## 6 Important Financial Ratios for Investors

There are a number of financial ratios that investors need to be familiar with in order to assess the financial strength of a company. Understanding these different ratios can help you become a better investor in the share market.

These are the top 6 financial ratios that share investors need to be familiar with

### 1. Price to Earnings Ratio

The P/E ratio represents how much stock investors are willing to pay for each dollar of earnings.

The formula is: Current Share Price /Earnings Per Share

This ratio can show what level the share price is compared to the firm’s current earnings.  It is the price investors are paying for the stock with \$1 of the company’s profit.

For example, if a stock is trading at \$80 and the earnings per share is \$5 then the PE is 16. That is, 80/5. So this means the investor is investing \$16 for every dollar of earnings. Investors can use the P/E ratio from different companies and compare them to determine which company is cheaper compared to others in the industry.

Uniquely combining both Fundamental and Technical Analysis

A high P/E means the stock is expensive compared to what it is earning. This is because investors believe that the company will grow over time and are willing to pay the premium. A low P/E means the stock is cheap and investors believe that the growth will be slow or low in the future.

### 2. Debt to Equity Ratio

This ratio shows how much capital has been borrowed compared to the amount of capital which has been generated by shareholders.

The formula is: Total Liabilities/Total Shareholder Equity

If a firm’s debt to equity ratio is too high then it could mean the firm may not be able to meet debt repayments. A lower debt to equity ratio may represent a more financially stable company.

### 3. Return on Equity (ROE)

This ratio measures how much share holders receive from their investment in the company.

The formula is : Net Income / Average Shareholder Equity.

The higher the ROE, the more shareholders are rewarded for their investment in the company. If a company has an ROE of 20%, it means that for every \$1 that shareholders own, the company rewards the investor \$0.20 in profits each year.

### 4. Return on Capital Employed

This is reflected by the formula ROCE = Earnings Before Interest and Taxes/Capital Employed.

This ratio shows how effectively the company uses all the capital to generate earnings. It also takes into account the long-term financing of the company.  The capital employed figure is calculated by summing up ordinary and preferred share capital as well as all debt obligations.

### 5. Net Profit Margin

This is calculated from the formula: Net Profits/Net Sales. It represents what revenue is remaining after expenses have been deducted from sales. The ratio indicates how successful a business is. A net profit over 10% is considered good.

### 6. Dividend Yield

The dividend yield formula  = Dividend Per Share / Share Price. A high dividend yield means that the company pays a large dividend as a portion of its earnings. A low one means the company pays out a smaller dividend. Investors looking for income will find this ratio useful as higher yield means higher income.

Lauren Hua is a private client adviser at Fairmont Equities.

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