Learn · Chapter 02 of 09
Ratio analysis
Ratios compress statements into comparable numbers — but every ratio has blind spots. This chapter covers the six ratios Indian investors actually use, the ranges that are normal here, and why a cheap P/E is often cheap for a reason.
Start here · 4 lessons · 13 min read
Key takeaways
- No ratio works alone — price ratios need return ratios, return ratios need leverage context.
- Compare within sectors and against history, never against fixed global rules.
- A low P/E is a question ('why is it cheap?'), not an answer.
Lesson 1
Price ratios: P/E and P/B
- P/E = price per rupee of earnings. Compare only within sectors — a 15 P/E bank and a 15 P/E FMCG stock mean different things.
- Nifty 50's long-run P/E band (~17–24) gives context: index-level cheapness and expensiveness are relative to history.
- P/B suits asset-heavy businesses (banks, NBFCs); it misleads for asset-light compounders whose book value understates worth.
Lesson 2
Return ratios: ROE and ROCE
- ROE = profit per rupee of shareholder money; ROCE = profit per rupee of all capital employed. ROCE is harder to game with leverage.
- Consistent 15%+ ROCE over 5–10 years marks a quality business in India; sub-10% needs growth or cheapness to compensate.
- Rising ROE driven by rising debt (not margins or turnover) is financial engineering, not improvement.
Lesson 3
Leverage and coverage: D/E and interest cover
- Debt/equity under ~0.5 is comfortable for most non-financial businesses; above 1 demands stable cash flows.
- Interest coverage (EBIT ÷ interest) below 2–3x means profits barely service debt — one bad year from stress.
- For banks and NBFCs, ignore D/E entirely — leverage is their raw material; use capital adequacy and NPAs instead.
Lesson 4
Margins and turnover
- Operating margin stability over 5 years signals pricing power; wild swings signal commodity exposure or competition.
- Asset turnover (sales ÷ assets) separates efficient operators from capital-guzzlers at the same margin.
- Compare margins to sector peers, not absolutes — a 10% margin is superb in retail, weak in software.
Mistakes that cost money
- Screening purely on low P/E and buying value traps with falling ROCE.
- Applying D/E screens to banks and NBFCs.
- Paying 60x earnings for growth without checking whether growth is funded by debt or dilution.
Chapter FAQ
What is a good P/E for Indian stocks?
There is no universal good number. Mature large-caps often trade 15–25x, quality compounders 30–60x, cyclicals under 12x at mid-cycle. Always compare to the company's own 5-year range and sector peers.
ROE vs ROCE — which should I track?
ROCE first: it includes debt, so leverage can't flatter it. Use ROE alongside to see how much of shareholder return comes from borrowing.
Do ratios work for loss-making companies?
Poorly — P/E is meaningless without earnings. For turnaround or growth-stage firms, use price-to-sales, cash burn runway and path-to-profitability milestones instead.
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