is used to determine the operating efficiency as this doesn’t factor for interest, taxes, and depreciation which are more dependent on policies. Net profit margin gives you the final margin after you pay to the Government and creditors. The net profit margin is for shareholders.
EBITDA margin and net profit margin can be calculated by using EBITDA or net profit number and dividing them by revenue. In our example, the EBITDA margins for HUL and ITC are 13.53% and 34.08% while the net profit margins are 11.56% and 22.91%. The data clearly shows that ITC is more profitable than HUL.
Debt Equity ratio –
Debt equity ratio measure the proportion of debt in relation with equity. Lower ratio is preferable because if the debt portion is high, a large part of the profit may go to pay debt and leave very little for shareholders. The value is calculated by dividing the debt from balance sheet by net worth. Debt equity ratio for both HUL and ITC are very low.
