LOOKING to buy stocks but you are not sure how to select them? Don't fret. We have, here, eight ratios that would make your life easier, and of course, enable you to make the best possible stock selection.

1. Ploughback or Reserves
Every year, the company divides its net profit (profits in hand after subtracting various expenses including taxes) in two portions: ploughback and dividends.

While dividends are handed out to the shareholders, ploughback is kept by the company for its future use and is included in its reserves. Ploughback is essential because, besides boosting the company’s reserves, it is a source of funds for the company’s expansion plans. Hence, if you are looking for a company with good growth prospects, check its ploughback figures. Reserves are also known as shareholders’ funds, since they belong to the shareholders. If a company’s reserves are twice its equity capital, the company can reward its shareholders with a generous bonus. Also any increase in reserves will push the share price of your share.

2. Book value per share
This ratio shows the worth of each share of a company as per the company's accounting books. It is calculated as:
Shareholders' funds
------------------------------------------------ = Book Value per share
Total quantity of equity shares issued

Shareholders' funds can be computed as such:
Total assets (equity capital to the company's reserves) less total liabilities (money owed to creditors).

Book value is an old record that uses the original purchase prices of the assets.

However, it doesn't show the present market price of the company’s assets. As a result, this ratio has a restricted use when it comes to estimating the market price of the shares, but can give you an estimate of the minimum price of the company’s shares. It will also help you judge if the share price is overpriced or under-priced.

Also read: 4 golden rules of equity investing

3. Earnings per share (EPS)
One of the most popular investment ratios, it can be computed as:
Profit Post Tax
------------------------------------------------ = EPS
Total quantity of equity shares issued

This ratio computes the company's earnings on a per share basis. Say, you own 100 shares of ABC Co., each having a face value of Rs 10. Assume the earnings per share is Rs 10 and the dividend declared is 30 per cent, or Rs 3 per share. This implies that on every share of ABC Co., you earn Rs 6 each year, but you actually get Rs 3 via dividend. The balance of Rs 4 per share goes into the ploughback (retained earnings). Had you purchased these shares at par, it implies a return of 60 per cent.

This example shows that instead of looking at the dividends received from to company as the base of investment returns, always look at earnings per share, as it is the actual indicator of the returns earned by your shares.

4. Price Earnings Ratio (P/E)
This ratio highlights the connection between the market price of a share and its EPS.
Price of the share
------------------------ = P/E
Earnings per share

It shows the degree to which earnings of a share are protected by its price. Say, the P/E is 40, it means the share price is 40 times its earnings. So if the company's EPS is constant, it will need about 40 years to make up for the purchase price of the share, after taking into account the dividends and the capital appreciation. Hence, low P/E means you will recover your money quickly.

P/E ratio shows what the market thinks about the earnings potential and future business forecast of a company. Companies with high P/E ratios are the darlings of the investors and thus enjoy a higher market rating. In order to use the P/E ratio properly, take into account the future earnings and growth projections of the company. If the current P/E ratio is low, as against the future prospects of a company, then the shares make an attractive investment option. But if the company is saddled with losses and falling sales, stay away from it, despite the low P/E ratio.

Also read: Tips to invest in equity

4 more tips on page 2

Illustration: Vipurva Parekh




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