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Which Ratios Shareholders are Most Interested in?
There are a lot of financial ratios to measure the relationships between different financial items, and they are useful for various types of calculations. Some ratios are more applicable to measure specific tasks and hence these ratios can be specifically applied to measure specific relationships.
For the shareholders who are mostly interested in investing their money in profitable stocks, the following are the ratios that have proved to be most useful.
Net Working Capital Ratio
Working capital shows a company’s capacity to pay its liabilities with its current assets. Working capital measures the liquidity of a company. In other words, working capital is the measure of how fast assets can be converted to liquid assets.
The net working capital ratio is calculated by dividing current assets by current liabilities. These assets and liabilities used in the calculation of the working capital ratio are short-term in nature. They are usually valid within one year from the date of calculation.
Quick Ratio
The quick ratio is the ratio where current assets are considered after deducting the inventory from it. Inventories take more than a year to convert to cash. So, it cannot be considered among the items that are readily liquid or can be liquidated within a short span of time.
The main purpose of using quick ratio is to see how well the assets can service the liabilities.
For example
if a company has Rs 10 crores of Current Assets, Rs 4 crores of Inventories, and Rs 4 Crores of Liabilities, the Quick ratio will be as follows −
$$\mathrm{\frac{10\, crores - 4\, crores}{4\, crores }\, =\,1.5:1 }$$
Although a 1: 1 ratio is most desirable, companies having a lesser value are sometimes okay. This is so because it means the company’s inventory turnover is faster.
Earnings per Share (EPS)
Earnings per share measure the net income per share. To get the correct EPS figure, the company's net income should be divided by the total outstanding general shares of the company.
EPS is a very important ratio for the shareholders because it shows the earning potential of each share on which the shareholders are most interested. If a company has negative or zero earnings, the EPS will also be negative or zero.
Price-Earnings or P/E Ratio
In determining Price Earnings, the share price of the stock is first determined and then, it is divided by EPS. This ratio is usually measured to check the future earnings of a company.
If the value of earnings for a company is zero or negative, the Price-Earnings ratio cannot be determined. It should be stated and not applicable in these cases.
Debt-Equity Ratio
This ratio is calculated by dividing total debt by the total value of shareholder’s equity. While considering the debt, both short- and long-term debts should be considered.
With increasing debt, the Debt-Equity ratio shoots up. In such circumstances, the company may become unable to meet its short and long-term needs and also fall into a financial calamity.
Return on Equity (ROE)
Return on Equity shows the efficiency of capital invested by the investors in a company. Take the net assets, subtract preferred dividends, and divide the figure obtained by the total shares of the company to get ROE. ROE shows the profitability of investment that is made for a given project of a firm. It is one of the most desirable ratios for risk-averse investors in the capital markets.
Conclusion
It must be noted that there are many other financial ratios that can help investors sharpen their decisions. However, the above-mentioned ratios must be considered in order to evaluate a stock’s true potential.
Moreover, all of the ratios must be analyzed to get a holistic picture of the company’s condition. No one ratio in isolation is enough to get a perfect result.
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