Evaluating the value of the company may seem difficult but it will prove essential in helping you save money and make a better decision in your investment diversity. Using simple mathematical formulas, you too can use the number on the company's financial statements to make valuations of your own.
Here are 3 simple financial ratios that you should consider while making your investments:
1. Earnings Per Share (EPS)
EPS, as the name suggests, is the portion of the company's earnings (profit) that is allocated per share (excluding preferred share). It gives you an idea of how profitable the company is to its investors.
The formula for earnings per share = (Net income-dividends on preferred shares)/average outstanding shares
Average outstanding share means just the common equity shares that are available on the market. The number of these outstanding shares could keep changing and you should be able to find the published details on the companies on financial websites. (click here to find out company details on GoodReturns).
2. Price to Earnings Ratio (P/E)
One of the most used investment valuation indicators, a P/E ratio indicates how much the investors are paying for today's earning in anticipation of future earnings growth. In simpler words, it gives you an idea of how many years' earnings it will take to recover the price you paid for the share.
P/E ratio= Price per share/ EPS
Suppose the P/E ratio comes to 10, it means that you have paid Rs 10 to earn each rupee. Therefore, it will take you 10 years to earn worth as much money you have spent on purchasing the shares.
3. Debt to Equity Ratio
This leverage ratio gives you an idea about the soundness of a company's long-term financial policies by comparing its total liabilities to its total shareholders' equity.
The formula for debt to equity ratio= total liabilities/shareholders' equity.
It measures how much capital the company's suppliers, lenders, creditors, etc have committed to it over the shareholders. A lower ratio will indicate less leverage and a stronger equity position and vice versa. You can use this ratio to understand the company's financial health before investing in it, if you are planning on long term investment.
You should note that this is not a pure measurement means to check a company's debt, as operational liabilities are a part of the total liabilities of the company and it also depends on the type of industry. However, this easy calculation will you get a fair idea on the company's financial policy.