Key Ratios for good stocks

Reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts - dividends and ploughback. Ploughback is the portion that the company retains and gets added to its reserves. All growth companies maintain a high level of reserve. Retained profits belong to the shareholders and are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price.

Book Value
On subtracting the total liabilities of a company from its total assets, what is left belongs to the shareholders, called the shareholders' funds. Dividing shareholders' funds by the total number of equity shares issued by the company, the result is book value per share. Shareholders' funds can also be obtained by adding the equity capital and reserves of the company. The market prices of shares are generally much higher than what their book values indicate, and the ratio between the two can be used to assess whether a particular share is over- or under-priced.

Earnings per share (EPS)
Earnings Per Share = Profit After Tax / Total number of equity shares issued. This ratio gives the earnings of a company on a per share basis. This includes both dividends and reserves. Under ideal conditions, the portion of earnings added to reserves would push up the market price proportionately.

Price to earnings ratio (P/E)
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share. This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios. Companies with high current earnings but dim future prospects often have low P/E ratios.

Dividend
It is illogical to draw a distinction between capital appreciation and dividends. Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth. On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.

Yield
Yield = (Dividend per share / market price per share) x 100. Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. Average yield figures in India usually vary around 2 per cent of the market value of the shares.

Return on Capital Employed (ROCE)
While analysing a company, the most important thing to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it. Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt). ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.

Return on Net Worth (RONW)
Return on net worth (RONW) is defined as net profit divided by Net Worth (shareholders funds). It is a basic ratio that tells a shareholder what he is getting out of his investment in the company. ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.

PEG ratio
The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company. The price/earnings to growth (PEG) ratio is used to determine a stock's value while taking the company's earnings growth into account, and is considered to provide a more complete picture than the P/E ratio. As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter. E.g. if a company is growing at 30% a year, and has a P/E of 30, it would have a PEG of 1. A lower ratio is "better" (cheaper) and a higher ratio is "worse" (expensive). The P/E ratio used in the calculation may be projected or trailing, and the annual growth rate may be the expected growth rate for the next year or the next five years.