Which Ratios you must check before investing in any stock (2024)

Investing in stocks has always been a matter of fear for us since we have been always taught stock market as speculation. However, times have changed now, with the outrage of social media and internet, people are becoming more and more aware of the financial literacy in India.

Any stock can be analyzed on many parameters but these are 6 basic checks which can tell you whether to go for further analysis or not. So here are 6 parameters which you must look at before investing in any stock.

1. Promoter Holding:

• Promoters are the people who start a company. So before investing in any share, you should always check how much percentage of the total share capital is held by promoter in the company.
• If it is decreasing every quarter then it might not be really good sign because it indicates that promoter might not have faith in the business of the company anymore or they have some other good alternative to invest their money.
• One should also check Number of shares pledged by Promoter as it tells you how much shares promoters have pledged to get loan for meeting any business or personal requirement.

2. EBITDA Margin:

• Earnings Before Interest, taxes and Depreciation and Amortisation represents the operating profit of a company which has been earned from core business operations.
• EBITDA margin tells you how much operating profit company has earned as a percentage of its revenue. An increasing EBITDA Margin is always good which means that company is able control its operating costs effectively. It is calculated as below:
  • EBITDA/(Total Revenue)*100

3. Debt to Equity Ratio:

• Any company can run its operations from the capital raised through Equity or Debt. In case of Debt certain percentage of interest is paid every year which is cost to the company. However, Equity shareholders have no such right of any fixed percentage of profit.
• Interest component reduces the profitability of any company to a great extent, therefore we should avoid companies with high debt, an Ideal Debt to Equity ratio is 2:1 which represents that debt component should not more than twice the equity of the company. Lower Debt to Equity ratio is always better. It is calculated as below:
  • Debt/Equity

4. Current Ratio:

• Current Ratio includes two components: Currents Assets and Current Liabilities. These are the assets/ liabilities which shall be realized/ paid off in the duration of 1 year.
• Therefore, it tells you company ability to pay off its current liabilities out of its total current assets.
• It is considered that higher the current ratio, better it is for the company however, one must notice the quality of current assets say if debtors are outstanding from a long time, then it means that company is not able to realize money from its customers on time. It is calculated as below:

Current Assets/Current Labilities

5. Return on Capital Employed:

• ROCE represents the operating profits which has been earned by company as a percentage of Total Capital Employed. It included both, Equity and Debt component.
• In increasing trend in ROCE indicates better utilization of funds by the management.
• It is calculated as below:
  • EBITDA/(Total Revenue)*100

6. Free Cash Flows:

• Free cash flow represents the cash earned from core business operations after investing into Fixed Assets. Higher the free cash flow better it is for the company.
• It is calculated as: Profit from Operating Activities-Net investment in Fixed Assets

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