Fundamentals of stock market- key financial ratios

The Fundamentals of Stock Market- Must Know Terms

Here are the few key financial terms that a stock market investor must know. Although the list is long, it will be worth to know these terms to get a good grasp on the fundamentals. Here it goes:


Promoter’s shares: – The company shares that are owned by the promoters i.e. the owners of the company is called Promoters shares. The public cannot own these shares.


Outstanding shares: The company’s shares that are owned by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company’s officers and insiders.

Public (retail investors), foreign institutional investors (FII), Domestic institutional investors (DII), mutual funds etc. can own outstanding shares.


Market Capitalization: – Market Cap or Market capitalization refers to the total market value of a company’s outstanding shares. It is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures. In general, market capitalization is the market value of company outstanding shares.

Market Capitalization = No of outstanding shares * share value of each stock


Book value: – It is the ratio of total value of company assets to the no of shares. In general, this is the value which the shareholders will get if the company is liquidated. Hence, it is always preferred to buy a stock with high book value compared to the current share price.

Book Value = [Total assets – Intangible assets (patents, goodwill..) – liabilities]


Earnings Per Share (EPS): This is one of the key ratios and is really important to understand before we study other ratios. EPS is the profit that a company has made over the last year divided by how many shares are on the market. Preferred shares are not included while calculating EPS. In general, Money earned per outstanding shares.

Earnings Per Share (EPS) = (Net income – dividends from preferred stock)/(Total outstanding shares)

From the perspective of an investor, it is always better to invest in a company with higher EPS as it means that the company is generating greater profits.


Price to Earnings Ratio (P/E):  The Price to Earnings ratio is one of the most widely used financial ratio analysis among the investors for a very long time. A high P/E ratio generally shows that the investor is paying more for the share. As a thumb rule, a low P/E ratio is preferred while buying a stock, but the definition of ‘low’ varies from industries to industries. So, different sectors (Ex Automobile, Banks etc) have different P/E ratios for the companies in their sector, and comparing the P/E ratio of the company of one sector with P/E ratio of the company of another sector will be insignificant. However, you can use the P/E ratio to compare the companies in the same sector, preferring one with low P/E. The P/E ratio is calculated using this formula:

Price to Earnings Ratio= (Price Per Share) / ( Earnings Per Share)

It’s easier to find the find the price of the share as you can find it from the current closing stock price. For the earning per share, we can have either trailing EPS (earnings per share based on the past 12 months) or Forward EPS (Estimated basic earnings per share based on a forward 12-month projection. It’s easier to find the trailing EPS as we already have the result of the past 12 month’s performance of the company.

If you want to read further in details, I will recommend you to read this book: Everything You Wanted to Know About Stock Market Investing -Best selling book for stock market beginners. 


Price to Book Ratio (P/B): Price to Book Ratio (P/B) is calculated by dividing the current price of the stock by the latest quarter’s book value per share. P/B ratio is an indication of how much shareholders are paying for the net assets of a company. Generally, a lower P/B ratio could mean that the stock is undervalued, but again the definition of lower varies from sector to sector.

Price to Book Ratio = (Price per Share)/( Book Value per Share)


Dividend yield: – It is the portion of the company earnings decided by the company to distribute to the shareholders. A stock’s dividend yield is calculated as the company’s annual cash dividend per share divided by the current price of the stock and is expressed in annual percentage. It can be distributed quarterly or annually basis and they can issue in the form of cash or stocks.

Dividend Yield = (Dividend per Share) / (Price per Share)*100

For Example, If the share price of a company is Rs 100 and it is giving a dividend of Rs 10, then the dividend yield will be 10%. It totally depends on the investor whether he wants to invest in a high or a low dividend yielding company.

Also Read: 4 Must Know Dates for a Dividend Stock Investor


Market lot: – It is the minimum no of shares required to purchase or sell to carry a transaction.


Face value: – It is the price of the stock written in the company’s books when issued during IPO. It is the amount of money that the holder of a debt instrument receives back from the issuer on the debt instrument’s maturity date. Face value is also referred to as par value or principal.


Dividend % – This is the ratio of the dividend given by the company to the face value of the share.


Basic EPS: – This is nothing but Earnings per share.


Diluted EPS: – If all the convertible securities such as convertible preferred shares, convertible debentures, stock options, bonds etc. are converted into outstanding shares then the Earnings per share is called Diluted earnings per share. The less the difference between Basic and diluted EPS the more the company is preferable.


Cash EPS: – This is the ratio of cash generated by the company per diluted outstanding share. If Cash EPS is more the more the company is preferred.

Cash EPS  = Cash flows / no of diluted outstanding shares


PBDIT:  Profit before depreciation, interest, and taxes.


PBIT: – Profit before interest and taxes


PBT: – Profit before taxes


PBDIT margin: – It is the ratio of PBDIT to the revenue.


Net profit margin: – It is the ratio of Net profit to the revenue.


Assets: – Asset is an economic value that a company controls with an expectation that it will provide future benefit.


Liability: It is an obligation that the company has to pay in future due to its past actions like borrowing money in terms of loans for business expansion purpose.

Assets = Liabilities + Shareholders equity


Asset turnover ratio: – It is calculated by dividing revenue to the total assets


Debt to Equity Ratio: The debt-to-equity ratio measures the relationship between the amount of capital that has been borrowed (i.e. debt) and the amount of capital contributed by shareholders (i.e. equity). Generally, as a firm’s debt-to-equity ratio increases, it becomes riskier A lower debt-to-equity number means that a company is using less leverage and has a stronger equity position.

Debt to Equity Ratio =(Total Liabilities)/(Total Shareholder Equity)


Return on Equity (ROE): Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders has invested. In other words, ROE tells you how good a company is at rewarding its shareholders for their investment.

Return on Equity = (Net Income)/(Average Stockholder Equity)


Price to Sales Ratio (P/S): The stock’s price/sales ratio (P/S) ratio measures the price of a company’s stock against its annual sales. P/S ratio is another stock valuation indicator similar to the P/E ratio.

Price to Sales Ratio = (Price per Share)/(Annual Sales Per Share)

The P/S ratio is a great tool because sales figures are considered to be relatively reliable while other income statement items, like earnings, can be easily manipulated by using different accounting rules.


Current Ratio: Current ratio is a key financial ratio for evaluating a company’s liquidity. It measures the proportion of current assets available to cover current liabilities. It is a company’s ability to pay its short-term liabilities with its short-term assets. If the ratio is over 1.0, the firm has more short-term assets than short-term debts. But if the current ratio is less than 1.0, the opposite is true and the company could be vulnerable

Current Ratio = (Current Assets)/(Current Liabilities)


Quick ratio:  The name itself tells quick means how well the company can meet its short-term financial liabilities.  The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.

Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities.


Note: This content is published by a guest author- Anjani Badam.

What is Mutual Fund? Definition, Types, Benefits & More.

A mutual fund is a collective investment that pools together the money of a large number of investors to purchase a number of securities like stocks, bonds etc.

When you purchase a share in the mutual fund, you have a small stake in all investments included in that fund. Hence, by owning a mutual fund, the investor participates in gains or losses of all the companies in the fund. For instance, you can take a mutual fund as a basket of investments. When you purchase a share of that mutual fund, you are buying one share of this basket and hence has an ownership in the all the investments in one such basket.

how mutual funds work

Image source: Corporatefinanceinstitute.com

Major Types of Mutual Funds:

Based on Asset Class

  1. Equity FundsThese funds invest the amassed money from investors in equities i.e. the stocks of different companies. The associated risks for these funds are comparatively higher as they invest in the market. However, they also provide higher returns.
  2. Debt Funds: These funds invest in debt instruments like bonds, securities, fixed income assets, the company’s debentures etc. They provide a safer investment option for investors looking for small regular returns with low risk.
  3. Hybrid Funds: As the name suggests, Hybrid or balanced funds invests in both equity and debt instruments like stocks, bonds etc. This ratio can be variable or fixed depending on the fund. This fund helps to bridge the gap between entirely equity or debt fund and suitable for investors looking to take higher risk than debt funds in order to get bigger rewards.
  4. Money Market Funds: These funds invest in liquid instruments such as bonds, T-bills, certificate of deposits etc. The risks associated with these funds are relatively low and suitable for short-term investments, less than 12 months.

Based on Structure

  1. Open End Funds: The majority of mutual funds in India are open-end funds. These funds are not listed on the stock exchanges are available for subscription through the fund. Hence, the investors have the flexibility to buy and sell these funds at any time at the current asset value price indicated by the mutual fund.
  2. Closed-End Funds:- These funds are listed on the stock exchange. They have a fixed number of outstanding shares and operate for a fixed duration. The fund is open for subscription only during a specified period. These funds also terminate on a specified date. Hence, the investors can redeem their units only on a specified date.

types of mutual funds

(Image Credits: Kotak Securities)

Benefits of Mutual funds:

There are a couple of benefits in investing in a mutual fund.

For example, if there is an investor who wants to invest in stocks but has no time to analyze and create a portfolio. Then he can be benefited from the mutual fund. This investor just has to buy a mutual fund and hence, in a single purchase he gets an investment similar to purchasing the entire portfolio of stocks.

mutual funds trade brains5

The various benefits of investing in a mutual fund are described below:

  • A simple way to make a diversified investment: A mutual fund has a number of securities like stocks, bonds, fixed etc already in its portfolio. Therefore, buying a mutual fund is a simple way to make a diversified investment. Further, diversification also reduces risk which is an added benefit of buying a mutual fund.
  • Managed by a financial professional: The Fund manager or managers actively manage a mutual fund. They try to give the maximum returns to the investors using their professional expertise. Hence, those investors who don’t have time to invest by their own can get benefits from the expertise of these fund managers.
  • Allow investors to participate in a wide variety of investments: This is one of the greatest advantages of buying a mutual fund. There are a variety of mutual funds available to invest in equity fund (Index funds, growth funds, etc.), fixed income funds, income tax saver funds, balanced funds etc. An investor can easily select the best one which suits his strategy.
  • Investors can buy/sell/increase/decrease their mutual funds whenever they want: There is great flexibility to for the investors while investing in mutual funds. They can easily buy, sell, increase or decrease their investment in different funds within seconds. However, please note that it’s suggested to read the mutual fund prospectus carefully before subscribing as some mutual funds have an entry or exit-load.

If you are new to mutual fund investing and want to learn from scratch, I highly recommed you to check out this online course: Investing in Mutual Funds? A Beginner’s Course.

Which mutual fund to buy?

After understanding the benefits of a mutual fund, the next question is which mutual fund to buy? There is a variety of mutual funds available in the market which you can find online. These mutual funds have different ratings & rankings and you can choose a suitable mutual fund according to your goal. Here are the two few sites where you can search online:

Generally, you need to read the prospectus of a mutual fund which gives a wide variety of information about the fund. The fund prospectus has details like fee & charges, minimum investment amount, performance history, risks, and other particulars. Here are the few examples of mutual funds (provided by moneycontrol website):mutual funds trade brains2

Disadvantages of Mutual Funds:

Here are the few disadvantages of buying a mutual fund:

  • Fees and Expenses: There are a couple of possible fees in mutual funds like expense fee, exit fees etc which might reduce the overall returns.
  • No Insurance: There is no guarantee of success in the mutual funds. The mutual fund providing companies always state the following in the declaimer in their advertisements:
  • Mediocre Performance: On an average, a majority of mutual funds are not able to beat the market indices.
  • Loss of Control: The fund managers are responsible for buying and selling of the securities and you have no say in managing the portfolio. You are trusting someone else with your money when you invest in mutual funds.

mutual funds trade brains 1

How to make money by the mutual fund?

There are basically two ways to make money by a mutual fund –

  1. Appreciation: When the mutual fund appreciates i.e. when the fund grows in value. You can sell the mutual fund at the appreciated value and get a good return on your investment.
  2. Dividend Payment: Mutual funds also provide dividends to the investors when they receive the dividend from the companies they own in their portfolio. Please read the prospectus carefully if you are buying a mutual fund for dividend payments.

Also read: Growth vs Dividend Mutual Funds: Which one is better?

So, that’s all for the basics of the mutual fund. In the next post, I will describe how to buy a mutual fund.

In the meantime, if you need any help or have any doubts, feel free to comment below. I will be happy to help you.

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