Key Financial Ratios
Ratios are the language used to compare companies — instantly, objectively, across industries and time. A company's ₹500 share price tells you nothing on its own. Its P/E of 12 vs a competitor's P/E of 45 tells you everything. This note builds your ability to read every major ratio: what it measures, how to calculate it, what "good" looks like, and crucially — where each ratio can mislead you.
Why financial ratios exist
Raw financial numbers — revenue, profit, share price — are useless in isolation. Ratios solve this by expressing one number as a proportion of another, making comparison meaningful.
Profit ₹100 cr
Profit ₹800 cr
multiple of earnings
Ratios let you compare a ₹500 large-cap with a ₹50 small-cap, a 2024 company with its 2019 performance, or an Indian bank with a US bank — on an equal footing. They compress complex financial statements into a single number that communicates something precise.
No single ratio tells the whole story. Think of ratios as questions that point you in a direction, not answers. A low P/E might mean "undervalued" — or it might mean "the business is deteriorating." You need multiple ratios working together, plus an understanding of the business, to reach a conclusion. You'll learn that synthesis in Section 11.
The four categories of ratios
Every financial ratio belongs to one of four categories. Knowing the category tells you what question the ratio is answering before you even calculate it.
Question: Is this stock expensive or cheap relative to what the company earns or owns?
Ratios: P/E, P/B, EPS, EV/EBITDA
Question: How efficiently does this company generate profit from its resources?
Ratios: ROE, ROCE, Net Margin, EBITDA Margin
Question: How much debt does this company carry? Is it a risk?
Ratios: Debt-to-Equity, Interest Coverage
Question: Can this company pay its short-term bills? Will it run out of cash?
Ratios: Current Ratio, Quick Ratio
P/E — Price to Earnings Ratio
The single most-cited ratio in all of investing. Every business journalist references it. Understanding it deeply — including its limitations — is foundational.
Price-to-Earnings (P/E)
P/E = Market Price per Share ÷ Earnings per Share (EPS)
// Example: TCS share price ₹3,800 | EPS ₹110
P/E = 3800 ÷ 110 = 34.5× // means: you pay ₹34.5 for every ₹1 TCS earns annually
// Two variants you'll see:
Trailing P/E = uses last 12 months of actual earnings // backward-looking, factual
Forward P/E = uses next 12 months of estimated earnings // forward-looking, involves analyst guesswork
Interpreting the P/E — the gauge
⚠️ These are general guidelines — context matters. A P/E of 40× for a company growing earnings at 35% per year may be reasonable. A P/E of 12× for a company with shrinking earnings may be a trap.
What P/E really represents — the payback period
Think of P/E as a payback period. A P/E of 20 means: if the company continues earning the same profit, it will take 20 years of earnings to "pay back" your purchase price. A lower P/E = faster payback = cheaper relative to earnings.
Company is undervalued and overlooked ✓
Business is declining or cyclically depressed ⚠
Industry naturally trades at low multiples (e.g. PSU banks, commodities)
Market expects strong future earnings growth ✓
Company has a durable competitive advantage (moat) ✓
Stock is in a speculative bubble ⚠
Never compare P/E ratios across different sectors. A P/E of 12 is normal for a steel company but dangerously low if the cycle is about to turn. A P/E of 50 is normal for a quality FMCG (Fast Moving Consumer Goods) company but alarming for a commodity business. Always compare P/E against: (1) the company's own historical P/E, (2) sector peers, (3) Nifty historical average.
Nifty 50's historical average P/E is around 20–22×. When Nifty P/E rises above 25–28×, markets are expensive by historical standards — future returns from that level tend to be lower. When Nifty P/E drops below 15× (as it did in March 2020 at ~16×), markets are historically cheap and have delivered strong 3–5 year returns from those levels. Nifty P/E is published daily on the NSE website — a free market valuation signal.
P/B — Price to Book Ratio
Especially important for banks, financial companies, and asset-heavy businesses. Tells you how much you're paying relative to the company's actual net assets.
Price-to-Book (P/B)
P/B = Market Price per Share ÷ Book Value per Share
// Book Value per Share = (Total Assets − Total Liabilities) ÷ Total Shares
// This is the "accounting value" of each share if the company were liquidated today
// Example: HDFC Bank share price ₹1,700 | Book Value per Share ₹380
P/B = 1700 ÷ 380 = 4.5× // means: market values HDFC at 4.5x its net assets
Why would anyone pay more than book value (P/B > 1)?
Because the market is paying for future earning power, not just today's assets. A company with strong brand, intellectual property, efficient management, and a dominant market position will always command a P/B above 1. The premium above book value reflects the market's faith in the company's ability to generate returns above its cost of capital in the future.
| P/B Range | What it typically signals | Common in |
|---|---|---|
| < 1.0× | Market values company below net assets. Could be deeply undervalued — or assets are overstated/deteriorating | Distressed companies, commodity cyclicals at trough |
| 1–2× | Reasonable valuation, especially for capital-intensive businesses | PSU banks, metals, utilities |
| 2–5× | Market paying meaningful premium for quality and growth | Private banks (HDFC, Kotak), consumer staples |
| 5–15×+ | Asset-light business with very high returns on equity; brand premium | IT services (TCS, Infosys), FMCG (HUL, Asian Paints) |
Banks are essentially money-lending businesses. Their main asset is their loan book — and P/B directly measures what you're paying for that loan book. A bank with strong asset quality, low NPAs, and consistent ROE deserves a high P/B. A bank trading at P/B of 0.6× might have serious hidden bad loans — not a bargain.
EPS — Earnings Per Share
EPS is not a ratio — it's a per-share profitability metric. It's the foundation on which P/E is built, and one of the most watched numbers every earnings season.
Earnings Per Share (EPS)
EPS = Net Profit (PAT) ÷ Total Shares Outstanding
// PAT = Profit After Tax — the company's actual bottom-line profit
// Example: Company X earned ₹500 crore net profit | 10 crore shares outstanding
EPS = 500 crore ÷ 10 crore shares = ₹50 per share
// If share price = ₹1,000 → P/E = 1000 ÷ 50 = 20×
// EPS growth matters more than EPS level:
EPS Growth = (Current EPS − Previous EPS) ÷ Previous EPS × 100
// A company growing EPS at 20% yr/yr is far more valuable than one with high but flat EPS
Why EPS growth is the most important number to track
Long-term stock prices follow earnings. A company that grows its EPS at 15% per year will, over a decade, have an EPS that is 4× higher than today — and its stock price will tend to reflect this. This is why investors pay careful attention to quarterly earnings reports and earnings surprises.
Companies can inflate EPS by buying back shares (fewer shares = same profit divided by fewer shares = higher EPS) without actually growing earnings. This is share buyback-driven EPS growth. Always check if EPS growth is accompanied by revenue and profit growth — not just a shrinking share count.
EV/EBITDA — Enterprise Value to EBITDA
The professional investor's alternative to P/E. More complete, harder to manipulate, and better for comparing companies with different debt structures.
EV/EBITDA
EV (Enterprise Value) = Market Cap + Total Debt − Cash & Equivalents
// EV = the true "takeover price" — what you'd pay to own the entire business
// You add debt because an acquirer must assume it. You subtract cash because you'd receive it.
EBITDA = Earnings Before Interest, Tax, Depreciation & Amortisation
// EBITDA = the business's raw operating cash-generating power
// Strips out financing choices (interest), tax jurisdiction (tax),
// and accounting policies (depreciation/amortisation)
EV/EBITDA = Enterprise Value ÷ EBITDA
// Example: Company market cap ₹2,000 cr | Debt ₹500 cr | Cash ₹200 cr | EBITDA ₹250 cr
EV = 2000 + 500 − 200 = ₹2,300 cr
EV/EBITDA = 2300 ÷ 250 = 9.2×
Why EV/EBITDA beats P/E in many situations
| Scenario | P/E tells you | EV/EBITDA tells you |
|---|---|---|
| Company has heavy debt | P/E looks low (interest payments reduce profit) | EV/EBITDA adjusts for debt — truer picture |
| Company uses aggressive depreciation | P/E looks high (large depreciation reduces profit) | EBITDA adds depreciation back — not distorted |
| Comparing across countries | P/E distorted by different tax rates | EBITDA is pre-tax — comparable globally |
| Loss-making company | P/E undefined (can't divide by negative earnings) | EBITDA may still be positive — EV/EBITDA works |
ROE — Return on Equity
Warren Buffett's favourite ratio. ROE tells you how well management is using shareholders' money to generate profit. It's the most direct measure of management quality for equity investors.
Return on Equity (ROE)
ROE = Net Profit (PAT) ÷ Shareholders' Equity × 100
// Shareholders' Equity = Total Assets − Total Liabilities (same as Book Value)
// Example: Company earns ₹200 cr net profit | Shareholders' equity = ₹1,000 cr
ROE = 200 ÷ 1000 × 100 = 20% // For every ₹100 of shareholder money, the company earns ₹20 profit
The ROE gauge
Why consistently high ROE = competitive moat
Any business can post one good year. A company that maintains ROE above 20% for 10+ consecutive years has demonstrated something rare: a durable competitive advantage. Competition should erode high returns — if it doesn't, the company has a moat. Consistent high-ROE companies in India: HDFC Bank, Asian Paints, Pidilite, Page Industries, Nestle.
A company can artificially inflate ROE by taking on more debt. More debt → lower equity (since equity = assets − liabilities) → same profit divided by smaller equity = higher ROE. Always check ROE alongside Debt-to-Equity. High ROE + Low D/E = genuinely excellent business. High ROE + High D/E = leverage game, potentially dangerous.
ROCE — Return on Capital Employed
The more rigorous cousin of ROE — includes debt in the denominator, giving a truer picture of how efficiently the entire capital base is used.
Return on Capital Employed (ROCE)
ROCE = EBIT ÷ Capital Employed × 100
// EBIT = Earnings Before Interest and Tax (operating profit)
// Capital Employed = Total Assets − Current Liabilities
// = Equity + Long-term Debt (same thing, different way to calculate)
// Example: EBIT = ₹300 cr | Capital Employed = ₹1,500 cr
ROCE = 300 ÷ 1500 × 100 = 20%
ROCE vs ROE — when each matters more
| Aspect | ROE | ROCE |
|---|---|---|
| Denominator | Shareholders' equity only | Equity + Long-term debt |
| Affected by leverage | Yes — high debt can inflate ROE | No — debt is included in capital base |
| Best for | Asset-light, low-debt businesses | Capital-intensive, leveraged businesses |
| Key question answered | "How well is equity being used?" | "How efficiently is all capital deployed?" |
| Use together when | ROCE > ROE suggests excess debt. ROCE ≈ ROE suggests minimal debt — healthy sign. | |
A company must earn ROCE above its cost of capital to create value. If the cost of debt is 9% and ROCE is 8%, the company is destroying value — it earns less than it costs to run. India's WACC for most businesses runs 10–14%. Any ROCE above this is value-creating. Great Indian businesses — Bajaj Finance, TCS, Hindustan Unilever — consistently post ROCE above 25%.
EBITDA & Profit Margins
EBITDA is not a single ratio — it's a profitability measure used in multiple ratios and to calculate operating efficiency. Margins tell you how much profit survives after various costs are deducted from revenue.
EBITDA & Profit Margins
Revenue = ₹1,000 // top line — total sales
− Cost of Goods Sold = ₹600 // raw material, manufacturing
Gross Profit = ₹400 → Gross Margin = 40%
− Operating Expenses = ₹150 // salaries, rent, marketing
EBITDA = ₹250 → EBITDA Margin = 25%
− Depreciation & Amort. = ₹40 // wear and tear on assets (non-cash)
EBIT (Op. Profit)= ₹210
− Interest = ₹30 // cost of debt
− Tax = ₹45
Net Profit (PAT) = ₹135 → Net Margin = 13.5%
Industry benchmarks — what margin is "good"?
Margins vary enormously by industry. Comparing margins only makes sense within the same sector.
| Industry | Typical EBITDA Margin | Typical Net Margin | Why |
|---|---|---|---|
| FMCG (HUL, Nestle) | 20–30% | 15–20% | Strong brands, pricing power, low capex |
| IT Services (TCS, Infosys) | 25–35% | 18–25% | Asset-light, no inventory, skilled talent |
| Pharma (Sun, Dr Reddy) | 15–25% | 10–18% | R&D costs, regulatory expenses |
| Auto (Maruti, Bajaj) | 10–15% | 6–10% | High raw material costs, competitive pricing |
| Retail (DMART) | 4–8% | 2–5% | Low-margin, high-volume business model |
| Commodities (Tata Steel) | 5–15% (cyclical) | 2–8% | Commodity prices outside company control |
When a company's margins expand over multiple years, it signals growing pricing power, operating leverage (fixed costs spread across more revenue), or improving efficiency. Margin expansion often precedes strong earnings growth. It's one of the most bullish trends you can find in a company's financial history.
Debt-to-Equity Ratio (D/E)
How much debt does the company carry relative to shareholder funds? The ratio that tells you how risky the company's balance sheet is — and how much cushion exists if things go wrong.
Debt-to-Equity (D/E)
D/E = Total Debt ÷ Shareholders' Equity
// Example A — low debt company:
D/E = 200 cr ÷ 800 cr = 0.25× // For every ₹1 equity, ₹0.25 debt — very conservative
// Example B — high debt company:
D/E = 900 cr ÷ 300 cr = 3.0× // For every ₹1 equity, ₹3 debt — risky if business hits turbulence
Debt is not automatically bad — context matters
A company borrows at 8% to fund a project earning 20% ROCE. Debt amplifies returns here. Infrastructure, real estate, and capital-intensive businesses often need debt to operate. As long as ROCE > cost of debt, leverage creates value.
Debt taken to fund operating losses, pay dividends, or finance acquisitions at bad prices. High D/E + falling ROCE = potential debt trap. The company may be unable to service interest payments if revenues dip — leading to default risk.
Exception: Banks and NBFCs (Bajaj Finance, HDFC Bank) operate with high D/E by design — their business model is to borrow and lend. For financials, use Capital Adequacy Ratio and NPA % instead.
Several large Indian conglomerates that appeared strong in 2012–2016 were carrying D/E ratios of 3–8×. When their business cycles turned down and interest rates rose, they couldn't service debt. IL&FS, DHFL, and Jet Airways are among the high-profile collapses where investors who had tracked D/E would have spotted the danger well before the collapse.
Current Ratio
Long-term solvency matters — but so does surviving the next 12 months. The current ratio answers: can this company pay its short-term bills without needing emergency funding?
Current Ratio
Current Ratio = Current Assets ÷ Current Liabilities
// Current Assets = cash, receivables, inventory (things convertible to cash within 1 year)
// Current Liabilities = payables, short-term debt (bills due within 1 year)
// Example: Current Assets = ₹500 cr | Current Liabilities = ₹250 cr
Current Ratio = 500 ÷ 250 = 2.0× // ₹2 of liquid assets for every ₹1 due in the next year. Healthy.
// Quick Ratio (stricter version — excludes inventory from current assets):
Quick Ratio = (Current Assets − Inventory) ÷ Current Liabilities
// Better for businesses where inventory may not be quickly convertible to cash
The company owes more in the next 12 months than it has in liquid assets. May need to borrow or issue shares just to survive — a serious short-term liquidity crisis risk.
Too much cash sitting idle. Management is not deploying capital effectively. Excess liquidity that earns nothing is a drag on returns. Also sometimes inflated by unsellable inventory.
Reading ratios together — the full picture
Individual ratios answer individual questions. Real analysis means reading them as a system — where each ratio either confirms, complicates, or contradicts what another ratio tells you.
The ratio analysis workflow
Quick screening example — Scenario A (good company)
| Ratio | Company A value | Benchmark | Signal |
|---|---|---|---|
| P/E | 18× | Sector avg 22× | ✓ Below sector — potential value |
| ROE | 22% | 15%+ good | ✓ Excellent profitability |
| ROCE | 19% | > WACC (~11%) | ✓ Value creating |
| D/E | 0.3× | < 1× healthy | ✓ Conservative balance sheet |
| Current Ratio | 2.2× | 1.5–3× | ✓ Good liquidity |
| EPS growth (3yr) | 18% CAGR | 10%+ good | ✓ Consistent earnings growth |
→ All signals green. This is a quality company at a reasonable price. Worth deeper investigation (business model, management, industry outlook).
Ratio traps & limitations
Ratios are tools — like a thermometer, they tell you something is wrong, not what is wrong or why. Here are the most dangerous ways ratios mislead investors.
"Low P/E = cheap. I should buy."
A low P/E could mean a business in secular decline (e.g., legacy media, coal). "Value trap" stocks stay cheap forever because the business is fundamentally deteriorating. Always ask why it's cheap.
"High ROE = excellent company."
High ROE inflated by excessive debt is dangerous, not impressive. Always pair ROE with D/E. High ROE + low D/E = genuine quality. High ROE + high D/E = leverage illusion.
"I can compare P/E ratios across industries to find the cheapest."
A utility company at P/E 12× and a software company at P/E 40× are not comparable. Different industries have structurally different growth rates, capital needs, and risk profiles — making cross-sector P/E comparison meaningless.
"High EBITDA margin = great company."
EBITDA ignores depreciation, interest, and tax — real cash costs. A company with great EBITDA but enormous interest payments (high debt) or rapid asset deterioration (needing heavy capex replacement) may still be cash-poor.
"Ratios alone are enough to make an investment decision."
Ratios are backward-looking — they describe the past. They say nothing about future strategy, management integrity, industry disruption, or regulatory risk. Ratios screen the universe; business understanding makes the decision.
Master cheatsheet — all 9 ratios
Your single-page reference. Every ratio, its formula, what to look for, and the key warning sign.
| Ratio | Formula | What "good" looks like | Red flag |
|---|---|---|---|
| P/E | Price ÷ EPS | Below sector average; consistent with earnings growth | Very high P/E with slowing earnings growth |
| P/B | Price ÷ Book Value per share | 1–3× for most; higher for asset-light quality businesses | P/B < 1 with no obvious reason — hidden bad assets? |
| EPS | Net Profit ÷ Shares outstanding | Growing 15%+ year-on-year consistently | EPS growing only because share count falling (buybacks, not profit growth) |
| EV/EBITDA | (Market Cap + Debt − Cash) ÷ EBITDA | Below 10× for most sectors | Very high multiple with no earnings growth to justify it |
| ROE | Net Profit ÷ Shareholders' Equity × 100 | 15%+ sustained for 5–10 years | High ROE with high D/E — may be debt-inflated |
| ROCE | EBIT ÷ Capital Employed × 100 | Above WACC (10–14%); excellent 20%+ | ROCE below cost of debt — destroying value |
| EBITDA Margin | EBITDA ÷ Revenue × 100 | Expanding over time; compare within sector only | Margin contraction over multiple years without explanation |
| D/E | Total Debt ÷ Shareholders' Equity | Below 1× for most sectors; 0 = debt-free | D/E rising year-on-year with falling ROCE |
| Current Ratio | Current Assets ÷ Current Liabilities | 1.5–3.0× | Below 1.0× — cannot cover short-term obligations |
Step 1 — Valuation
P/E vs sector peers + own history? // cheap, fair, or expensive?
EV/EBITDA if capital-heavy? // adjust for debt structure
Step 2 — Profitability quality
ROE sustained above 15%? // management quality
ROCE above WACC? // value creation check
Margins expanding or stable? // pricing power / efficiency
Step 3 — Balance sheet safety
D/E below 1? // financial risk
Current ratio 1.5+? // short-term survival
Step 4 — Growth trajectory
EPS growing 15%+ for 3–5 years? // earnings momentum
Revenue growing in line? // not just margin expansion