RATIO ANALYSIS Ebook

A COMPLETE
GUIDE TO
RATIO
ANALYSIS
A COMPLETE STEP BY STEP GUIDE TO ANALYSE STOCKS WITH RATIOS
INDEX
CHAPTER 1: Finding the Economic MOAT using ratio
Free Cash Flow upon Sales Ratio
Net Profit Margin
ROE
ROA
CHAPTER 2: Earnings Ratios

Earnings per share
Cash Earnings per share
Dividend per Share
Dividend Payout ratio
CHAPTER 3: Profitability Ratios

ROA
ROE
ROCE
PAT margins
CHAPTER 4: Liquidity Ratios

Current Ratio
Quick Ratio or Acid test Ratio
CHAPTER 5: Leverage Ratios

Debt to Equity Ratio
Debt to Asset Ratio
Interest Coverage ratio
CHAPTER 6: Efficiency Ratios

Inventory Turnover ratio
Total Asset Turnover ratio
Receivables Turnover Ratio
CHAPTER 7: Margin Ratios

Gross Margins
Operating Margins
Net profit Margins
CHAPTER 8: Valuation Ratios

Price to Sales Ratio
Price to Book value Ratio
PE ratio
PEG ratio
INTRODUCTION
"Humans can be wrong but math is rarely wrong when

done right."
Financial Ratios are one of the most important aspects of

analysis that cannot be ignored.
When it comes to stock investing, most of us look at
financial statements such as balance sheets, income
statements, and Cashflow statements, however, there are
hundreds and thousands of companies whose revenues
and profits are increasing, Cashflows are excellent, but you
can't invest in every company, right? At least not in our
case.
So what to do?
Not every company gives you multi-bagger returns but

there are some parameters that create a difference among
these companies and that will help you develop concrete
decisions in your investment choices.
What actually is Ratio Analysis?

Ratio analysis is to analyze a company's financial position,
liquidity, profitability, risk, solvency, efficiency, operational
effectiveness, and proper use of funds. It also shows the
trend or comparison of financial outcomes, which can be
useful for shareholders in making investment decisions.
Now let’s dive into the concepts of Ratio analysis.
What Ratios tells us?
Profitability A company's ability to generate income

Ratios from revenue
Liquidity The ability of a company to pay off

Ratios short-term debt
Efficiency Company’s efficiency in the utilization

Ratios of its resources
Leverage Evaluate the debt level of a company's

Ratios capital structure.
Valuation Evaluation of the company’s

Ratios share price.
So till now, we saw a brief introduction to ratio analysis, and

why it is necessary! now let’s dive into the concepts of
Ratio analysis.
CHAPTER 1
Finding the Economic MOAT
using ratio
I WHY ECONOMIC MOAT?
Assume there are no tea shops in your area, so you

decided to start a tea business. After starting up a tea
business, your business becomes a huge success in your
area, minting a lot of money. (see Fig-1.1)
TEA SHOP
Fig-1.1
However, as we all know, success attracts competition,

and as a result of your success, many people started tea
businesses in your area.
Now consider this scenario: when you were alone in the

game, you were serving the entire area; hence your profits
increased, but now as there are lots of tea businesses
www.community.anmolsharma.in
creating tough competition, hence your profits will shrink,
due to falling in market share.
Fig-1.2
But suppose you have built a moat in front of all of them by

boosting the taste of your tea with hidden substances that no one
knows about. People will travel from different areas to enjoy your
unique taste of tea, right? Your profits will not get affected by any
of your competitors and that’s why you must find a company that
is having a moat so that profits don’t get affected in the long run.
An economic moat is a competitive advantage that belongs to a

certain organization and serves to shield its profit margins from
both internal and external threats. It is a differentiating factor
enabling the company to hold a competitive edge.
Moat is the characteristic that helps great performing businesses

to remain consistent.
In this module, we have discussed complete filters and by

applying these filters you can get the list of efficient companies
that will give you good returns, these filters will help you to find a
company that’ll maximize your returns.
Given below is the most typical and simple structure of a P/L statement:
Net Sales (1) 100
Direct Costs (2) 20
Earnings Before Interest Tax Depreciation

80
and Amortization (EBITDA) (3) = (1) – (2)
EBITDA Margin (4) = (3)/ (1) 80%
Depreciation/ Amortization (5) 20
EBIT 60
Interest (6) 20
Other Income (7) 5
Profit Before Tax (8) = (3) – (5) – (6) + (7) 45
Tax (9) [@ 30%] = (8) * 30% 13.5
Profit After Tax (PAT) (10) = (8) – (9) 31.5
PAT Margin (11) = (10)/ (1) 31.5%
A profit and loss (P/L) statement is a

document that contains information on a
company's revenues, costs, and profitability
for any given period. Companies publish their
financial results quarterly, so we get quarterly
P/L statements as well as the final audited P/L
statement with the annual report.
A.) FREE CASHFLOW UPON SALES
Free cash flow(FCF) is the money that could be extracted

from the firm every year without damaging the core
business
The free cash flow to sales ratio is considered to be one of

the most critical performance metrics while analyzing any
company because this ratio gives an insight into the
internal factors of the company.
It is a no-brainer to see how well a company can sell its

products or services to determine if it is a worthy company
to invest in.
FCF
Formula for FCF upon sales = x 100
SALES
EXAMPLE
Scenario 1
Suppose Company A has revenue of Rs.1000 at month-end by selling
goods out of which Company got Rs.950 of their revenue in cash, Rs.50
yet to be paid.
To continue further business operations Company A needs Rs.500, so

here you can see that Rs.450 free cash is in the treasury of the company
and that is called free cash flow.
This Rs 400 is your Free cash flow
COMPANY A REVENUE ₹1000
CREDIT
₹100
CASH
₹900
₹500 ₹400
Now the company

needs ₹500 to continue its
operations for next month! FREE CASH FLOW
Fig-1.3
Scenario 2
You own a business and the total inventory is sold for Rs.1000 (Your
revenue), of which 100 rupees were sold on credit (yet to be paid) and
Rs.900 in cash.
So now you have Rs.900 cash in your hand, and you need Rs.500 to run
your firm and expansion, leaving you with Rs.400 in free cash.
This Rs.400 is your free cash flow for the company.
So approaching the math part,
if we Divide Free cash flow by sales that;
Rs.400
= 0.40 x 100 = 40%
Rs.1000
Ideal performance threshold; If you find a company with free cash flow
by sales ratio between 5% to 10% or more, then you found a cash-cow.
B.) Net Profit Margins
Net profit margins are essentially net income as a

proportion of sales, and they indicate how much net profit
a company makes for every rupee of sales.
Many start-ups can afford to be not

profitable but that isn’t the case for
the companies listed on the stock
market. Net profit margins are a
critical performance metric, after
all, it tells you at the end of the day
do you have a profitable business
or not and will they add any value to
shareholders or not.
Net profit margins are exactly why companies are able to

pay dividends and even focus on CAPEX (Capital
Expenditure) to increase their foothold in the industry.
Net Income
Formula for Net Profit Margin = x 100
Total Sales
EXAMPLE
Scenario 1
Company A has revenue or sales of Rs.1000 and the profit earned is
Rs.400 so the profit margin is;
Rs.400
= 0.40 x 100 = 40%
Rs.1000
COMPANY A
Revenue = ₹1000
Profit = ₹400
Rs.400
Net Profit Margin = = 0.40 x 100 = 40%
Rs.1000
Ideal performance threshold; If a company that can post-net margins

above 15% is doing a great job.
C.) Return On Equity
ROE tells us about the company's profitability and how

effectively it makes profits.
ROE or Return on Equity is one of the most common ratios

and most probably everyone recognizes it but its popularity
doesn’t diminish the value it brings to the table for an
investor who’s analyzing the company,
If simply put; Return on Equity is the net income with

respect to its shareholder's Equity. ROE reveals how much
is the company efficient in generating profits.
Net Income
Formula for Return On Equity = x 100
Shareholders
Equity
EXAMPLE
Scenario 1
Company A has profits of Rs.400 and total shareholder equity is worth
Rs.2000,
400
= 0.20 x 100 = 20%
2000
Ideal performance threshold: if a company is having consistent ROE of

15% or more are generating solid returns for investors.
D.) Return On Assets
A company is known to grow consistently when you see

the operations and management being efficient with their
decision-making and implementation. ROA helps you
decode the efficiency of the company against the assets
the company already holds.
It is understood that a higher ROA

would mean higher efficiency, so keep
a look on ROA while you’re looking for
a new company to invest in.
Sometimes investors might get

confused and ask is there any
difference between ROE and ROA,
well, we’ll let you in on a secret.
ROA accounts for the company’s debts while ROE does not
account for the company’s debts. This reason alone makes
ROA a performance metric that cannot be missed.
ROA is one of the financial ratios that is popular among the

research analysts and investing geeks, after all, it tells how
well the company is operating with all the assets at its
disposal.
The formula for Net Income

= x 100
Return On Assets Total Assets
EXAMPLE
Scenario 1
Suppose your company earns Rs. 400 and your total assets are worth Rs.
4000;
400
x 100 = 10%
4000
Ideal performance threshold: Ideal performance threshold: If a firm is

having ROA of more than 6 % to 7% then the company may have some
competitive advantage (must compare it with peers)
SUMMARY
If Free cashflow upon sales is greater than 5% then

you have found a cash machine
If a company that can post-net margins above 15% is

doing a great job
As a rule of thumb if a company is having consistent

ROE of 15% or more are generating solid returns for
investors
If a firm is having ROA of more than 6 % to 7% then the

firm may have some competitive advantage (must
compare it with peers)
CHAPTER 2
EARNING RATIOS
As the name suggests these ratios tell

us about the company's earnings
position and efficiencies.
A.) Earnings Per Share
EPS indicates the amount of profit the company has

earned for every share.
When a company is traded on the stock market it is not

necessary that the stock price is the direct value indicator
of a company, it could be undervalued or even overvalued,
Now that a company is publicly traded it is crucial to know

what is the value of each share with respect to the
company’s earnings keeping the market’s speculative
valuations and emotions away from the actual number,
This is exactly what EPS tells you.
(Net Income - Dividends)

The formula for EPS = x 100
Total Assets
EXAMPLE
Scenario 1
Suppose your company earns Rs. 200 and your total dividends payout is
Rs. 50 and have 3000 outstanding shares;
(200 - 50)
EPS = = 0.05
3000
Ideal performance threshold: If EPS has increased by 20% or more over

the last five years, it is an excellent Growth Stock. Now, your further
task is to investigate the sources of its earnings.
B.) Cash Earnings Per Share
Cash Earnings per share is more commonly known as

operating cash flow. From the initial look, one might
confuse Cash EPS with EPS; well, they are definitely
different. The EPS provides you with an outlook over the
company by comparing the net income to the total
outstanding shares, it tells you how much profit can be
allocated to each share while for Cash EPS, we compare
the operating cash flow of the company against the
outstanding shares, it tells you how much operating cash
flow can be allocated to each stock.
Cash EPS holds a reputation to be one of the safest

metrics to compare the company’s performance with. Cash
EPS is very hard to manipulate and shows a clear picture of
the cash flow and earnings,
Moreover, when Cash EPS is compared to EPS, EPS only
provides a short-term outlook of the market whereas Cash
EPS gives a long-term outlook. Cash EPS being tamper-
proof is automatically investors’ preferred metric to look
at.
Operating Cash Flow

The formula for Cash EPS = x 100
Outstanding Shares
EXAMPLE
Suppose your company has an operating cash flow of Rs. 1000 and your
total outstanding shares are 50;
1000
Cash EPS = = 20
50
C.) Dividend Per Share
One of the perks investors love the most on top of the

growth in stock is the dividends coming from the stocks
they’ve invested in and to know how much income of the
company will the investor receive on a per stock basis we
refer to Dividend Per Share (DPS, not to be confused with
the school lol)
If a company’s DPS is growing steadily then this tells us

that company is showing stable growth. If a firm's DPS is
declining then must figure out where they are using that
money in the business-
if they are reinvesting it in the business, or reducing debt,
then this can be a good sign because the company is
working on the future growth of the company. But suppose
the company is having high debt and even they are offering
dividends then this can be a poor management scenario.
Annualized Dividend Amount

The formula for DPS = x 100
Outstanding Shares
EXAMPLE
Suppose your company has Annualized Dividend Amount of Rs. 5000
and a weighted average share count are 50;
5000
EPS = = 0.05
50
Ideal performance threshold: If a company’s DPS is growing steadily

then this tells us that company is showing stable growth.
If a firm's DPS is declining then must figure out where they are using that
money in the business- if they are reinvesting it in the business, reducing
debt, then this can be a good sign because the company is working on
the future growth of the company
But suppose the company is having high debt and even they are offering
dividends then this can be a poor management scenario
D.) Dividend Payout Ratio
As mentioned before, the company pays out dividends with

the earnings they've made but only a certain percentage of
the earnings is given out as dividends and that ratio of
earnings and dividends paid out is called the dividend
payout ratio.
Investors look at the dividend payout ratio on a long-term

basis to assess the ranging dividends payouts over the
long term to determine if their investment will yield them
any form of passive income.
The formula for Total dividends

= x 100
Dividend payout ratio Net income
This ratio tells us How much earnings are paid out as a

dividend to shareholders and How much they are keeping
for long-term growth
Growth companies have Low DP ratios and Prefer to invest

in their business for further growth while mature
companies have generally High DP ratios and don't have
reinvestment needs because they already are industry
leaders.
EXAMPLE
Suppose your company has total dividends of Rs. 1000 and net income
to be Rs. 30,000;
1000
Dividend payout ratio = 0.033
30,000
Ideal performance threshold: If a company’s DPS is growing steadily

then this tells us that company is showing stable growth.
If a firm's DPS is declining then must figure out where they are using that
money in the business- if they are reinvesting it in the business, reducing
debt, then this can be a good sign because the company is working on
the future growth of the company
But suppose the company is having high debt and even they are offering
dividends then this can be a poor management scenario
Growth Companies
Low DP Ratio
Prefer to invest in their business
Mature Companies
High DP Ratio
Don't have reinvestment needs
SUMMARY
Earning per share is the net profit divided by the total

number of shares- Higher is the better
CASH EARNINGS PER SHARE - Earnings before interest

tax and depreciation - Higher is better
Dividend per share

- Steady or Growing DPS
- Signal of stability and growth
Declining DPS
- Firm is reinvesting in its business, reducing debt, and
poor earnings.
Dividend Payout Ratio
Growth Companies
- Low DP Ratio
- Prefer to invest in their business
Mature Companies
- High DP Ratio
- Don't have reinvestment needs
CHAPTER 3
PROFITABILITY RATIOS
These set of ratios tells us how

much profit is the company
generating relative to the amount
of money invested in the
business from different angles.
A.) Return on Assets
ROA or Return on Assets is not as popular as its

particularly familiar ratio called ROE but we can assure you
that analysing ROA is just as important as analysing ROE,
Return on Assets is the company’s net income with respect
to the company's assets.
ROA tells us whether the company’s assets have been

effectively and efficiently used or not. To get a better
picture compare it with the companies in the same
industry,
Sometimes investors might get confused and ask if is

there any difference between ROE and ROA, well, we’ll let
you in on a secret; ROA accounts for the company’s debts
while ROE does not account for the company’s debts. This
reason alone makes ROA a performance metric that cannot
be missed.
Net income
The formula for ROA =
Total assets
EXAMPLE
Suppose your company has a net income of Rs. 1000 and total assets
worth to be Rs. 5000;
1000
ROA = = 0.033
5000
If ROA is less than 5% - means it is a capital intensive business
If ROA is greater than 15% - means it is an asset lite business
Prefer Higher ROA- Higher is better
B.) Return on Equity
ROA or Return on Assets is not as

popular as its particularly familiar
ratio called ROE but we can assure
you that analysing ROA is just as
important as analysing ROE, Return on
Assets is the company’s net income
with respect to the company's assets.
ROA tells us whether the company’s assets have been
effectively and efficiently used or not. To get a better
picture compare it with the companies in the same
industry,
Sometimes investors might get confused and ask if is

there any difference between ROE and ROA, well, we’ll let
you in on a secret; ROA accounts for the company’s debts
while ROE does not account for the company’s debts. This
reason alone makes ROA a performance metric that cannot
be missed.
The formula for Net income

=
Return on Equity Average shareholder's equity.
EXAMPLE
Suppose your company has a net income of Rs. 1000 and the average
shareholder's equity is 100;
1000
ROE = = 10
100
Higher ROE - Better the firm but always be careful with Debt
As a rule of thumb if a company is having consistent ROE of 15% or

more are generating solid returns for investors
C.) Return on Capital Employed
For a business to grow, it is absolutely necessary to deploy

capital to grow the business but it also important to see
how well has been the capital employed has been put to
use, And this is exactly what Return on Capital Employed
tells you.
ROCE is a measure that determines how well a company

uses its capital to generate profits. It is not only about how
much money has been employed, it is about how well has
the money been employed and what results have they
produced.
EBIT
The formula for ROCE =
Capital Employed
EXAMPLE
Suppose your company has an EBIT of 4000 and capital employed is

1000
4000
ROCE = = 04
1000
A higher Ratio is more preferable OR as a benchmark more than 12%

is excellent.
SUMMARY
Return on assets < 5% (Capital intensive business) and

Return on assets > 15% (Asset lite business)
Higher ROE - Better the firm but always be careful with

Debt (As a rule of thumb if a company is having
consistent ROE of 15% or more are generating solid
returns for investors)
ROCE - Higher Ratio is preferable OR as a benchmark

more than 12% is excellent.
CHAPTER 4
LIQUIDITY RATIOS
What is Liquidity?
Suppose, You want to pay for your daughter’s school fees

which are Rs. 1,00,000
Now, you have 3 things:
1. Gold jewelry worth Rs. 1,00,000/-

2. Shares of some companies worth Rs. 1,00,000/-
3. And, cash Rs. 1,00,000/-
What would you choose to pay her fees? Of course cash!
Now if I remove 1 lakh cash from the option then what

would you choose? Of course gold!
This is called LIQUIDITY: how easily and immediately you

can convert a thing into money (or substitute of cash) to
buy other goods or services.
Order of liquidity of some of the securities:
Cash > Gold > Stocks > Art.
Now that you know what liquidity is, let's talk about liquidity
ratios.
Liquidity ratios are the ratios that measure the ability of a
company to meet its short-term debt obligations. These
ratios measure the ability of a company to pay off its short-
term liabilities when they fall due.
As our Investments must be liquid and Can be converted

into cash in case of an emergency just like a company’s
assets must be Liquid and converted into cash in case of
an emergency.
A.) Current Ratio
For a company to operate, it is normal for them to have

some sort of debt or liabilities but it must be understood
that companies must expose themselves to risks like
debts and liabilities when they have the ability to pay for
them in a year, And this is exactly what Current Ratio tells
you.
It is evident why this ratio is important, it helps the

investor assess if the company has enough resource
management to handle debts and other payables in the
short term, lower the current ratio, the higher the risk.
Current Assets
The formula for Current Ratio =
Current Liabilities
EXAMPLE
Suppose your company has current assets of 2000 and current liabilities
of 500;
2000
Current Ratio = = 04
500
CR < 1: Tells us that the firm may not be able to meet its short-term
obligations in case of emergency and can become insolvent within a
year.
CR = 1: Represents safety. It tells us that the firm is in a position

where it is able to meet its short-term obligations in case of
emergency.
CR > 1: It is the safest ratio because the company now can easily
solve the short-term need
A.) Quick Ratio or Acid Test Ratio
An eye-catching name for a ratio but it has a reason for its

name.
The current ratio tells us the ability of a company to satisfy

the obligations towards debts, liabilities and other
payables in a year but the Acid test Ratio tells the same
information for the obligations next in line,
Acid test ratio also disregards the assets under the

company’s possession which is hard to liquidate to
determine the true ability of the company to payback and
meet their requirements.
The formula for

=
Quick Ratio
Cash and cash Accounts Marketable

equivalents + receivable + securities
Current
Liabilities
EXAMPLE
Suppose your company has cash of Rs. 5000 and accounts receivable of
Rs. 1000. Market securities are 500 and liabilities are 1000
5000+1000+500
Acid Test Ratio = = 6.5
1000
QR < 1-(The firm may become insolvent within a year.)
QR = 1- Represents safety.
QR > 1- It is the safest ratio because the company now

can easily solve short-term needs.
SUMMARY
Current ratio -The ability of a company to pay its short-

term or current liabilities with that of its short-term
assets. The current ratio of 1 or more than 1 is better
Quick Ratio - Better the firm but always be careful with

Debt (As a rule of thumb if a company is having
consistent ROE of 15% or more generating solid returns
for investors)
CHAPTER 5
LEVERAGE RATIOS
A.) Debt To Equity Ratio
As mentioned before the debt is a normal thing in a

business until it is under control and limit, this safe
threshold can be determined by the Debt to Equity Ratio,
The ratio gives us an insight into the company’s total

liabilities with respect to the total outstanding shares with
the shareholders, the ratio only tells the financial health of
the company but it also shows how big is the company’s
reliance on debt.
The formula for Total Debt

=
Debt to Equity ratio Total Equity
EXAMPLE
Suppose your company has debt of Rs. 2000 and total equity is 50
2000
Debt to Equity = = 40
50
High DE Ratio - High Risk
This indicates the company is too much dependent on its borrowings
Low DE Ratio - Low Risk

This indicates the company doesn't need debt to finance its business
The Ideal DE Ratio is less than one or 1

DE Ratio < 1
B.) Debt To Asset Ratio
With another metric to analyse debt we can have an

understanding of how important debt management is for a
company, Debt to Equity ratio is something people are
familiar with but Debt to Asset ratio is a metric that people
are not so familiar with,
What it tells; Represents the percentage of the company’s

assets that were funded by debt.
The formula for Total Debt

=
Debt to Asset Ratio Total Assets
EXAMPLE
2000
Debt to Equity = = 40
50
DAR = 1
This means companies have the same amount of liabilities as their
assets, which means the company is highly leveraged.
DAR > 1
This means the company has more liabilities than assets that is
Extremely leveraged and highly risky to invest in.
DAR < 1
This means the company can pay off its obligations by selling its assets
if needed that is no trouble with respect to debt
C.) Interest Coverage Ratio
This is one of the unique ratios you will come across as

this ratio can be considered to be both debt and
profitability ratio. The Interest Coverage Ratio is also
called the time's interest earned (TIE), this is heavily used
among lenders and creditors and with you knowing about
this ratio, even investors can use it,
In a nutshell, this ratio gives you clarity over a company

how easily can they pay interest on their outstanding debt,
this will tell you how risk-averse the company is and are
they healthy enough for future borrowings,
The formula for EBIT

=
Interest Coverage Ratio Interest Expense
EXAMPLE
Suppose your company has an EBIT of 400 and Interest expense of Rs.
1000,
400
Interest Coverage Ratio = = 0.4
1000
ICR < 1
This indicates that the firm is struggling to generate enough cash to
repay its interest obligations.
Low ICR
Indicates a higher debt burden and a greater possibility of default or
bankruptcy. So avoid companies having an ICR ratio of less than 3
ICR > 3
Indicates that the firm will pay off its accumulated interest on debt with
its current earnings.
SUMMARY
The debt to Equity ratio indicates the weight of total

debt against shareholder's Equity. The Ideal DE Ratio is
less than one or 1
The debt to Assets ratio represents the percentage of

the company’s assets that were funded by debt. DA
ratio less than 1 is considered
ICR represents the percentage of the company’s assets

that were funded by debt. The more is better
CHAPTER 6
EFFICIENCY RATIOS
A.) Inventory Turnover Ratio
Any business, there is inventory and for the company to

efficiently use its inventory against their cost of goods
sold in a given time is what determines how well oiled their
operations are, the ratio is extremely helpful to compare
the companies which are in the same sector as the
underlying factors are bound to be the same,
The inventory turnover ratio not only helps the investors

but also the business itself, the ratio will allow them to
make better and calculated decisions on pricing,
production and purchasing.
The formula for COGS

= Average Value of
Inventory Coverate Ratio Inventory
(NOTE; Here COGS is Cost of Goods Sold)
EXAMPLE
500
Inventory Turnover Ratio = = 0.5
1000
HIGH Inventory Turnover ratio - The company is selling goods quickly

which means that demand for the product is high.
LOW Inventory Turnover ratio - This may indicate that the company has
an excess amount of inventory because they are unable to sell it may be
because of low demand or excessive defective inventory.
For a better picture compare the Inventory Turnover ratio with its peers
and always remember higher is better.
B.) Inventory Turnover Ratio
As the name would suggest this ratio dabbles around the company
assets and extracts the efficiency metric out of it and that is determined
by knowing how much is the company able to generate sales with the
total assets they have
Typically the ratio is calculated on an annual basis and in a nutshell it

tells how effcinet is the company with their assets,
Total Sales
The formula for Total
= (Beginning Assets +
Asset Turnover Ratio Ending Assets / 2)
EXAMPLE
Suppose your company has Total sales of Rs. 5000 and Beginning Assets
of Rs. 1000 and Ending assets of Rs. 500,
5000
Asset Turnover Ratio = = 6.66
(1000+500/2)
HIGH Asset Turnover ratio - It signifies more efficient use of Assets.
LOW Asset Turnover ratio - This means the Company may not use its
assets efficiently.
C.) Receivables Turnover Ratio
This one ratio here goes deep into the books but still focuses on the
efficiency bit of it, every business has its client base and there is money
exchanging hands on a regular basis, this means there are instances
when there would be certain dues left from the client side to pay for the
company’s services/product and the company’s competency to collect
the outstanding dues in due time.
Net Credit Sales

The formula for =
Receivables Turnover Ratio Average Accounts
Receivable
EXAMPLE
Suppose your company has Net Credit Sales of Rs. 500 and Average
Accounts Receivable of Rs. 200,
500
Receivable Turnover Ratio = = 2.5
200
Higher Receivables Turnover Ratio - It indicates that Companies are

collecting their receivables more frequently throughout the year.
The ratio of 2 - Means that company has collected its average

receivables twice during the year
SUMMARY
The debt to Equity ratio indicates the weight of total

debt against shareholder's Equity. The Ideal DE Ratio is
less than one or 1
The debt to Assets ratio represents the percentage of

the company’s assets that were funded by debt. DA
ratio less than 1 is considered
ICR represents the percentage of the company’s assets

that were funded by debt. The more is better
CHAPTER 7
MARGIN RATIOS
Let’s understand Margin;
Why does your nearest Kirana store owner sell you maggie
or biscuits which is not made by him? Apart from the fact
that he’s not a manufacturer, the answer is simple he
earns margin by selling goods from a large scale
manufacturer,
Let us explain you- Your nearest kirana store owner buys

maggie for Rs.20 and sells it to you for Rs.24 so the Rs.4
is the margin he earns, similarly Margin ratios tells us the
how much money goes into the pocket of a firm for every
single rupee of sales
Margin ratio - Company’s ability to turn its

sales into profits
A.) Gross Margin
This term you’ve heard a lot in articles, news snippets or

while even talking, pretty popular ratio in the financial
world but now it is time for you to know what it is exactly.
For any company there are costs which needs to be

accounted, these costs might derive from manufacturing,
operations, marketing etc and when these costs are
subtracted against the company sales by services or
products, we arrive at a number and this number is how
much money does the company retains, this retained
capital is called as the gross margin.
The gross margin plays a vital role for the company and
the investors to analyse the company, gross margins are
how the company will pay back their dues and debts.
Investors will look at the gross margin to determine how
well is the company keeping the cost of production low
and how well are the sales happening,
The formula for (Net Sales - COGS)

=
Gross Margin Revenue
EXAMPLE
Suppose your company has Net Sales of Rs. 500 and COGS of Rs. 200,
(500 - 200)
Gross Margin = = 60%
500
Higher Gross margin Ratio is preferable, higher the margin better the
firm.
B.) Operating Margin
This margin is somewhat similar to the margin ratio we

discussed above but this digs a little deeper,
The Operating margin will account all variable costs of

productions such as the salaries, raw materials, rent,
operational bills etc but before paying interest and tax. The
operating margin is also a good indicator for an investor to
judge how stable the company or the sector is because
you obviously wouldn’t want companies which have widely
varying operating margins because that would indicate an
unstable company or a sector performance wise,
Operating margin is also used by the companies

themselves to assess the company’s management, asset
picking, resource management etc.
The formula for Operating Earnings

=
Operating Margin Revenue
EXAMPLE
Suppose your company has Operating Earnings of Rs. 500 and Revenue
of Rs. 2000,
500
Operating Margin = = 0.25
2000
Higher the Operating margin, better the firm

If a firm is continuosly increasing its profit margin this indicates that
firms profitability is increasing and has efficient control over operating
cost
C.) PAT (Profit After Tax) Margin
At the end of the day PAT determines what does the

company actually have which they can further use to grow
the business or look into other sectors where they can
expand to,
A business operates to produce profits and when the

company is able to save up on their profits after paying
tax, that remainder profits are called profits after tax.
Net Income
The formula for PAT Margin =
Sales Revenue
EXAMPLE
Suppose your company has a Net Income of Rs. 2000 and Sales Revenue
of Rs. 5000,
2000
PAT Margin = = 0.4
5000
High Net Profit Margin means company has
Efficient management
Low cost (Expenses)
Has Strong Pricing Strategy
Low Net Profit Margin means company has
Inefficient management
High cost or expenses
Has weak pricing strategy
SUMMARY
Gross margin tells us how much profit a company

makes after paying off its Cost of Goods Sold. Higher is
better
Operating Margins tell us how much money a company

has after covering operating and non-operating
expenses like marketing costs, research and
development cost, and logistics costs of a business.
Higher is better
Net Profit margin is the “take-home” money for a firm

so Higher the NPM better the firm
CHAPTER 8
VALUATION RATIOS
“Great companies can sometimes be poor Investments If
purchased at a too high price.”
What creates a difference between an Investor and a

speculator is that Investors purchase assets at less than
their actual worth while speculators purchase assets
because they think another investor will pay more for them
at some point.
So to be a better investor you must value the business and

if you are not satisfied with the value you are getting even
in a very good stock, you leave it and search for better
opportunities.
Here are some ratios that will help you find out the value
of a company
A.) Price to Sales Ratio
As an investor, you always strive to find value for the

company and you do that by looking inside the company and
determining its value.
Price to sales ratio will help you to compare the company’s

market capitalization and the revenue they generate to arrive
at a value. The PS ratio helps the investor to determine
the sales growth and price growth simultaneously to figure
out if the stock is valued right or not.
The formula for Market Capitalisation

=
Price to Sales Ratio Annual Revenue
EXAMPLE
Suppose your company has a Market Capitalisation of Rs. 200,000 and
Revenue of Rs. 5000,
200,000
P/S Ratio = = 40
5000
A company with high PS is considered overvalued and a company with

low PS or PS less than 1 can be considered as undervalued but always
remember - to get a clear picture compare it with peers
B.) Price to Book Ratio
This is a classic ratio that is mostly used by value

investors.
The company themselves have a number set to their

company which tells the value of the company’s stock
from their perspective after assessing the business but in
the open market it isn’t necessary for investors to perceive
the value of the company’s stock to be the same as what
the company says, it could be higher or lower than it,
When company’s stock is trading at a value higher than the
book value then the stock is said to be overvalued while if
the company’s stock is trading at a value lower than the
book value then the stock is said to be undervalued.
The formula for Market Price Per Share

=
Price to Book Ratio Book Value Per Share
EXAMPLE
Suppose your company has a Market price per share of Rs. 20 and Book
value per share of Rs. 5,
20
P/B Ratio = = 4
5
If PB ratio is less than 1 then Company is undervalued and Future

outlook may be awesome
If PB ratio is greater than 1 then Company is overvalued Future outlook

may be not be good
Compare this ratio between companies of same industry.
C.) Price to Earnings Ratio
This ratio is probably one of the most popular ratios and

most of the people know about this, hence keeping this
ratio for the end,
As clear as day, the name itself suggests, this ratio

compares the price of the share to the earnings per share
(also called as earning multiple), this ratio is extensively
used by the investors to find the value of the company
based on the earnings they’re able to produce,
So a higher price to earnings ratio will tell the company is

overvalued while at the same time a lower price to
earnings ratio will tell the company is undervalued. This
again is a favourite ratio that a value investor would like to
have in their arsenal.
The formula for Price = Market Price Per Share

to Earnings Ratio Earnings Per Share
EXAMPLE
Suppose your company has a Market price per share of Rs. 20 and EPS is
Rs. 2,
20
PE Ratio = = 10
2
Low PE
Stock is undervalued
Less growth or negative growth
Future prospects are not great
EXAMPLE
Suppose your company has a Market price per share of Rs. 20 and EPS is
Rs. 2,
20
PE Ratio = = 10
2
Low PE
Stock is undervalued
Less growth or negative growth
Future prospects are not great
High PE
Stock is overvalued
Company has high growth
It has great future prospects.
Now the problem arises that how to use this PE ratio?

So there are 2 ways you can use PE ratio to value a
company
Number 1: Use Historical PE ratio
Just go to screener and check the graph of historical 5

year and 3 year PE of a company and find the median PE in
both time frames. Then add both past 5 year and 3 year
median PE and divide it by 2. Now if current PE is less than
the number that we just calculated then the company is
undervalued if not then it is overvalued.
For example Suppose Company A 5 year historical Median

PE is 15 and 3 year historical median PE is 30, then add
both the number 15 + 30 =45 and divide it by 2
By dividing it by 2 we’ll get 22.5. So now if current PE is
less than 22.5 then it is Undervalued but if Current PE is
greater than 22 then it is overvalued
Number 2: Compare it with Growth rate

Suppose there are 2 companies - Company A and
Company B having same share price of Rs 1000
Company A is having PE ratio of 10 whose growth rate is
10% and Company B PE is 20 whose growth rate is 20%,
which one looks attractive
On the basis of PE ratio Company A looks more attractive

than Company B but on a growth perspective company B is
more attractive than company A, so now question arries
that in which company should you invest?
So lets do some maths
If company A has to maintain its 10 PE it must grow at

10% yearly and after 10th year its price will be 2593.74
PE = 10 YR 1 YR 2 YR 3 YR 4 YR 5 YR 6 YR 7 YR 8 YR 9 YR 10
1000 1100 1210 1331 1464.1 1610.5 1771.5 1948.7 2143.6 2357.9 2593.74
If company B has to maintain its 20 PE it must have to

grow at 20% yearly and after 10th year its price will be Rs
6191.7
PE = 20 YR 1 YR 2 YR 3 YR 4 YR 5 YR 6 YR 7 YR 8 YR 9 YR 10
1000 1200 1440 1728 2073.6 2488.6 2985.9 3583.2 4299.8 5159.8 6191.7
Bonus for You:
We hope you had a great time with the ratio analysis

ebook, it's punched with information and it basically has
everything you need to navigate your way through and
invest on your own,
Although we have covered and explained all the ratio with

theory and a bit of formulas, you definitely do not need to
sit down and calculate each ratios for each company you
interested in,
All the ratios we've mentioned in the ebook, you will find all
of them on the moneycontrol website for any company on
the Indian stock market,
So all you have to do is search the company name along

with the ratio name, you will find it readily available.
Step 1: Visit Money control website and search any

company
Step 2: Scroll down to financial section and click on ratios.
Step 3: Boom
Next time we will come up with
another investing Ebook

Until then. Happy Investing.
Loved it? Don't share it with anyone outside.

Make your friends join the community too.

RATIO ANALYSIS Ebook

Uploaded by

Copyright:

Available Formats

RATIO ANALYSIS Ebook

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

RATIO ANALYSIS Ebook

Uploaded by

Copyright:

Available Formats

A COMPLETE

CHAPTER 2: Earnings Ratios

CHAPTER 3: Profitability Ratios

CHAPTER 4: Liquidity Ratios

CHAPTER 5: Leverage Ratios

CHAPTER 6: Efficiency Ratios

CHAPTER 7: Margin Ratios

CHAPTER 8: Valuation Ratios

"Humans can be wrong but math is rarely wrong when

Financial Ratios are one of the most important aspects of

Not every company gives you multi-bagger returns but

What actually is Ratio Analysis?

Profitability A company's ability to generate income

Liquidity The ability of a company to pay off

Efficiency Company’s efficiency in the utilization

Leverage Evaluate the debt level of a company's

Valuation Evaluation of the company’s

So till now, we saw a brief introduction to ratio analysis, and

I WHY ECONOMIC MOAT?

Assume there are no tea shops in your area, so you

However, as we all know, success attracts competition,

Now consider this scenario: when you were alone in the

But suppose you have built a moat in front of all of them by

An economic moat is a competitive advantage that belongs to a

Moat is the characteristic that helps great performing businesses

In this module, we have discussed complete filters and by

Net Sales (1) 100

Direct Costs (2) 20

Earnings Before Interest Tax Depreciation

EBITDA Margin (4) = (3)/ (1) 80%

Depreciation/ Amortization (5) 20

Other Income (7) 5

Profit Before Tax (8) = (3) – (5) – (6) + (7) 45

Tax (9) [@ 30%] = (8) * 30% 13.5

Profit After Tax (PAT) (10) = (8) – (9) 31.5

PAT Margin (11) = (10)/ (1) 31.5%

A profit and loss (P/L) statement is a

Free cash flow(FCF) is the money that could be extracted

The free cash flow to sales ratio is considered to be one of

It is a no-brainer to see how well a company can sell its

To continue further business operations Company A needs Rs.500, so

This Rs 400 is your Free cash flow

Now the company

if we Divide Free cash flow by sales that;

Net profit margins are essentially net income as a

Many start-ups can afford to be not

Net profit margins are exactly why companies are able to

Ideal performance threshold; If a company that can post-net margins

ROE tells us about the company's profitability and how

ROE or Return on Equity is one of the most common ratios

If simply put; Return on Equity is the net income with

Ideal performance threshold: if a company is having consistent ROE of

A company is known to grow consistently when you see

It is understood that a higher ROA

Sometimes investors might get

ROA is one of the financial ratios that is popular among the

The formula for Net Income

Ideal performance threshold: Ideal performance threshold: If a firm is

If Free cashflow upon sales is greater than 5% then